Capitol Recap

THE PLS REPORTER Volume 5 Number 377 Special bonus coverage from the PLS Reporter, included each Monday in the Capitol Recap July 30, 2018 Outside Pittsburgh and in Philadelphia, two staffers jump onto ticket Contents THE PLS REPORTER 1 AROUND THE ROTUNDA 2 At a nominating convention Saturday, Allegheny County Republicans named Lori Mizgorski, COMMITTEE NEWS 3 a Shaler Township Commissioner, their new candidate for the 30th Legislative District. NEW LEGISLATION 11 UPCOMING MEETINGS 12 The seat is currently held by Rep. Hal English (R-Allegheny), who announced July 3 that he was not running for reelection. Mizgorski also works in English’s district office.

At 12:17 p.m. on In a release, Republican Committee of Allegheny County Chair D. Raja called Mizgorski “a Wednesday, June 27, 2018 superbly qualified candidate who will do an incredible job as the next Representative for the the Senate met briefly in people of 30th Legislative District.” non-voting session and now stands in recess until Mizgorski bested three other candidates for the nomination and won on the first ballot of the the call of the President Pro 49 assembled GOP committee people. Tempore. The Senate is not expected to reconvene In response, Democratic opponent Betsy Monroe’s campaign released a statement criticizing until September 24. the lack of transparency in the meeting.

At 3:37 p.m. on Monday, “Every cycle the nomination goes either to the incumbent or someone handpicked by party June 25, 2018 the House leaders behind closed doors,” Monroe said in a statement. “Why doesn’t the Republican stands in recess until Committee appreciate competition and trust the democratic process?” the call of the Chair. The House is not expected to Republican primary voters, rather than local committee members, last selected their candidate reconvene until September for the 30th District in 2006. At that time, voters went with then-local police sergeant Randy 12. Vulakovich.

Vulakovich won that November, and served as a member of the House until 2012, when he UPCOMING SESSION DAYS then ran in and won a special election to replace disgraced former Sen. Jane Orie.

House September 12, 13, 24, 25, With Vulakovich’s departure after the primary, committee members picked English, an 26 attorney and Marine veteran, to carry the GOP’s banner on the ballot. October 1 (NV), 2 (NV), 9, 10, 15, 16, 17 Local Republican officials had to make a similar decision this year after English, whom some November 13 said was shaken by the primary loss of Vulakovich, retired post-primary this year.

Senate Monroe, a Fox Chapel resident and first time candidate drawn to politics by the Women’s September 24, 25, 26 March, held that given the dearth of information on who was even interested in the position, October 1, 2, 3, 15, 16, 17 one of the candidates should have publicized more of what happens. November 14 The RCAC did not reply to a request for comment by press time. The selection process, however, is laid out in state party bylaws that elected committee members from the district chose candidates post-primary.

Provided by Pennsylvania Concerns over insider shenanigans haven’t just raised political hay for Republicans. With Legislative Services the retirement of Rep. Michael O’Brien (D-Philadelphia), City and State PA reported that 240 N. 3rd St. 6th Floor local Democratic Party committee members felt that their selection meeting — held less than Harrisburg, PA 17101 717.236.6984 phone a week after O’Brien’s announcement — happened too quickly. 717.236.5097 fax www.mypls.com The concerns about alienating voters were escalated by the selection of O’Brien’s chief of staff, , to carry the party’s banner.

How the selection impacts November is still too early to tell, but suburban seats like the 30th — representing Pittsburgh’s northern, affluent suburbs — are high value targets for both state and national Democrats come the general.

The 30th alone overlaps with the 38th Senatorial District, where Vulakovich’s bester, Ross Township Commissioner Jeremy Shaffer, is facing off against former teacher’s union staffer Lindsey Williams. The district voted for Hillary Clinton in 2016, but by only half a percentage point.

The seat also overlaps with the newly redrawn 17th Congressional District, pitting two incumbent congressman — Democrat Conor Lamb and Republican Keith Rothfus — against each other.

As for the 30th proper, Trump took the district 51.6 to 44.8 percent. However, Democrats hold a slim advantage in registered voters.

Stephen Caruso is the Harrisburg bureau chief at The PLS Reporter. Have a question, comment or tip? Email him at [email protected].

The PLS Reporter provides original news, insight and in-depth analysis on current topics and proposals moving through the state legislature. For more information about adding the PLS Reporter to your subscription, please email us at [email protected].

AROUND THE ROTUNDA PLS coverage of Capitol events including press conferences, bill signings, & media availabilities

ADMINISTRATION DEMONSTRATES “PA BUSINESS ONE-STOP SHOP” WEBSITE By Jeff Cox, Pennsylvania Legislative Services | July 30, 2018

Representatives from the Wolf Administration along with a Harrisburg-area entrepreneur held a news conference today to demonstrate the new PA Business One-Stop Shop, a website designed to help entrepreneurs with starting and running a business in the Commonwealth.

Carol Kelko, deputy secretary for business finance at the Department of Community and Economic Development (DCED), explained that in 2016 Gov. Tom Wolf announced in his budget address that he would be “initiating a new program for those people who want to start a business, for those who are in business, and small businesses to help them get through all the various resources the commonwealth has available for them.” She further explained that to start or run a business an individual has to know who at the Department of State, the Department of Revenue, the Department of Labor and Industry and others to contact to help find the resources.

According to Kelko, the website “provides all the information and access to those three agencies and DCED.” She commented, “This is an excellent, excellent opportunity and a collaborative effort by all of the four agencies to be able to pull all of this content together and put it on one website and allow our clients, our customers and our citizens of Pennsylvania to be able to access the information.” Kelko added, “This is truly government that works.”

Amma Johnson, founder and designer at the Harrisburg-based AMMA JO brand designer handbags, clothing and fashion accessories, commented, “It’s great to have a resource like the PA Business One-Stop Shop available to entrepreneurs.” She continued, “By far the most difficult thing is you have so much to do and you have only a little bit of time and you need to be able to find and access exactly what you need without wasting your time.” Johnson said she would encourage everyone to tell their friends about this resource.

2 Michael McManus, director of the PA Business One-Stop Shop, demonstrated the website and provided an overview of what resource are available through the website. He explained the website provides information on such topics as turning an idea into a business; writing a business plan; naming a business; choosing a business structure; getting business advice; registering a business; registering with the Commonwealth; local registrations, permits, and zoning; special registrations; hiring workers; and state taxes and state permits.

Kelko pointed out that in addition to the website, aspiring entrepreneurs and current business owners can also call a toll- free telephone number at 1-833-722-6778 to connect with business consultants and subject matter experts who can answer questions. She explained, “Together, the website and the team of experts will help guide and support businesses through all stages of development from planning and startup to operation and expansion.”

The PA Business One-Stop Shop can be found at business.pa.gov.

COMMITTEE NEWS Comprehensive coverage of House & Senate public hearings & voting meetings

Joint State Government Commission 7/30/18, 9:00 a.m., G-50 Irvis Office Building By Andre Dienner, Jessica Richardson, and Robert Cochran, Pennsylvania Legislative Services The committee held a public meeting of the Public Pension Management and Asset Investment Review Commission (PPMAIRC) to hear testimony examining improvements in transparency around investment expenses and returns of Pennsylvania’s two statewide pension systems, the State Employees’ Retirement System (SERS) and the Public School Employees’ Retirement System (PSERS). Testimony at the meeting specifically focused on transparency and stress testing. Commissioners present included: • Chairman (R-Schuylkill) • State Treasurer Joe Torsella • Michael Torbert, retired BB&T Wealth Advisor • James Bloom, executive assistant, Department of Banking and Securities (DoBS) • Steven Nickol, director of retirement programs, Pennsylvania State Education Association (PSEA), as a substitute on behalf of Bernard Gallagher, senior budget analyst, office of Representative Joseph Markosek (D-Allegheny) Chairman Tobash explained this is the first hearing of three as required in Act 5 of 2017.

First the commission discussed future meetings and business of the commission. Chairman Tobash discussed what the commission has been tasked with under the act, indicating major discussion sections include performance of current investment strategies which will be discussed in hearing two, the cost of active and passive investment strategies in relation to future investment activities which will be discussed in hearings two and three, and improving investment fee transparency in alternative investments and implementing recommendations on stress testing which will be discussed today. He commented testifiers will be very important in understanding how to fulfill those responsibilities and outlined testifiers in the first meeting have “tremendous expertise” in transparency and stress testing.

Torsella thanked all parties involved with putting the commission and its business together and also mentioned PSERS has qualified the meeting for continuing education requirements. He outlined the subjects of today’s meeting being stress testing and transparency which he opined are “hugely important” and areas where real progress can be made. He said understanding the economics of everything is critical which today’s discussion will address.

Nickol followed up on a request for more information on where the final report is currently, what has been done to date, and who is doing what in that respect. Chairman Tobash explained the act required a report six months from the organizational 3 meeting which was held on May 30, which creates a deadline of November 30 for the report. He mentioned there was a potential meeting discussed for August 16, which could be used to introduce the committee to Ashby Monk, a consultant the commission has enlisted to aggregate testimony and compile the final report, even if there is no substantive material to go over at the meeting. Nickol indicated he is impressed with Monk’s credentials. Glenn Pasewicz, Joint State Government Commission (JSGC) executive director, noted he will plan the logistics of the August 16 meeting to meet with Monk if he is available.

Torsella agreed that would be a good date to hold the meeting with Monk.

Nickol next followed up on a letter regarding Pew Charitable Trusts testifying. He caveated he is not opposed to them testifying as they are experts in the area but voiced concern with the organization being a lobbyist group and the action exempting them from disclosing certain lobbying activities. He wondered what their potential educational role is as they may be advocating for things which some commissioners disagree with. Chairman Tobash replied testimony at each meeting will be widely varied and Pew has done much research related to stress testing, also mentioning other requests for additional testifiers at this hearing. He said he wants to be very accommodating of testimony requests but agreed Pew does operate in a lobbying capacity. He indicated Pew will address the commission as a consultant due to their valuable perspective on stress testing. Nickol gathered this could exempt them from some federal and state lobbying standards. Chairman Tobash summarized they are offering testimony as a consultant, not from a lobbyist perspective. Nickol repeated his concern with the status of Pew in this respect and wondered “what they will actually be doing.”

Torsella confirmed there is no reimbursement for testimony.

Chairman Tobash next moved to topics of future hearings. He explained today the commission will discuss best practices for transparency, fee recording, and stress testing; on September 20 the commission will receive an analysis of Pennsylvania pension funds relating to assets, investment strategies, investment performance, fees, cost, and procedures against established benchmarks; and at a third hearing sometime in October the commission will discuss cost savings, initiatives for both pension boards, cost benefits, and limitations of each option.

Chairman Tobash also noted a list submitted by Gallagher for additional testifiers, saying within the next two weeks a final list of testifiers should be established for the September meeting.

Bloom wondered if the systems will be invited for testimony. Chairman Tobash indicated they will testify at the third hearing and requested any ideas for testifiers be submitted to JSGC. On a date for the October meeting, he added he wants to make sure to accommodate Gallagher who could not make the July meeting.

Lastly Chairman Tobash credited the JSGC for accommodating the logistics of the meeting.

Bloom inquired as to minutes from the first meeting. Chairman Tobash stated there was no stenographer at that meeting. Pasewicz mentioned a minutes summary document was distributed to commissioners shortly after the meeting and he would resend the document.

Minutes from the May 30 meeting were unanimously approved.

Chairman Tobash noted the JSGC website will hold transcripts and videos of the hearings.

Chairman Tobash summarized the commission is charged with delivering a report according to Act 5 and has enlisted a consultant in Monk for that purpose. He stated today the commission will be evaluating and receiving recommendations on improving investment fee transparency, alternative investments, and implementing panel recommendations on stress testing. He noted Rep. ’s (R-Lebanon) attendance, whom he described as a great resource for the legislature on the topic.

Next Chairman Tobash commented the investment environment is increasingly scrutinized and litigious which reveals improprieties and in some cases major loss. He added causes increased regulatory layers in oversight and a cultural shift to greater fiduciary responsibility and liability for those who oversee the plans. He drew on underfunding of the systems,

4 especially in Pennsylvania, to say the work of the commission is extremely important and will give the systems the tools to shift their culture to improve their performance and implement a greater degree of scrutiny on costs and fees.

Torsella maintained the goal is to strengthen the system for beneficiaries to better manage and preserve their resources and establish the systems as a promising retirement security. He said there are lots of reasons to be for more transparency especially considering modern financial scandals, but also wanted to ensure comparisons are made fairly to seek an alignment of beneficiary and manager interest. Torsella concluded seeking this interest requires knowledge of the compensation structure and transparency goes to the core of what Act 5 aimed to do.

Chairman Tobash asserted there is an overall hypothesis of overpaying for pension fund administration but often there is no way to find out what those amounts actually are, which calls for increased transparency.

Dr. Ludovic Phalippou, assistant professor of finance, University of Oxford, presented to the commission online via Skype. He outlined a private equity (PE) transaction example used to purchase many corporations managed by PE firms, which includes various transactions between general partners (GP), limited partners (LP), portfolio companies, banks, operating partners, and consultants. He outlined this process to discuss the alignment of interests between the GP and LP, indicating they both want the portfolio company to be worth as much as possible but the GP might be tempted to incur frivolous expenses on the rental income, hire itself for consulting services, or give kick-backs to any consultant advising LPs to invest with the GP.

Dr. Phalippou summarized this aspect of the business is unregulated and down to the GP’s goodwill. “If LPs do not have full information or cannot process it, they do not know what she (the GP) takes,” he stated, also noting the U.S. Securities and Exchange Commission (SEC) did create some discipline in 2012 but its lasting effectiveness remains to be seen.

Continuing, Dr. Phalippou begged the question how correct information on how the GP behaves can be acquired. He cited the need for this information due to potential fairness and ethical concerns, ability to track future performance, and establishing a true and accurate rate of return. To exemplify this, Dr. Phalippou mentioned all pension funds and other asset owners report fees at around one to 1.5 percent but this is a false number due to carried interest, fees charged to the asset, fund expenses, other related part transactions, and exact co-investment arrangements. He specifically outlined a deal conducted by Apollo and TPG in September 2006 with $22 billion in debt and a total enterprise value of $31 billion. He boiled the GP services agreement down to “I may do some work from time to time… I’ll decide how much I’ll work… potentially I won’t do anything… a $200 million showing-up fee even though the GP already receives between 2 and 4 percent of the equity invested per year… $30 million a year irrespective of how much I decide to work… if I do decide to do something, I’ll charge extra… and I can stop charging when I want but if I do I get all the money I was supposed to receive from that point up until 2018.”

He continued saying the company ended up bankrupt and a total of $300 million has been taken out of its cash till by the GPs, which has also happened in other situations. “For a long time, those who knew kept that secret,” Dr. Phalippou said. “Most LPs were happily ignorant. Because of people researching this topic, spreading it in the press, pushing transparency, the industry had to back up a bit. GPs now often refund most of these fees to the LPs, and responded by saying ‘Ah, yes, these were not very nice practices, but we’ve moved on now.’ Can you still trust these fund managers? There are many other ways for them to help themselves, Are we satisfied with transparency achieved so far or do we want more?”

Chairman Tobash said returns for private equity are alluring and many time claim to be high, but asked for a comparison to other investments “that are more transparent and measurable” with respect to being able to benchmark fees and returns. Dr. Phalippou responded it is unknown how much is being charged and even defining a fee can be difficult, which is then followed by defining excessive expenses. He summarized the numbers are unknown as of now but some quantifications place the fee number at around six percent per year. He repeated going forward contracts can be better examined and compared to past returns, but previous reporting is often incorrect. “The point is that they have kept to themselves most of the surplus that they have generated and the LPs have tried to hide that fact so that they don’t get in trouble,” Dr. Phalippou concluded.

Chairman Tobash referenced basis points for private equity which often performs well but benchmarking is critical to understand what is really going on. He wondered about the idea of communicating rates of return that are “midstream” in 5 some of the investments and how they are reported in the interim to pension systems. Dr. Phalippou repeated there are many “fake numbers” with respect to rates of returns. Chairman Tobash agreed internal rates of return deserve scrutiny.

Torsella understood the argument that the full picture of all costs borne by the funds and real returns should be more visible but wondered if there are any meaningful downsides that outweigh economic improvement. He also drew on arguments that private equity is time limited and LPs usually make money which means fees are effectively zero and only net return matters. Dr. Phalippou first said there is more upside to being transparent but one downside can be the potential loss of investment if a firm refuses to follow the code set forth. He also described the argument of fees being out of returns as “very weird.”

Nickol discussed an interview in which Dr. Phalippou quantified the scale of the problem of “tunneling,” being added fees and expenses, and asked him to put in perspective how much of a problem it is in the industry. Dr. Phalippou replied he went through SEC filings and found an approximate total of $10 billion, which as a fraction is 1.5 percent of equity invested by pension funds every year. He caveated it can be difficult to quantify exceptions laid out in contracts.

Bloom mentioned the average return on private equity is 12 percent which is minus the fees paid and the return to the GP would be six or seven percent, including carried interest. Dr. Phalippou said expenses are hard to quantify but have been found to be around six to seven percent. Bloom discussed net asset value, which Dr. Phalippou agreed is an “indicated guess.” He also mentioned the correct numbers may be reported when things are going well but made up when things are going badly, which can cause discrepancies. Bloom wondered if that is in reference to California, which Dr. Phalippou concurred in and stated Pennsylvania is in a similar situation.

Jennifer Choi, managing director, Institutional Limited Partners Association (ILPA), discussed the ILPA template. She mentioned ILPA has more than 480 member organizations and 4,500 active professionals across diverse roles, and they began their transparency initiative in 2015 with 42 participating organizations to identify and promote enhanced, uniform practices to improve the quality of reporting and disclosures on costs to LPs. She said this included a standardized fee and expense reporting template quarterly, with expanded disclosure on fee offsets, partnership expenses, related parties, carried interest, guidelines around fee/expense reporting, regulatory compliance and other disclosures, and recommendations on expanded scope of annual fund audits and role of third parties in enhanced assurances of LPA compliance. Choi outlined this standardized template and its key features being endorsed by many organizations, adding the next phase of the process will be realizing implementation benefits towards the ultimate goal of automation and benchmarking. She estimated more than 300 managers provide the ILPA Reporting Template to investors requesting it, 22 percent of GPs use the ILPA Fee Reporting Template, and GP adoption of the template grew 69 percent between 2016 and 2018.

Choi also discussed inconsistent levels of fee reporting in the U.S. by state, but outlined several states efforts to legislation transparency in PE including California passing the measure into law. She summarized navigating the complexity and compliance challenges in public reporting of PE costs is difficult, but the ILPA template is an effective tool to improve transparency.

Renee Astphan, senior investment officer, Rhode Island Treasury, offered testimony explaining how Rhode Island in 2015 launched Transparent Treasury, “one of the most comprehensive transparency policies in the nation,” which requires pension fund managers to allow their performance and fees to be published online in order for state to invest. She said New York City, California, and other large funds have adopted similar policies. She highlighted how each manager must sign a transparency agreement, investor code of conduct, and placement agent certificate for all funds new after June 2015, and while funds prior to then are grandfathered in, requested voluntary disclosure has seen 85 percent success. Astphan concluded with examples of how the information is compiled and available online, stating the law was essential for transparency and good government.

Lorelei Graye, principal, Leodoran Financial, defined the elements required for transparency as “consistency, granularity, and optical depth with an eye to automation in data aggregation.” She stated the lack of transparency for investors is in the lack of standardization of reporting and the resulting inability to automate the collection of accurate, consistent, and sufficiently granular incoming data across many investments within the LP’s portfolio. “Today, we have hundreds of GPs completing the ILPA Template and other accepted standard templates,” Graye offered, but listed current hurdles including PDFs versus Excel hindering automation, customization of standards preventing scale, plus-one requests for templates are not in place of other custom requests, market conditions giving GPs the upper hand in negotiations, a need for adaptation to 6 all areas of broader private equity space, proprietary data concerns with certain details at greater optical depth, and public records or Freedom of Information Act (FOIA) that interfere with GP compliance or LP requests.

“The goals or elements required to achieve transparency in private equity remain the same today and while substantial progress has been made, a coalescence of LPs and all supporting or oversight bodies is needed to continue to push, together, toward the future, desired state,” Graye concluded. “Sunlight in private equity has the potential to chase away real and perceived threats but overexposure could be damaging to all involved… It will be important in the coming months and years for pension fiduciaries to continue to pursue a very objective and rational view of private equity and its investment costs, which must always be viewed in context of returns, while considering private equity’s role in the portfolio allocation and its benefit to the plan beneficiaries.”

Chairman Tobash mentioned HB 1460 estimates adopting ILPA standards would come at a cost of $300,000 per year per system for staff but the Independent Fiscal Office (IFO) said the cost would be nothing, wondering what Choi’s perspective is. Choi responded that cost seems reasonable and any cost would be based on staff to secure the data and follow up on requests. The technology investment for the systems to warehouse the data is also a cost factor, she said. Chairman Tobash wondered if there has been feedback from those who endorsed the template for decreased fees. Choi commented there has been some marginal decrease in recent years but the data collection process is still underway. Chairman Tobash lastly indicated both systems endorsed ILPA and wondered how they are doing in moving towards that. Choi declined to venture how they are doing with the information.

Torsella thanked Choi for clarifying why the ILPA template is so powerful through standardization as opposed to just generally collecting the information. He wondered why it is important to have the data public in Rhode Island and if the benefits have outweighed potential performance issues as a result of the information being public. Astphan responded portfolios are getting more complex and performance has been positive, and getting ahead of public records requests is also an important aspect to keeping the information public. She stated they have never had a manager turn away based on the state’s requirements.

Torbert commented clients constantly ask about fee levels and being responsible is important, but also on the personal side, clients want to become more aware of what their fees are which keeps everyone honest and can improve returns.

Nickol wondered if the Rhode Island law specifies ILPA is required for reporting. Astphan said it does not specify ILPA but rather the fee terms for each investment. Nickol mentioned some GPs did not want to use ILPA and Rhode Island accepted other types, wondering what the biggest pushback on ILPA specifically was. Astphan indicated some older funds with a small dollar value left did not want to put the time towards a fund that will soon be wound down, but were open to ILPA for future funds. She also mentioned some GPs gave the information but not in the template form. Nickol added that is a similar approach used in California where they try to use ILPA but do not require the template as long as they get the information.

Graye discussed automation and adoption of data standards saying the ILPA template was looked at as a prospective standard and granularity was not there for some older funds and in some cases the data was provided in other forms, “which is not an unreasonable accommodation.”

Bloom mentioned of the 550 to 600 total some are old legacy funds with as little as $100,000 and wondered “how to clean those up” as reporting would not be worthwhile in those cases. He mentioned the three agreements Rhode Island requires, wondering if they tell potential investors before they interview and if they use a consultant. Astphan concurred they tell investors beforehand and use a consultant, but the legislation passed only relates to the transparency pledge while the other two agreements are internal policy. Bloom wondered if that means Rhode Island will not sign a non-disclosure agreement for fees, which Astphan said is correct. In conclusion Bloom opined there would be a tipping point if all fees were transparent where competition would start.

Torbert wondered if both the gross of fees and the net of fees performance are collected. Astphan said they both are collected, Rhode Island is making a better effort with gross of fees now, and they always report gross and report net when they can. Torbert commented that information is helpful in the investment business.

Choi commented getting gross performance measures is not yet the standard so LPs are trying to build it back up from a net perspective with transparency around fees charged. 7 David Draine, senior officer, The Pew Charitable Trust, explained stress testing is a simulation technique used to assess the impact of different economic conditions on pension balance sheets and governmental budgets. He stated for public pensions, stress testing involves taking existing actuarial reporting standards. Overall, state and local pension systems have never been more exposed to market volatility, based on fiscal measures and economic outlook, Draine said. He commented Connecticut and Pennsylvania have taken meaningful steps on the pension issues. Draine said employer contribution rates for Pennsylvania and Connecticut are projected to be above 30 percent for the next 20 years.

Draine continued that for the stress testing simulation model they combined three inputs: actuarial projections, capital market and asset allocation assumptions, and state revenue forecasts. He noted each of the inputs represents a system that is already in place. Draine commented using risk analysis to assess potential policy changes allows policymakers to consider the full impact of pension legislation, and recent changes in reporting standards have led to increased momentum among states in adopting stress testing. He said pension risk reporting is coming and stress testing is important because it provides a scorecard to assess current and proposed funding policies based on a range of possible market outcomes. Draine stated Pennsylvania already has the pieces to start stress testing and including stress testing can give early warning signs, improve budget planning, allow for better assessment of pension changes, and prevent costly mistakes.

Chester Spatt, Carnegie Mellon University, clarified financial market risks and stated systematic risk cannot be diversified away in forming portfolios while idiosyncratic risk is diversified in a portfolio. He said risks are not just about returns but reflect a possibility of market losses. Spatt stated pension recipients anticipate the pensions will be paid in all circumstances. He explained if there is an expectation the defined benefit plan will not pay off when the market does badly, then equity investment would reflect this payoff risk.

Spatt asked if it is ethical for politicians and union leaders to negotiate underfunded plans without being transparent and without resolving the risk-sharing issue. He noted the commission, treasurer, and trustees could play an important role in transparency. He stated that a little bit of equity risk can be borne without moving the pension plan from risk neutrality, and a reason public and private plans desire to hold equity risks is it would create an opportunity to bargain away benefits due to the threat of limited funding.

Spatt continued there is a concern about excess or inefficient risk-taking and leverage leads to greater systematic risk and potential for further underfunding. He said equilibrium analysis does not support generic use of leverage, except to potentially bargain away future benefits. Spatt added there is a basic measurement problem with illiquid assets as the riskiness if often understated since valuations are artificially smoothed. Illiquid assets should be only modestly held as a slight role in the market portfolio, Spatt said. He noted private pensions have moved away from defined benefit investing and moved toward various incentives.

Chairman Tobash asked what the historic vulnerability of pension funds is for Pennsylvania. Draine replied states like Pennsylvania have taken meaningful steps are better prepared for the future when funding levels are low. He said with the big picture there has been little recovery in the last two recessions. Chairman Tobash questioned with regard to relative vulnerability, what position Pennsylvania is in. Spatt replied he does not think Pennsylvania is near the worst of states. He noted states like Illinois, New Jersey, and California are more discussed. Spatt continued there is concern there was little recovery after the Great Recession but that is related to ongoing funding issues. He explained private portfolios have done extremely well because of returns, but a main concern over time is holding more and more illiquid investments. Chairman Tobash inquired about the idea of more transparency and possibly a national model. Spatt commented more transparency is a good thing and the industry is likely to naturally be resistant to different disclosures for each specific state so relative uniformity in disclosures makes sense.

Torsella questioned if a stress test should impact how they look at their liquidity profile in the fund, and asked who the intended audience is for the stress test. Spatt relayed stress testing is important as it informs trustees, taxpayers, and workers. Comparing it to the stress testing of the Federal Reserve, Spatt stated, it would look at the situation confronting the largest financial institutions in bad returns and that is what it would be doing here as well. Draine added the audience is policymakers and the public. He said it is good to think of it as a useful budgeting tool.

Bloom inquired if there is an idea of what stress testing should be done and if enough is being done. Draine replied it is often something incorporated into the annual actuarial calculations and involves public disclosure for a baseline of what may 8 happen. Bloom commented he is not sure who does the stress testing but thinks it seems to be an independent actuarial firm. Draine stated there can be an actuary hired by each of the two plans and then a separate actuary to keep eyes on the testing.

Nickol commented the commission has been invited to listen to the PSERS discuss stress testing and what they do, which could be beneficial to the commission.

Chairman Tobash asked how the discount rate affects the ability to manage debt the state currently has and the debt that is forecasted. Draine replied in each scenario the long-term investment stays the same but the amount the employers have to pay varies. Spatt commented the amount of underfunding is going to be dramatically higher and suggested providing a second disclosure to discount cash flows.

Kenneth Kent, consulting actuary for Cheiron and Vice President of Pensions for the Academy of Actuaries, provided background on stress testing and its importance for managing public pension plans. Kent indicated he had prior experience with pensions in the commonwealth and Philadelphia.

“Since joining Cheiron in 2005, stress testing has been an integral part of my consulting for every one of our clients and is included in every actuary evaluation report,” Kent stated, adding stress testing is an essential tool for decision-making regarding pension plans.

“Pension systems are constantly in the news and mostly in terms of those with severe funding challenges.” Kent said, noting the tendency for the news to report crises instead of successes. Kent claimed large multi-employer and some public pension plans have reached a tipping point. “The actuary community and think-tanks have made note with the consensus and theme that: while not a solution, stress testing is an important of measuring the risks and addressing them to mitigate the trends of systems and correcting them,” Kent said, adding the evaluation process is necessary to benchmark the progress of contribution rate and funding policy.

Kent indicated pension systems have a historic view of funded status. “Unless the report provides projections of future funded status, you have no certification the effectiveness of the funding policy,” Kent said. According to Kent, the first piece in an evaluation report is a deterministic projection which forecasts pension programs based on their assumptions and the second piece is stress testing. Kent said other financial systems are obligated to evaluate solvency for continue viability, highlighting Social Security’s process in reviewing their future funded status. According to Kent, population and demographics provided the greatest threats of volatility towards the entitlement program.

Kent opined the importance of knowing the limitations of stress testing, reminding the committee that stress testing is not a solution, but a measurement of potential outcome. “(Stress testing) is not a decision, but a valuable form of information in which you can compare the impact of decisions on future outcomes,” Kent stated, calling stress testing a visualization for deterring future risk. “Stress testing measures the risk of the financial system’s ability to meet future obligations.”

“For pensions,” Kent claimed, “things usually look like they will work out because when contributions have to increase to respond to financial conditions, the funding status always improves.” Kent said the assumption resources are or will be available to achieve funding are not accurate. Stress testing would provide insight on how much financial contributions can vary by allowing for sensitivity testing to define what is and what is not sustainable and the measurement of alternatives for mitigating the unsustainable threshold, Kent stated. According to Kent, Act 5 provided alternatives to avoid unsustainable funding practices.

Kent said that by letting the rate of return vary, elected officials may have to budget for higher pension costs. After the deterministic projection, the risk tests would perform 1,000 trials to allow for the rate of return to vary within the range of expectation, Kent stated. “What you then get is a distribution of likely outcomes,” Kent claimed, adding the distribution of cost may vary over time. Risk tests would provide realization of unstable events that may occur down the road, Kent said.

Pension plans that do not recover well are related to the net cash flow of a retirement system, according to Kent. He indicated a negative cash flow is typical for pension systems, but the magnitude determines how the pension will respond to adverse market. Kent stated neutral cash flow provides consistent returns over a period of time, while a negative cash 9 flow would reduce the return regardless of the market’s performance. Stress testing in decision-making reduces the risk a pension fund could be exposed to and without a projection of returns, lawmakers do not know the future funding, Kent said.

Bob Stein, former chairman of Actuaries Blue Ribbon Panel, provided testimony regarding the changing funding status of public pension trusts and provided recommendations in strengthening public pension plans. According to Stein, Actuaries Blue Ribbon Panel is composed of left and right wing think-tanks, government officials and union representatives and encourage stronger public pension practices, including stress testing. Stein said the major risk for public pension programs include investment performance and consistent contributions to the plan, potential jeopardizing longevity of pension programs.

Stein claimed stress testing provides three key functions for public pension trustees: • Quantifies the financial consequences of risk • Provides framework for analyzing alternatives for reducing and managing risk • Aiding the development of an action plan in an event of financial crisis Stein provided recommendations to the committee, including managing normal volatility and providing a stress test with 20 years of “stress” and financial outcomes for 30 years. According to Stein, retiree mortality and new hires should also be included when analyzing public pension systems. Stein claimed stress testing measures total risk and risk in investment return. “Stress testing is really the best way…to get objective evidence of the affordability and stability of proposed (pension) plan changes,” Stein said.

Stein indicated two other ways the panel recommends to reduce risk: • Computing plan liability and contribution at risk free rate • Standardized contribution which benchmarks recommended contribution to assess funding risks Stein concluded with saying stress testing quantifies risk and change to payroll and is the only objective framework to evaluate risk.

Joseph Newton, pension market leader, Gabriel Roeder Smith & Co, provided testimony regarding how to optimize stress testing. Newton said unique risk provides evaluation of pension programs with specific regard to the potential stress that may occur. According to Newton, different pension programs have different risk concerns in which certain solutions are not applicable. If a stress test is conducted, Newton highlighted the importance of knowing the moment in which crisis could occur and being able to solve short term solutions which result in policies and procedures that improve the state of a pension system.

According to Newton, financial discipline is paramount to maintaining a solid pension system. Newton claimed one percent stress tests are more realistic than three percent because it provides for better protections against a funding crisis. Newton raised concern over certain stress testing methodologies because some scenarios may bring bias in deciding a funding rate.

Newton said funding policies that are not designed to respond to market downturns have substantial risk because there is no mechanism to create changes when necessary and enforcing a disciplined funding rate provides a positive impact on the contribution rate volatility. Newton indicated funding policies without an allowance for offsetting gains and losses face substantial budget volatility and providing a cost-of-living-adjustment in pension funding allows for the ability of a plan to withstand significant adverse experiences.

Newton concluded saying that all pension systems face the downside of risk but the focus should be on decision-making and constructive observations, not specific outcomes. According to Newton, viewing the results of a stress test in context of the objectives of the pension program will allow for better decision-making.

The panel took questions from members of the committee.

Rep. Tobash asked Stein if the Blue Ribbon Panel would submit comments to the committee. Stein informed Rep. Tobash the panel is disbanded but he would provide further discussion on the issues to the committee. Rep. Tobash asked Newton for details of Detroit’s pension fiasco. Newton said he did not work on that case, but from his understanding the problem was

10 not the pension plan itself rather the declining population that no longer could provide for the program.

Chairman Torsella said the commonwealth faces a real risk in regards to its pension program. Chairman Torsella asked the panel if the stress test should be conducted by an actuary or investment consultant. The panel agreed a stress test should be conducted by an actuary but admitted their bias because of their occupations. Kent said actuaries have all the information possible to conduct a stress test with regard to all potential risk. Stein said actuaries have the tools to measure all variabilities. Newton responded saying actuaries place all information into one study but may not have to be conducted by one annually.

Nickol asked the cost and the impact a 3.5 percent risk-free pension would have on employers. Stein said many experts agree funding calculations should not use a risk-free rate but should use it as a measurement of risk itself. Nickol said people may suggest a 3.5 percent plan in order to encourage people to use 401ks instead of pension plans. Stein said evaluating risk and funding may have to be separated.

Nickol said the committee may adopt recommendations that this panel did not bring forward. Stein said other experts have suggested to perform a stress test, but no clear indication on how to do so and there are some debates around guidelines of stress testing. Kent said there is a difference in opinion on stress testing among actuaries themselves. Nickol asked what purpose a public bond would serve. Stein said it is fundamentally the same calculation but could not say why it is suggested. Bloom asked Newton to clarify consistent contribution. Newton did not get an opportunity to respond.

NEW LEGISLATION

HB 2570 Cox, Jim (R) (PN 3882) Amends the Public School Code, in reimbursements by Commonwealth and between school districts, by reducing the amount of student-weighted basic education funding as follows: for the 2019-20 school year, the Commonwealth shall pay each school district an amount equal to 80 percent of the school district.s basic education funding allocation for the 2013-14 school year; for 2020-21 school year, an amount equal to 60 percent of the school district.s basic education funding allocation for the 2013-14 school year; for the 2021-22 school year, an amount equal to 40 percent of the school district.s basic education funding allocation for the 2013-14 school year; for the 2022-23 school year, an amount equal to 20 percent of the school district.s basic education funding allocation for the 2013-14 school year; and for the 2023-24 school year and each school year thereafter there will no longer be a guaranteed base level of funding. Effective immediately. Jul 30, 2018 - H-Introduced and referred to committee on House Education

HB 2571 Klunk, Kate (R) (PN 3883) Amends the Public Employe Relations Act adding language requiring a public employer to notify a nonmember in writing that there is no statutory obligation by nonmembers to make any payments to an employee organization that serves as the nonmember.s exclusive representative. Provides for the content of the notification. Further provides for notification to a new public employee. Also prohibits a public employer from collecting through wage deduction any form of payment from a nonmember to an employee organization. Effective in 30 days. Jul 30, 2018 - H-Introduced and referred to committee on House Labor and Industry

HB 2575 Cox, Jim (R) (PN 3884) Amends the Pennsylvania Election Code increasing the amount paid to poll workers to attend voting machine training from $5 to $20. Also requires the county board of elections to provide for each election district in which a paper ballot is used a supply of official ballots equal to ten percent more than the greatest number of ballots cast in the prior three comparable elections in the election district. Adds language providing the Secretary of the Commonwealth shall only certify an electronic voting system that provides for reasonable measures consistent with established standards to prevent unauthorized physical or electronic access to the voting system. Effective immediately. Jul 30, 2018 - H-Introduced and referred to committee on House State Government

11 HB 2580 Cox, Jim (R) (PN 3885) Amends the Vital Statistics Law adding language prohibiting the Department of Health from processing a payment by an applicant until the requested copy of the vital statistics record or part thereof has been mailed to the applicant. Requires the department to publish notice on its website that an applicant.s payment will not be processed until such time as the requested copy of the record or part thereof has been mailed to the applicant and to cause the same notice to be published on the online VitalChek service. Effective in 60 days. Jul 30, 2018 - H-Introduced and referred to committee on House Health

UPCOMING MEETINGS

MONDAY - 8/6/18 Senate Republican Policy Committee 1:00 p.m., Peters Township Library, 616 E. McMurray Road, McMurray Public Roundtable on School Safety

House Democratic Policy Committee 2:00 p.m., Neumann University, John J. Mullen Communication Center, Student Multi-Purpose Hall, 1 Neumann Drive, Ashton Public Hearing with Rep. -Braneky on Connecting Workers to Real Jobs

TUESDAY - 8/7/18 Senate Republican Policy Committee 11:00 a.m., Artman Elementary School, Community Room, 411 N. Hermitage Road, Hermitage Public Roundtable on School Safety

House Democratic Policy Committee 12:00 p.m., District 1199 Union Hall, 1319 Locust Street, Philadelphia Public Hearing with Rep. on Janus vs. AFSCME Decision’s Impact on Women of Color

WEDNESDAY - 8/8/18 Senate Republican Policy Committee 10:00 a.m., Cedar Crest High School, Large Group Instruction Room, 115 E. Evergreen Rd., Lebanon Public Roundtable on School Safety

House Democratic Policy Committee 2:00 p.m., Philadelphia City Hall, City Council Chambers (Room 400), 1400 John F. Kennedy Boulevard, Philadelphia Public Hearing with Rep. Joanna McClinton on Probation Reform

THURSDAY - 8/9/18 House Consumer Affairs 10:00 a.m., Room B31, Main Capitol Public hearing on small wireless cell deployment focusing on: HB 2564 Farry, Frank Act re small wireless facilities deployment

House Democratic Policy Committee 10:00 a.m., Temple University, Shusterman Hall, 1834 Liacouras Walk, Philadelphia Public Hearing with Rep. Jim Roebuck on: HB 2444 Roebuck, James Act re PA Promise Program & Fund

TUESDAY - 8/14/18 House and Senate Veterans Affairs & Emergency Preparedness 10:00 a.m., PA State Fire Academy, 150 Riverside Drive, Lewistown Joint public hearing on: SR 6 Vulakovich, Rand Concurrent resolution re emergency services

12 WEDNESDAY - 8/15/18 House and Senate Agriculture and Rural Affairs 10:00 a.m., Russell E. Larson Agricultural Research Center, Theatre Area of the College Exhibits Building, 2710 West Pine Grove Road (Route 45), PA Furnace Joint informational meeting on agriculture industry update

THURSDAY - 8/16/18 House Environmental Resources and Energy 9:00 a.m., Room 140 Main Capitol Informational meeting on: SB 799 Alloway, Richard Act re PA Clean Water Procurement Program

Independent Regulatory Review Commission 10:00 a.m., 14th Floor Conference Room, 333 Market Street, Harrisburg To consider the following regulations: 3208 Environmental Quality Board #7-550: U.S. Nuclear Regulatory Commission (NRC) Consistency Rule (Final-Omit) 3169 Environmental Quality Board #7-499: Radiological Health

WEDNESDAY - 8/22/18 Senate and House Democratic Policy Committee 10:00 a.m., SCI Dallas, 1000 Follies Road, Dallas Joint policy hearing on criminal justice reforms

THURSDAY - 9/20/18 House Human Services 10:00 a.m., Manor College, 700 Fox Chase Road, Jenkintown Public hearing on supporting the well-being of young adults leaving the foster care system

TUESDAY - 9/25/18 House Finance, House Local Government, and House Urban Affairs 8:30 a.m., Room 140 Main Capitol Joint public hearing on Act 47

13 Capitol Recap is a comprehensive daily report on legislative and executive actions in the Pennsylvania capitol and is compiled and edited by PLS.

For subscription information, questions or more information contact PLS at [email protected] or 717-236-6984.Thank you, Lynn, Kim, Jeff, Mike, Matt Hess, Nina, Matt Hykes, Deborah, Kara, Cheryl, Andre, Aaron, Becky, Amyra, Nick, Jessica, Nicole, Stephen, Robert and Derek.

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