MINUTES OF THE meeting
of the
ASSEMBLY Committee on Government Affairs
Seventy-Second Session
February 7, 2003
The Committee on Government Affairswas called to order at 8:32 a.m., on Friday, February 7, 2003. Chairman Mark Manendo presided in Room 3143 of the Legislative Building, Carson City, Nevada. Exhibit A is the Agenda. Exhibit B is the Guest List. All exhibits are available and on file at the Research Library of the Legislative Counsel Bureau.
COMMITTEE MEMBERS PRESENT:
Mr. Mark Manendo, Chairman
Mr. Wendell P. Williams, Vice Chairman
Mr. Kelvin Atkinson
Mr. Chad Christensen
Mr. Pete Goicoechea
Mr. Tom Grady
Mr. Joe Hardy
Mr. Ron Knecht
Ms. Ellen Koivisto
Mr. Bob McCleary
Ms. Peggy Pierce
Ms. Valerie Weber
COMMITTEE MEMBERS EXCUSED:
Mr. Tom Collins
GUEST LEGISLATORS PRESENT:
None
STAFF MEMBERS PRESENT:
Susan Scholley, Committee Policy Analyst
Eileen O'Grady, Committee Counsel
JoAnn Aldrich, Committee Secretary
OTHERS PRESENT:
George Pyne, Executive Officer, Public Employees’ Retirement System of Nevada
Dana Bilyeu, Operations Officer, Public Employees’ Retirement System of Nevada
Laura B. Wallace, Investment Officer, Public Employees’ Retirement System of Nevada
Brian K. Krolicki, State Treasurer, State of Nevada
Chairman Mark Manendo introduced Mr. George Pyne, Executive Officer, Public Employees’ Retirement System (PERS), who presented an overview of Nevada’s retirement system.
Mr. Pyne submitted copies of his testimony (Exhibit C) and of a PowerPoint presentation titled “Public Employees’ Retirement System, 1947-2003” (Exhibit D). He introduced Dana Bilyeu, PERS’ Operations Officer, and Laura B. Wallace, PERS’ Investment Officer.
Mr. Pyne stated that PERS’ current assets were approximately $13 billion, with 85,000 public employees actively participating, and about 25,000 benefit recipients who received close to $50 million in benefit payments each month. He estimated there were 150 public employers in the system, which included counties, cities, school districts, and small public employers.
The PERS’ topics Mr. Pyne covered in his presentation were: Purpose, Mission, History, Administrative Structure, Legal Considerations, Plan Design, Funding, Legislators’ Retirement System, Judicial Retirement System, Legislative Program 2003, and Investment Program. Page numbers refer to the “Public Employees’ Retirement System, 1947-2003” report (Exhibit D).
Mr. Pyne stated that the purpose of PERS is to provide a reasonable base income to public employees whose earning capacity has been reduced because of age or disability. He added that PERS’ mission is further defined as providing a system which will make government employment attractive to qualified employees, and encourage them to remain in government service to give the public employer and the public the full benefit of their training and experience, as stated on page 3 (Exhibit D).
Ms. Bilyeu, PERS’ Operations Officer, reviewed the next four topics, beginning with a brief history of the Nevada retirement system, as shown on page 4 (Exhibit D). PERS was established in 1947, because public workers were not allowed to participate in the Social Security system. In those years, the approach to retirement was “very piecemeal.” Some employers had retirement programs and some did not. These programs were consolidated into the current PERS. In 1967, the Legislators’ Retirement System was created and, in 1977, the Nevada Legislature created the Police and Firemen’s Retirement Fund to allow an early retirement option for public safety employees. The Judicial Retirement System was created in 2001 and was administered and funded in the same way as the PERS.
Ms. Bilyeu stated that in 1971, the Nevada Legislature recognized that the benefit structure created in 1947 was a good one, but the actual funding of the retirement system had not kept up with the benefit structure. The funding issue was a high priority because the PERS was less than 50 percent funded at the time. In response to these concerns, the Legislative Study Committee commissioned a study to suggest recommendations to the next Legislature. The 2-volume Final Report to the State of Nevada Public Employees’ Retirement System Legislative Study Committee by Harris, Kerr, and Forster & Company was published in September 1972.
Over the next four years legislators made changes to the PERS. They implemented a payment schedule to bring the PERS fund to full actuarial funding status by 2024. They amended the Constitution of the State of Nevada to create a separate PERS trust fund, and granted the PERS independence from all public employers, including the state. Legislators sought to prevent the state from exerting more influence than other employers over the plan because PERS was equally responsible to all public employers. However, the Nevada Legislature retained budget approval authority and oversight over the PERS.
Ms. Bilyeu explained that the PERS administrative structure is essentially corporate with a “slight public twist.” The Governor appointed 7 members to the Board of Trustees, which was representative of employees, employers, and retirees of the system. The Executive Officer, Operations Officer, and Investment Officer directed the daily business of the agency, as indicated on page 5 (Exhibit D). She stated that PERS administered a disability program and a survivor benefit program, in addition to the retirement and benefit programs.
Ms. Bilyeu described the PERS as a trust fund authorized by the Nevada Constitution and by state statute, chapter 286, of the Nevada Revised Statutes (NRS). Article 9, Section 2, of the Nevada Constitution stated that monies paid for the purpose of funding and administering the PERS must be segregated and never used for any other purpose, as shown on page 6 (Exhibit D). She explained that in 1996, constitutional protections were expanded to protect the PERS from potential raids. Those protections included requirements that:
· The pension system would be run by the retirement board.
· The retirement board would be the hiring authority for the executive officer.
· The retirement system would employ an independent actuary.
· The Board of Trustees would adopt actuarial assumptions based upon the recommendations of the independent actuary it employed.
· PERS would be prohibited from investing in obligations of the state and from loaning money to the state.
Ms. Bilyeu stated that PERS’ benefits were protected by the United States Constitution and the Nevada Constitution. The guaranteed vesting right, as outlined in the Nevada Constitution, mandated that benefits could be changed but could not be diminished from the first day of employment.
By state statute, NRS Chapter 286, all PERS plan documents, statutes, and policies complied with provisions of the Internal Revenue Code. Ms. Bilyeu pointed out that these provisions were necessary to ensure that the fund operated on a tax-deferred basis.
Ms. Bilyeu said that the PERS had been classified by the Internal Revenue Service (IRS) as a 401A defined-benefit plan, and that plan benefits were based on formulas shown on page 7 (Exhibit D). She described the three components of the defined-benefit program:
· Age and years of service credit
· A service-time multiplier, currently 2.67 percent of pay
· Compensation based on the average of the highest consecutive 36 months’ pay
In order to receive benefits, members of the PERS must have had at least 5 years of service. Most members retire with about 20 years of service.
Mr. Pyne presented an overview of the PERS funding dynamics shown on page 8 (Exhibit D). Monies for PERS’ benefit payments came from two sources: contributions by employees and employers, and investment returns. He noted that up to 80 percent of the benefits employees received during retirement would come from investment returns, as opposed only 20 percent from contributions. He said that this illustrated just how important investment was to financing future benefits.
Mr. Pyne defined the “actuarial reserve basis” of the PERS as the process where contributions are set aside and invested today to pay for expected future benefits. That was different than the Social Security system, where benefits were funded on a pay-as-you-go basis, which meant that active worker contributions would be paying for retiree benefits. In that type of system, a funding problem would arise if the ratio of active workers to retirees diminished. Retirement systems funded on an actuarial reserve basis, such as the Nevada PERS which secured early funding in order to utilize the power of compounding to finance future benefits, and created a solid foundation for ensuring the financial health of the retirement system.
Mr. Pyne reported that the PERS was 82 percent funded, indicating that the PERS had 82 cents on hand for each dollar of liability. Although the PERS Board had not yet attained their goal of full funding, a payoff schedule had been implemented to pay off the unfunded liability over a 40-year period, beginning in 1984. Mr. Pyne expected the PERS would meet that goal and achieve full funding by 2024. Page 9 (Exhibit D) charts the actual progress of PERS funding status from 1984 to 2002.
Mr. Pyne described the two different contribution plans. Under the employer/employee joint contribution plan, the employer and a regular member would both pay an after-tax contribution of 9.75 percent today. An employer and a member of the Police and Firemen’s Retirement Fund would both pay an after-tax contribution of 14.75 percent. To date, about 20 percent of PERS’ membership was enrolled in the employer/employee joint contribution plan.
Mr. Pyne said that 80 percent of the PERS members were enrolled in the Employer Pay Contribution (EPC) retirement plan. The EPC plan was passed by the Nevada Legislature in 1975 and provided a cost savings to public employers and increased take-home pay for public employees. In the EPC plan, the public employer and the employee shared in the cost of retirement, which was financed by either the employee taking a reduction in pay, or forgoing a pay raise equal to half of the total contribution. For example, Mr. Pyne reported that in 1975 when this program began, the EPC rate was 15 percent. Under that plan, employees’ pay was reduced by 7.5 percent, or they gave up 7.5 percent in pay raises when they signed up for the plan.
Mr. Pyne noted that under the EPC plan, because of actuarial losses from investments, a rate increase was scheduled for July 2003. He explained that, by law, statutory rates of contribution had to change if the difference between the rate determined in the latest actuarial valuation and the statutory rate was greater than 0.5 percent. Pages 10 and 11 (Exhibit D) illustrated how the rate increases were calculated.
Mr. Pyne then moved to 12 (Exhibit D), which charted past growth and projected future growth in terms of active members, benefit recipients, and the ratio between those two groups. The ratios of members to benefit recipients demonstrated the importance of continuing to fund PERS’ benefits on an actuarial reserve basis.
Mr. Pyne discussed on page 14 (Exhibit D) the benefits of the Legislators’ Retirement System (LRS), which included survivor benefits, but no disability benefits. That program was, like the PERS, a defined-benefit plan, which based benefits on a formula tied to age and years of service at retirement. He noted that the cost-of-living increases were similar to those in the PERS. To date, the LRS was 72 percent funded with full funding expected in 2024.
Mr. Pyne said that the new Judicial Retirement System was established in 2001, and that it was presently 21 percent funded, with full funding expected in 2037.
Mr. Pyne next spoke about the legislative program for 2003. A.B. 431 of the 71st Session directed the PERS Board of Trustees to conducted an Interim Study on Lump-Sum Optional Retirement Plans, including an analysis of Deferred Retirement Option Plans (DROP). Instead of receiving a monthly annuity at retirement, those programs would offer employees the option of receiving a reduced annuity with a lump-sum payment up front.
The purpose of the study was to determine whether those programs would be beneficial to PERS’ members and to public employers. After analysis and deliberation, the PERS’ Board of Trustees voted to submit the study to the Legislative Commission without recommendation. Hence, PERS’ officers had not drafted legislation that would offer those types of programs.
The main reasons the study was submitted “without recommendation” was that the PERS Board of Trustees had several concerns regarding the cost of lump‑sum option programs, such as reduction of retirement income and replacement ratios for retirees, and that some public employees might be considered “winners,” but other would be “losers.” Furthermore, as the study progressed, Board members disagreed over the best program for public employers.
Mr. Pyne presented a summary of BDR 23-563, the PERS technical or “housekeeping” bill. BDR 23-563 made several definition and clarification changes to the Public Employees’ Retirement Act and to the judicial retirement. Mr. Pyne suggested that two areas might be of interest to legislators:
1) Restrictions on rehiring PERS’ retirees who desired to return to work in areas of critical labor shortage had been relaxed. BDR 23-563 recommended that the rehire period be limited to two years. After the two-year period expired, the employer would need to document once again that the critical nature of that position continued, before the retiree would be allowed to continue in the position.
2) BDR 23-563 proposed a provision for multiple payees under the single-survivor beneficiary designation. The intent was to provide unmarried members with a survivor benefit for an individual of their choice, in event of their death prior to retirement.
In conclusion, Mr. Pyne noted that the PERS Board had not proposed any fiscal legislation this session.
Mr. Pyne turned the presentation over to Laura B. Wallace, PERS’ Investment Officer, who outlined the PERS Investment Program. Ms. Wallace said she would address the funding aspects, portfolio strategies, and investment performance of the Investment Program. The goal of the program, as shown on page 16 (Exhibit D), was to generate an investment return that would be sufficient to fund the pension plan over the long term and would do so with a minimum amount of risk.
Pie charts on page 17 (Exhibit D) clarified the risk control aspect of three portfolios: the PERS Fund, the Legislators’ Retirement Fund, and the Judicial Retirement Fund. Ms. Wallace said that the PERS followed a very conservative asset allocation strategy to minimize stock exposure, the standard barometer of market risk. The PERS Board’s allocation policy of holding a maximum of 45 percent in stocks was significantly more cautious than the asset mix at other large public pension funds and large institutions.
Ms. Wallace said that the Legislators’ Retirement Fund and Judicial Retirement Fund strategies were different because of their smaller size.
Page 18 (Exhibit D) charted the 20-year performance history of the PERS Fund. Ms. Wallace pointed out that the graphs on pages 18 and 19 (Exhibit D) for the other two funds, dramatized the cyclical nature of the markets in which they invested. In spite of the market cycles, the PERS’ conservative investment strategy captured their stated objective of generating an overall 8 percent actuarial return.
All three portfolios were carefully managed for risk, as indicated on page 21 (Exhibit D). The Judicial Retirement Fund’s performance shown on page 20 (Exhibit D) was a short-term perspective because PERS took control of the portfolio in 2001 in a very negative investment environment. In spite of negative returns, all investment managers carefully estimated return potential and risks into the future. Those policies were applied regularly, formally, and systematically to all three funds, in order to ensure that PERS’ investments are never overly aggressive. Ms. Wallace projected that the Judicial Retirement Plan had a reasonable probability of generating the same 8 percent return as the other two funds, because risk and return potential were weighed and balanced in every investment transaction.
Ms. Wallace stressed that asset allocation strategy, the most important of PERS’ policies, would be the greatest determinate of success and wealth over time. To protect against losses, a portfolio diversification strategy was carefully managed at the security level, at the management level, at the allocation level, and at every other level. Everyone in the investment business accepted that there would be losses over time. The strategies just described had proven to be the best kind of damage control for that eventuality.
Finally, Ms. Wallace addressed the compliance monitoring aspect of the PERS investment program. She said that Nevada, more than any other state, has gone to a great deal of work to monitor and understand changes in the portfolios. When a portfolio failed to meet PERS’ quality standards, warning signals prompted specific re-evaluation procedures. Procedures were in place to monitor circumstances that might change an investment’s risk outlook. If a situation caused a quality investment to decline significantly, that investment would be removed from the portfolio.
Ms. Wallace concluded her presentation and asked if there were questions.
Assemblywoman Weber asked whether the asset allocations had changed, and if the mix of stocks, bonds, and investment categories on page 17 (Exhibit D) was flexible, and who determined the proportions of the mix.
Ms. Wallace responded that the current procedure was that administrators made recommendations to the PERS Board of Trustees regarding proposed changes to the asset mix. Prior to 1983, the asset mix strategy had been set by individual investment managers. In 1983, they recommended that the Board make those decisions because it was the single most important investment decision. At the same time, the Board implemented an in-depth annual review of this policy. However, the asset allocation mix had been a very stable policy. For example, since 1983, the percentage allocated to stocks had only changed from 40 percent to 45 percent. The PERS investment policy was not to make adjustments anticipating market events.
Assemblywoman Koivisto said that her intention was to get some information on the record. She had heard that many legislators were receiving calls from non-state PERS’ retirees about the extreme rise in the cost of benefits. Mrs. Koivisto asked whether the PERS officers could clarify the relationship, if any, between the PERS and the Public Employees Benefit Program (PEBP).
Ms. Bilyeu replied that there were about 25,000 retirees in the PERS, and insurance coverage was provided by the employers. She said that the Public Employees Benefit Program (PEBP) administered the state’s program and an adjunct program, with which she was not very familiar. She described PERS as “really just a pay center.” PEBP set the rates, told us what the rates were, listed the participating members, and PERS deducted the premiums out of their paychecks.
Assemblyman Christensen asked about the IRS classification of PERS. Ms. Bilyeu responded that PERS was classified by the IRS as a 401A defined-benefit program.
Assemblyman Christensen also requested a brief description of what costs were covered by the “75 basis points,” shown on page 10 (Exhibit D), that were currently paid by both employer and employee.
Mr. Pyne answered that contribution rates were scheduled to increase by 1.5 percent, effective July 1, 2003, and those costs would be shared equally by employers and employees, resulting in a 0.75 percent contribution increase for each group.
Assemblyman Christensen asked for business cards from each of the presenters, and asked if they would be willing to assist him in answering constituents’ questions. Mr. Pyne replied affirmatively on behalf of all three officials.
Assemblywoman Pierce asked for a recap and explanation of page 10 (Exhibit D) of the presentation. Mr. Pyne replied that it was an example of the EPC plan, in which 80 percent of PERS’ membership was enrolled. Page 10 (Exhibit D) showed that the rate of payroll contribution that the employer currently submitted into the plan for regular members was 18.75 percent of payroll. The contribution rate for members of the Police and Firemen’s Retirement Fund was 28.5 percent of payroll. The actuarial rates were listed below the current rates.
Mr. Pyne added that, in June of each year, the PERS’ actuary calculated the actuarial rates in order to determine what rates were necessary to fully fund the PERS by 2024. Rate increases were based on the difference between existing contribution rates and the recalculated actuarial rates. By statute, rate increases had to be shared equally between employer and employee. Rates were higher for police/fire contributions because they retired earlier than regular members, and those rates were capped at the existing rate of 28.5 percent of payroll.
Assemblywoman Pierce asked if it was correct to say that page 10 (Exhibit D) reflected the retirement plan containing 80 percent of PERS’ members, and page 11 (Exhibit D) reflected the plan containing about 20 percent of PERS’ members. Mr. Pyne concurred.
Assemblyman Goicoechea asked Mr. Pyne if it was correct to say that the actual shortfall in the PERS fund today would be in excess of $2 billion. Mr. Pyne responded that the unfunded liability of the pension plan was around $3 billion.
Assemblyman Knecht asked if new plan members as well as currently employed members could switch plans, as long as the new benefit plan would not reduce benefits.
Ms. Bilyeu replied that the benefit structure had been subject to much litigation over the years. Challenges to the law caused it to evolve into the current version, which prevented choices that diminish benefits. Changing to a different benefit plan was allowed, but the new benefit plan would have to be a plan of equal or greater value. The courts would hold such choices to a very high standard. Current employees were not typically allowed to switch plans, and the courts discouraged it, but new employees were allowed those choices.
Assemblyman Knecht pointed out on pages 18 and 19 (Exhibit D) that the 8 percent actuarial objective had exceeded expectations by garnering an average of 10.6 percent for regular employees and 9.4 percent for legislative participants. He said he remembered investment returns on equities as high as 7.8 percent, although they had been dropping the last three years because of the down market. He observed that given a 7 percent real return, plus 2 percent or more as a hedge against inflation, he would have aimed for a 9 percent long-term sustained market return. Mr. Knecht wanted to know how the PERS Board had arrived at an 8 percent investment return target, and how they justified that target compared to available returns in the market.
Ms. Wallace stated that the expectations and weighting of each asset class caused the PERS Board to believe that an 8 percent return was reasonable. She prefaced her next statement by stating that she would address total returns, as opposed to inflation-adjusted or real returns, “just to keep the discussion simple.” In terms of total investment return, the PERS Board of Trustees had long-term expectations for both equity portfolios of 9.75 percent. The expected return for real estate was between 8 and 9 percent. When expected returns for all five asset classes were combined, the average expected return came to slightly above 8 percent. This 8 percent target also covered the cost of administering the PERS, and it acted as a hedge against the potential inaccuracy of working with estimates.
Assemblyman Knecht sought confirmation of Ms. Wallace’s testimony by asking if she intended to describe the target in terms of a risk/reward trade-off, and, if so, if her conclusion was that PERS’ investment goal was less than the market’s anticipated return because they chose a lower risk level.
Ms. Wallace agreed with Mr. Knecht’s interpretation.
Ms. Wallace clarified that the PERS fund managers could increase the expected return if they would recommend to the Board that the PERS portfolio should take on more risk. The basic way to increase risk in the investment portfolio would be to increase the percentage of stocks to 50 or 60 percent. Many pension funds acquire 60 to 70 percent stocks, but that kind of investment strategy would invite extreme market volatility.
Ms. Wallace informed the Committee that the argument for increasing a portfolio’s stock exposure was that the PERS’ long-term investment horizon would balance any increase in volatility. However, Ms. Wallace projected that that course of action would have a tremendous impact, because investment volatility translated into contribution volatility. PERS made the choice to minimize stock exposure because the PERS Board needed to stabilize contribution rates as much as possible.
Mr. Pyne added that increasing risk by increasing stock exposure translated into contribution volatility because of the benefit formulas they used to set the contribution rates, which were recalculated annually.
Ms. Wallace clarified that increasing risk in the PERS asset allocation mix would result in volatility because the engine that drove the wealth accumulation was in part related to contributions.
Assemblyman Hardy said he had been comparing local government investment fund returns, and that none had been negative for more than three years in a row. Mr. Hardy was interested in comparing PERS’ rate of return with returns of other public investment funds. He also inquired about available technology for tracking market activity on a daily basis, whether investments were laddered to cover benefit payments, and what activities were outsourced, if any.
“In other words,” Assemblyman Knecht summarized, “how do we compare with others; do we use the latest technology; and do we save money by outsourcing.”
Ms. Wallace referred to the comparison of investment returns as “less a science, and more an art.” When PERS’ investment returns were compared to other government fund returns within Nevada, the greatest difference was PERS’ longer investment horizon. Typically, other funds had a shorter investment horizon and some limitations on whether you could use stocks or real estate in the asset mix. To understand relative performance, PERS normally compared the PERS’ fund with other pension funds across the country, because those funds also had long investment horizons. Because of that long investment horizon, the PERS Board was able to take on the risk of owning equities, which had resulted in tremendous positives over many years.
Regarding new technology, Ms. Wallace said that the technology was available, but PERS’ staff was not involved with it on a daily basis. The strategy was so long term in orientation, that the PERS could best achieve their goals by keeping the long-term view at an administrative level. However, PERS’ administrators hired experts in a variety of disciplines who made the buy-and-sell decisions on a daily basis around the world. The PERS administration had monitoring systems to evaluate each expert’s performance in order to determine achievement of the stated objectives and standards.
Ms. Wallace next addressed the two main sources of cash flow, regarding how the PERS generated enough cash flow for benefit payments that totaled about $50 million per month. Part of the money to cover the $50 million monthly cash flow requirement came from monthly deposits from employers and employees in the form of payroll deposits. Another important source for those benefit payments was the income from PERS’ asset mix on the investment side. In Nevada, a healthy cash flow on the contribution side meant that the PERS fund does not have to change its investment strategy for cash flow purposes.
Assemblyman Hardy asked whether Ms. Wallace thought that the PERS might be missing some investment windows and options that could offer higher rates of return if they were not outsourcing or somehow directly monitoring daily and minute-to-minute market trading activities.
Ms. Wallace said that, via the portfolio managers, the PERS Board was in tune with the market on a minute-to-minute basis, although that was not something Ms. Wallace handled personally. The investment return on stocks had a tremendous influence, especially in years when the environment was as negative as it had been over the last three years in the United States. This calendar year the market, as represented by the S&P 500, lost about 20 percent. Long-term investors like the PERS fund managers, whose goal was to maintain a consistent position in the market, were vulnerable to poor investment returns during market downturns. Yet, PERS normally balanced that vulnerability by garnering huge gains when the market cycle surged upwards, often more than 20 percent.
In Ms. Wallace’s professional judgment and experience, it was not possible to consistently and successfully beat the market, in terms of timing in and out of the allocations, without injecting too much risk. Taking that kind of high-risk approach could cause significant damage to the PERS, and it would derail their systematic approach to long-term funding. Ms. Wallace stated that PERS’ primary risk-control strategy was to maintain the current risk exposure. Negative markets of the last few years would affect returns, but not the Board’s long-term strategy.
Ms. Wallace presented evidence that PERS’ investment strategy had generated top performance results. In September 2002, the PERS was rated one of the top 4 or 5 performers out of 85 public funds in the country. When the market was down, PERS had always remained a very strong performer because there was risk control built into the program. She said that even as some returns were negative, the PERS investment managers maintained constant exposures in markets that were periodically negative. Overall, the PERS relative performance had been consistently superior in every way.
Assemblyman Hardy asked if she would agree that the PERS did not have problems similar to the rest of the state, in terms of trying to make up for losses. Ms. Wallace said that, in spite of the negative environment in the world today, all three PERS’ officials were confident and proud of their investment results. She said that they were on track with their goals, with their policies, and with the law.
Assemblyman Atkinson asked the PERS panel if their projection that full repayment of the unfunded liability would be achieved by the year 2024 might change; and, if not, how they would achieve the results shown on pages 8 and 9 (Exhibit D). Mr. Pyne responded that there might not be positive progress on a year-to-year basis, but that they were confident they would reach the goal because contribution rates would continue to adjust and that ensured success. Currently, 3 to 4 percent of the contribution rate was allocated to paying off the unfunded liability. For example, because of the market situation, that portion of the contribution rate would increase effective July 1, 2003, so that the unfunded liability schedule remained on track, which ensured that the PERS would achieve full funding by 2024.
Assemblyman McCleary asked Ms. Wallace whether compensation to investment experts was based on results and productivity and, if not, should it be.
Ms. Wallace explained that in the past there had been some incentive fee arrangements, but that PERS did not use incentives today. The fee structure the PERS adopted many years ago was a tiered, flat schedule, based on the type of assets under management, and it was different for stocks, bonds, and real estate. The PERS administration appreciated that the current fee structure had stabilized costs to the PERS and stabilized revenue to investment management firms, as well. Their experience did not validate the opinion that those firms were working less hard when they were more challenged in terms of investment performance than when times were good. She said that the PERS Board handled performance issues by firing firms if they did not meet the specified standards.
Chairman Manendo thanked the PERS’ panel for their testimony and introduced Mr. Brian Krolicki, State Treasurer, State of Nevada.
Mr. Krolicki described the organizational structure and basic operational responsibilities that included: Administration, Cash Management, Debt Management, Investments, Unclaimed Property, and Educational Programs. He referred the Committee to the Office of the State Treasurer organization chart that included both the Carson City and Las Vegas offices, on page 3 of his PowerPoint presentation (Exhibit E).
Mr. Krolicki then described the additional responsibilities he enjoyed, which included serving as an ex-officio member on the State Board of Finance. The Governor was Chairman of the State Board of Finance, the State Controller was a member, and two members were appointed by the Governor, one a “CPA type,” and one who had been active in commercial banking activities in Nevada.
In addition, Mr. Krolicki stated that the State Treasurer acted as an ex-officio State Disbursing Officer for the United States Government as described in NRS 226.180, was the Chairman of the Board of Trustees for the College Savings Plans of Nevada, and served as a member of the Executive Branch Audit Committee. However, Mr. Krolicki clarified that that committee did not have the authority to audit the Legislative Branch.
Mr. Krolicki said that the State Treasurer handled a tremendous cash flow that amounted to over $25 billion per year. To give the Committee some idea of the volume, he estimated that they processed close to 7,000 deposits totaling almost a quarter million dollars on a monthly basis, which included over 230,000 checks and thousands of wires and Automatic Clearing House (ACH) payments per month, as shown on page 5 (Exhibit E). Careful handling of the cash flow was important because incremental earnings on billions of dollars added up to a lot of money.
Mr. Krolicki was responsible for the state’s balance sheet, both liabilities and assets. The Treasurer’s Office actively managed all existing debt, which added up to a $2 billion to $3 billion portfolio. When Mr. Krolicki tried to balance the budget last fiscal year, what legislators witnessed was an attempt to find new ways to manage the debt side of the state’s balance sheet. The Treasurer’s Office generated two different arrangements that produced over $30 million cash that was deposited directly into the State General Fund.
Assemblyman Knecht congratulated Mr. Krolicki on his success in managing the debt, and he asked for a brief explanation and a tangible example of how this was accomplished.
Mr. Krolicki said that refinancing the debt was the State Treasurer’s responsibility. As an example, the $30 million dollars resulted from a combination of “things that were outside the box.” In fact, Nevada was the first state to pursue the “forward purchase debt service agreement” that generated $20 million. However, while the Treasurer’s Office managed the $2.3 billon debt, the state continuously received revenue and payments. He said that the time value of money meant, for example, that if the Treasurer’s Office received a property tax payment today, debt service might not be necessary for 5 days, or 15 days, or 20 days. Those monies would traditionally remain in the General Investment Portfolio.
The General Investment Portfolio was the “mother ship” which contained 800 to 900 separate accounts. The General Investment Portfolio was different from the General Fund, which was the largest account in the Portfolio. Rates earned in the General Fund were part of managing the state’s checkbook, not looking out at the 20- to 30-year investment horizon, as did the PERS fund managers. Therefore, the liquidity and cash components were critical factors. The General Investment Portfolio covered a much shorter time span. The General Investment Portfolio’s duration was usually between 280 days and 400 days, with the average being about a year. So the rate earned was usually lower in a normal yield curve market, because the further out they invested, the more they could earn.
Instead of receiving the revenue and payments at the state level and keeping them until debt payment was made, Mr. Krolicki said he immediately took some of those monies and bid them out to a financial institution. The ability to invest those monies for that short amount of time had a value far greater than the value of investing in the General Investment Portfolio. He stated that about 50 percent of the state’s debt payment stream was encumbered, amortized, and locked into a 6 percent rate of return, at a time when the state could only earn a little over 1 percent return.
Mr. Krolicki added that investing in this way allowed Nevada to take the present value of future savings to $20 million, but the risk in that transaction was in full disclosure. Mr. Krolicki questioned whether the state could earn more than 6 percent on those monies. He said it was certainly a topic of conversation, but having a 1.25 percent federal fund rate made the argument on his side much easier.
Looking at the historical performance of General Fund investment yields, Mr. Krolicki said it had averaged about 5.85 percent over the last 10 or 15 years, so he was very comfortable with the 6 percent rate in today’s market. Not having to cut an additional $20 million to $30 million out of the budget allowed the Governor to avoid some very difficult decisions.
Assemblyman Knecht summarized to verify if he understood Mr. Krolicki:
So, essentially, you encumbered some portion of our stream of revenues that would go to pay off the debt, and committed that stream to some contracting party like Merrill Lynch. In return, we received the present value of the cash up front from that transaction. Correct?
Mr. Krolicki replied that he was correct.
Chairman Manendo directed the Committee to take a 5-minute recess, and then called the meeting back to order at 10:12 a.m. He directed Mr. Krolicki, Nevada State Treasurer, to continue his presentation.
Mr. Krolicki testified that the State Treasurer’s Office managed $2.3 billion, plus the $30 million of revenue generated for the General Fund. Last year the state issued $312 million in debt and generated $8.6 million in savings. Nevada’s debt rating had remained constant at AA since first rated in 1977. In 2002, Fitch, a major rating agency, upgraded Nevada’s debt to an AA+ rating.
Mr. Krolicki said the superior rating caused an increase of 5 to 10 basis points on several billion dollars of investments, which meant “everyone who owned Nevada bonds made some money that day.” Furthermore, Mr. Krolicki testified, when Committee members voted on a budget, part of it was dedicated to pay off the debt service. This year, because of Nevada’s AA+ debt rating, the state would pay less for debt service, which would, in turn, free up other monies in the Bond Interest and Redemption Fund.
Mr. Krolicki said that, as State Treasurer and protector of the taxpayers’ money and the state’s checkbook, his investment priorities were safety, liquidity, and yield, in that order. In contrast, PERS’ approach to investment was determined by statute and law, and allowed a broad range of investments, as long as those investments would be considered reasonable by most people. The State Treasurer’s Office could only make investments that were explicitly allowed in the NRS. Approved investments for the state’s General Fund monies were usually conservative and fixed-income investments.
Mr. Krolicki stated that the investment manager for the State Treasurer’s Office invested over $1.5 billion on a daily basis. However, Nevada had also been affected by market problems and challenges that everyone faced today. The General Investment Portfolio was actually worth several million dollars less than it was a year ago, in spite of the fact that the State Treasurer’s Office investment policies were more restrictive than NRS required. Due to the leadership of former Nevada Governor Bob Miller and former Nevada State Treasurer Bob Seale, Nevada was the first state to receive a certificate of excellence for its investment policies.
In Nevada, the Unclaimed Property program was originally not part of the State Treasurer’s Office, but in most states in the country it was, which was a topic of great debate. Mr. Krolicki said that the program was finally moved from the Department of Business and Industry during the last legislative session. Because of those changes and changes to several statutes, the state generated $12 million in revenue for the General Fund, which was used to balance last year’s budget.
Since the Unclaimed Property program was established in Nevada, over $120 million of public monies had accrued, of which $33 million was restored to the rightful owners or their heirs. Of the State Treasurer’s Office annual revenue from this program, an average of 33 percent was returned to the rightful owner. The unclaimed monies normally accumulated in the state General Fund but were returned to the rightful owners when their claims were validated.
Regarding higher education programs, Mr. Krolicki said that the State Treasurer’s Office had continued to make improvements to the Prepaid Tuition Program that former Nevada Governor Bob Miller and former Nevada Treasurer Bob Seale started many years ago. Over 9,000 students were now enrolled in the Prepaid Tuition Program, which was backed by a $36 million trust fund. That trust fund guaranteed in-state tuition for students who contracted with the program. Any person or student could initiate such a contract by choosing a lump-sum payment, a five-year monthly payment plan, or a monthly plan that began at enrollment and ended at matriculation.
The reason the state implemented these educational programs was because Congress enacted federal laws that created Regulation 529 of the IRS code, which authorized states to act as exclusive agents for qualified plans.
Mr. Krolicki explained that the goal of all higher education programs was to “change the face of Nevada” within the next two decades, by attracting better employment opportunities for “our best and brightest,” so that they would not leave the state. The expectation was that educated youth would provide a larger talent pool, and thus a greater incentive for companies to relocate to Nevada, and that dynamic would eventually contribute to Nevada’s overall economic development.
Nevada’s other Regulation 529 Program was a savings plan with no defined benefit. Anyone could deposit money into this type of savings account, and the account’s compound interest would accumulate tax-free. Federal tax would not be levied if the money were used to cover the cost of higher education.
Mr. Krolicki affirmed that Nevada had built unique and lucrative relationships with many investment firms in the country. For example, he described the strong management link to Vanguard, a Wisconsin-based investment firm, that administered a $600 billion fund. He said, “If you are a citizen of New York, and you buy Vanguard, you’re actually buying Nevada.” Vanguard employed brokers all over the country who sold 529 Savings Plans originating in Nevada. The state received a percentage of those fees.
If the State Treasurer’s Office successfully managed its portfolios, Mr. Krolicki hoped to someday finance his office “off-budget.” To that end, his office had promoted legislation that passed into law to allow college savings plan monies to be deposited into the Prepaid Tuition Plan fund, which would ensure that unfunded liability situations did not arise. It was his ambition never to come in front of a legislative body saying that there was an unfunded liability. He believed that revenue generated from the private sector, not from the General Fund, would guarantee that the state would never have an unfunded liability.
Out of 24,000 eligible students in Nevada, the Millennium Scholarship Program enrolled 8,700 students in 2002. To date, 13,400 young people had participated in the Millennium Scholarship Program. A baseline study would soon be available that summarized information about the program and described the importance of the Millennium Scholarship Program to the future of Nevada.
Mr. Krolicki concluded his testimony by quoting Governor Kenny C. Guinn:
This isn’t about giving away money to young people to go to college, whether they need the money or not. This is about creating a whole new working class of people in Nevada who will be talented, who will be able to bring in good jobs because we have the talent pool here, and who will be productive citizens for Nevada for decades to come.
Mr. Krolicki said that the Treasurer’s Office supported five pieces of legislation this session, and most of those would be referred to the Assembly Government Affairs Committee.
Mr. Krolicki urged Nevada legislators to decide on a plan to secure and manage the tobacco settlement payments, which would bring in revenue approximating $1.2 billion over the next 25 years. The state was in line to receive payments from the Master Tobacco Settlement Agreement in the near future. Although the monies would be held in perpetuity, Mr. Krolicki asserted that, looking 25 years into the future, it was “unbelievably hypocritical and untenable” to rely on tobacco settlement monies or on tobacco company revenue, while using those same monies to fund smoking cessation programs. Looking at the issue from a public policy standpoint, Mr. Krolicki said that it was not realistic to take their money and then do everything possible to run them out of business.
As the session progressed, the Committee would be hearing legislation that proposed to triple the tobacco tax. Such taxation, if implemented, would bring in annual revenue in an amount approaching the amount of the annual payments from the Master Tobacco Settlement Agreement. Mr. Krolicki estimated that triple tobacco taxes would generate about $200 million per year from the tobacco industry. He noted that, even if people did not smoke less, many would buy tobacco online because it would be cheaper, which would cause the state to lose that revenue. He pointed out that anything legislators could do to prevent risking such a loss would be in the best interest of the state.
Mr. Krolicki pointed out that because Nevada was facing a dire budget situation, the Assembly discussed how legislation might prevent a raid on tobacco monies starting last legislative session. He said that if Nevada decided to securitize more than $1.2 billion in tobacco settlement monies, the State Treasury would receive a $400 to $450 million payment tomorrow. Mr. Krolicki suggested that, instead of raising taxes by $1 million, the Nevada Legislature should consider raising taxes by $500 million and use tobacco settlement revenue to make up the difference.
Mr. Krolicki agreed that this issue was a legitimate concern and that the anticipated revenue was extraordinary. He told the Committee that the various projects they might want to pay for with settlement monies, from senior prescriptions to millennium scholarships, were very worthy, but he urged the Committee to “do everything you can to avoid those temptations.”
Mr. Krolicki then advised that BDR C-300 might come before the Committee this session. BDR C-300 proposed a constitutional amendment to restrict using tobacco settlement monies for any other purpose than the purpose for which it was originally intended. The effect of this BDR would essentially cap the amount of monies that could be removed from the following three trust funds:
· Trust Fund for a Healthy Nevada, 50 percent cap
· Trust Fund for Public Health, 10 percent cap
· Millennium Scholarship Trust Fund, 40 percent cap
The State Treasurer’s Office would support legislation to provide bankruptcy protection for citizens who participated in 529 College Savings Programs.
Mr. Krolicki also supported the creation of a “collateral pool” in the State Treasurer’s Office on behalf of local governments. State resources and personnel would ensure that local governments’ investments were properly collateralized and would assist in streamlining the process.
Mr. Krolicki also supported proposed legislation for some housekeeping items relating to the structure of the State Treasurer’s Office.
Assemblyman Hardy thanked Mr. Krolicki for his work with municipalities. For the record, Mr. Hardy said he understood that the State Treasurer’s Office would continue to work with municipalities by allowing their General Fund investments to pass through state portfolios, thereby benefiting from that expertise.
Mr. Krolicki replied that the fund was called the Local Government Investment Pool. He said that the State Treasurer’s Office did not want to become a “Big Brother,” but was willing to help local governments, so they continued to share their sophisticated and highly efficient money-management expertise with local government entities. The main benefit to local governments of participating in the investment pool was their ability to continue to utilize “the checkbook” while receiving a higher yield, because the local monies became part of a larger and longer-duration portfolio. This had been an incredibly successful program, which grew from about $120 million to $500 million over 12 years, and involved 70 to 75 local government participants, out of 120 eligible Nevada governments.
Chairman Manendo thanked Mr. Krolicki for his presentation, and adjourned the meeting at 10:37 a.m.
RESPECTFULLY SUBMITTED:
JoAnn Aldrich
Committee Secretary
APPROVED BY:
Assemblyman Mark Manendo, Chairman
DATE: