Call to Order and Roll Call
The fifth meeting of the Interim Joint Committee on State Government was held on Wednesday, November 19, 2014, at 1:00 PM, in Room 154 of the Capitol Annex. Representative Brent Yonts, Chair, called the meeting to order, and the secretary called the roll.
Present were:
Members: Senator Joe Bowen, Co-Chair; Representative Brent Yonts, Co-Chair; Senators Ernie Harris, Stan Humphries, Christian McDaniel, Morgan McGarvey, Gerald Neal, R. J. Palmer II, Albert Robinson, and Reginald Thomas; Representatives Johnny Bell, Kevin Bratcher, Dwight Butler, John Carney, Larry Clark, Leslie Combs, Will Coursey, Derrick Graham, Mike Harmon, Kenny Imes, James Kay, Jimmie Lee, Mary Lou Marzian, Brad Montell, Sannie Overly, Tanya Pullin, Jody Richards, Tom Riner, Steven Rudy, Sal Santoro, Kevin Sinnette, Diane St. Onge, Tommy Turner, Ken Upchurch, and Jim Wayne.
Guests: House Speaker Representative Greg Stumbo; Beau Barnes, Kentucky Teachers’ Retirement System; Stephanie Winkler, Kentucky Education Association; Brent McKim, Jefferson County Teachers’ Association.
LRC Staff: Judy Fritz, Alisha Miller, Karen Powell, Brad Gross, Kevin Devlin, Terrance Sullivan, and Peggy Sciantarelli.
Recognitions
The committee recognized and applauded the following members who are leaving the General Assembly in January: Senator Palmer and Representatives Butler, Lee, and Stacy. Senator Bowen, Representative Marzian, and Representative Kay recognized constituents in the audience. Representative Marzian recognized Linda Belcher, former state representative and representative-elect in House District 49. Representative Montell recognized James Allen Tipton, representative-elect in House District 53. Representative Graham recognized members of Capital City Retired Teachers.
Approval of Minutes
The minutes of the October 22 meeting were approved without objection, upon motion by Senator Bowen.
Kentucky Teachers’ Retirement System Bonding Proposal
Beau Barnes, Deputy Executive General Counsel and Secretary of Operations, Kentucky Teachers’ Retirement System (KTRS), discussed a proposed financing plan for the KTRS pension fund. He thanked the General Assembly for passage of House Bill 540 (2010 RS). The financial strategy offered by that legislation included issuance of a series of three bonds totaling almost $900 million. As a result, KTRS retiree medical insurance is now on an actuarially sound basis, after transitioning from a pay-as-you-go benefit to a prefunded benefit. As of June 30, 2013, the medical insurance fund reached a funding ratio of 11.7 percent and continues to grow.
KTRS has over 141,000 members and distributes approximately $144 million in benefits each month to over 49,500 retired members. Assets exceed $18.5 billion. One in four teachers are eligible to retire. As of June 30, 2013, the pension fund was 51.9 percent funded. In June 2008, it was 68.2 percent funded.
KTRS has a nine member board of trustees. The outside investment consultants are nationally recognized. Based on one-year return as of June 30, 2013, the pension fund ranked eighth among the ten top-performing public pension funds. One-year return for the 2014 fiscal year was 18.1 percent, two percent higher than the average return of other public pension plans. The 20-year return was 8.2 percent, exceeding the 7.5 percent assumed rate of return. According to a September 2012 report by the LRC Program Review and Investigations Committee, KTRS average investment and administrative expenses are among the lowest in the nation. KTRS does not do business with money managers who use placement agents. Investment return pays for approximately 70 percent of retirement benefits. In FY 2014, KTRS paid $1.968 billion in retirement benefits. These benefits provide an economic stimulus within the state, since 92 percent of retirees live in Kentucky.
The fixed employer contribution of 13.105 percent was sufficient in past years. However, with the flat 13-year market (2000-June 2013) and the 2008 Great Recession, additional funding has been needed since the 2006-2008 biennium. The KTRS board is looking at possible benefit changes for new hires, but any changes would not address the existing unfunded liability, which was $13.9 billion as of June 30, 2013.
Future investment return is expected to be close to the long-term assumed rate of 7.5 percent. The 18.1 percent return for FY 2014 was helpful, but additional funding will be required in order to stabilize the pension fund. KTRS has been asked to develop a short-term funding plan. One option is to re-purpose monies already budgeted to KTRS by issuing a bond to refinance a portion of the pension unfunded liability, which is growing by 7.5 percent yearly. A bond could be issued at a rate substantially lower than 7.5 percent, since interest rates are at an historical low. This plan would allow time for the economy to improve, revenue to grow, and for the commonwealth to develop a long-term funding plan. Bonding would pay the full actuarially required contribution (ARC) for several years, improve the funded ratio, and reduce the amount of funding needed in future years.
Mr. Barnes reviewed financial details of the bonds issued in 2010, 2011, and 2013 to fund medical insurance; KTRS funding in the 2014-2016 budget; and the proposed $1.9 billion and $3.3 billion bonding plans.
New Governmental Accounting Standards Board (GASB) rules will require underfunded pension plans to report unfunded liability using a lower assumed rate of return, thus reducing the funded percentage. Under the new GASB rules, the KTRS assumed rate of return would be about five percent instead of the current 7.5 percent. Funded status of the pension fund would be reduced from 51.9 percent to 42.4 percent.
Teachers’ pension benefit is guaranteed by an inviolable contract. KTRS is not enthusiastic about bonding, but it successfully addressed the medical insurance underfunding. The current interest rate environment is optimal. The proposed bond issue would not create new debt but would refinance existing debt at a lower interest rate. KTRS investment consultants do not foresee a repeat of the 2008 Great Recession. KTRS has been experiencing negative cash flow since 2008 and will have to sell approximately $1.3 billion in assets in FY 2014-2016. Investment strategy is becoming increasingly constrained by liquidity requirements. These constraints will lower future investment returns. Additional funding will help stabilize this deteriorating situation while a long-term solution is considered.
Stephanie Winkler, a Madison County teacher now serving as President of the Kentucky Education Association, testified in support of the bonding proposal. She said the financial health of KTRS is a matter of grave concern. Teachers contribute 9.105 percent of gross salary to the KTRS pension fund. According to the state Department of Education, the average teacher salary in 2013-2014 was $51,000, with a pension contribution of about $4,644. Health insurance for retired teachers is not guaranteed, while most other public employees’ health insurance in retirement is guaranteed by an inviolable contract. Under the “shared responsibility” plan enacted in the 2010 regular session, by July 1, 2015, every active teacher in the state will be contributing another three percent of gross income to prefund retiree health care, in addition to the .75 percent they already contribute. At that time the average annual teacher contribution to KTRS will total more than $6,556.
Unlike other public and private employees, teachers cannot draw social security benefits and are wholly dependent on KTRS benefits when they retire. Teachers deserve and are willing to protect the defined benefit structure of KTRS. The financial health of KTRS impacts all Kentuckians. The commonwealth has repaid all money borrowed from the KTRS pension fund in order to fund retiree health insurance. Teachers applaud the legislature’s commitment to meet its statutory obligations to the fund. The trustees and administration at KTRS take their fiduciary duties seriously and have made good investment decisions that generated healthy returns. There is no one person or entity to blame for the funding shortfall. KEA supports the bonding plan proposed by KTRS. It will leverage money already appropriated to the pension fund to help address the unfunded liability in the short term, while a more permanent solution is sought for the long term.
Brent McKim, President of the Jefferson County Teachers Association (JCTA), spoke in support of the bonding plan, if framed as part of a long-term solution. JCTA has worked with KTRS to consider available options, and bonding was identified as the best option. It will re-purpose existing budgeted funds and lower the interest rate on the debt. It is equally important to have a long-term plan to fully fund the system. Otherwise, the unfunded liability will increase significantly under the new GASB rules, and the state’s bond rating will be adversely affected.
House Speaker Representative Greg Stumbo testified in support of the proposal. He said that when bonding was suggested several years ago by then Senate President Williams, it was met with skepticism. That was fortunate from the standpoint of timing. States that sold pension obligation bonds during that period are losing money because of adjustments in the market. From a policy perspective, though, it was probably a mistake not to explore bonding. After discussion and research, including studies by Boston College and others, he is convinced the KTRS proposal is fundamentally sound and has great merit if interest rates continue to be favorable. The proposal is also time-specific. Market rates will likely not be favorable much longer. He urged that both parties in the General Assembly consider the plan and work with KTRS to craft a proposal that can be supported by both chambers. Otherwise, the window of opportunity could be lost. He agreed with the other speakers on the need for a long-term plan in order to receive full benefit of the bonding proposal.
In response to Representative Bratcher, Mr. Barnes discussed the role of the board of trustees and significant actions taken by the board. He said retired teachers do not receive social security benefits but have a guaranteed 1.5 percent cost-of-living adjustment (COLA) built into the contribution rate. KTRS does not provide an additional COLA unless it is funded by the General Assembly. Because of tight budgets, additional COLA funding has not been available since the 2006-2008 biennium.
Representative Montell said he is encouraged by the proposal and open to further discussion. Responding to questions from Representative Montell, Mr. Barnes said the proposed bonds are for a 20-year term. KTRS has a ratio of about 58,000 full-time active members to 48,000 retirees/survivors of retirees. In anticipation of the expected baby boomer retirement surge, the board has made changes that encourage members to delay retirement. Average retirement age has increased from 54 to 58. Average years of service upon retirement has increased from 27 to 30.
Representative Wayne said it is important to protect and invest in the commonwealth’s teachers, but he is concerned about the larger fiscal picture. The proposal appears to have merit but should be tied to a permanent financial plan. No money is available even for a long-term stable financial plan under the present revenue structure, and the fiscal situation is not expected to improve. The KTRS unfunded liability is symptomatic of a more serious problem. The revenue system is not growing to meet the commonwealth’s needs, demands, and responsibilities.
Representative Clark said KTRS should consider participating on the Public Pension Oversight Board in order to enhance the system’s transparency and accountability. He also asked Mr. Barnes to provide the committee with debt service percentage figures for both the $1.9 billion and $3.3 billion bond proposals.
Representative Kay spoke in support of the bonding as a way to refinance debt and invest in a quality education system. He encouraged all active and retired teachers to contact their elected officials and community leaders to educate them on the importance of the KTRS proposal.
Representative Marzian said the proposed bonding is a viable solution. She urged the legislature to act soon on the proposal while interest rates are still favorable.
Representative Graham expressed support for the proposal and asked about the sale of $1.3 billion in assets in FY 2014-2016. Mr. Barnes said the sale of assets is intended to address liquidity issues relating to payroll for active employees.
Responding to questions from Senator Thomas, Mr. Barnes said the larger bond of $3.3 billion would improve the funded ratio to 63 percent. It is KTRS policy to strive for 100 percent funding. When fully funded, the system would be in a better position to withstand any future economic decline.
Subcommittee Report
Senator Bowen, Co-Chair of the Task Force on Elections, Constitutional Amendments and Intergovernmental Affairs, reported on the October 28 meeting. A motion to adopt the report was seconded and passed without objection.
There being no further business, the meeting was adjourned at 2:37 p.m.