Opinion
Opinion By: Chris Gorman, Attorney General; Lynne Schroering, Assistant Attorney General
As legal counsel for the Workers' Compensation Funding Commission you have requested an opinion from our office regarding the investment of Commission funds by the Office of Financial Management and Economic Analysis (OFMEA).
Specifically you inquire:
1. Does OFMEA's combining of the Commission's funds for overnight investment violate KRS 342.1223(2)(a).
2. Does OFMEA's "lending" of the Commission's securities constitute a violation of KRS 342.1227 regarding prohibitions against loan or transfer to the Commonwealth.
As background, you explain that the Workers' Compensation Funding Commission was created by House Bill I of the 1987 Extraordinary Session of the General Assembly. The Commission is an agency of the Commonwealth created for the public purpose of controlling, investing and managing the funds collected pursuant to KRS 342.122. KRS 342.122(1)(b) and (c) authorize that a special fund assessment be imposed upon workers' compensation premiums received by every insurance carrier writing workers' compensation insurance in Kentucky and every self-insurer operating pursuant to KRS 342.350(4). All assessments collected pursuant to KRS 342.122 shall be paid to the Workers' Compensation Funding Commission. KRS 342.122(3).
The duties of the Commission include:
(2) The commission shall:
(a) Hold, administer, invest, and reinvest the funds collected pursuant to KRS 342.122 and its other funds separate and apart from all "state funds" or "public funds, " as defined in KRS Chapter 446;
(b) Act as a fiduciary, as defined in KRS Chapter 386, in exercising its power over the funds collected pursuant to KRS 342.122, and may invest association funds through one (1) or more banks, trust companies, or other financial institutions with offices in Kentucky in good standing with the Department of Financial Institutions, in investments described in KRS Chapter 386. Provided, however, the commission shall not invest any of the funds collected pursuant to KRS 342.122 in any corporation, company, partnership, or other business entity, or any bank, investment service firm, or other financial entity which directly or indirectly maintains operations or has financial dealings with the Republic of South Africa;
(c) Report to the General Assembly at each regular session the actuarial soundness and adequacy of the funding mechanism for the special fund and other funds supported by such mechanism, including detailed information on the investment of funds and yields thereon;
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(g) Conduct periodic audits independently or in cooperation with the Labor Cabinet or the Revenue Cabinet of all entities subject to the assessments imposed in KRS 342.122[.]
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(3) The commission shall have all of the powers necessary or convenient to carry out and effectuate the purposes for which it was established including, but not limited to, the power:
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(c) To contract for investment counseling, legal, actuarial, auditing, and other professional services in accordance with the provisions relating to personal service contracts contained in KRS Chapter 45A;
(d) To appoint, hire, and contract with banks, trust companies, and other entities to serve as depositories and custodians of its investment receipts and other funds;
(e) To take any and all other actions consistent with the purposes of the commission and the provisions of this chapter; and
(f) To make and promulgate administrative regulations.
(4) Notwithstanding the provisions of KRS Chapter 342 to the contrary, the Kentucky Workers' Compensation Funding Commission shall utilize the investment expertise and advice of the Office of Financial Management and Economic Analysis rather than entering into a consulting contract for investment counseling. The fees charged by financial institutions for managing the investments of the funds of the funding commission shall be paid from the investment earnings of such funds.
KRS 342.1223.
You explain that the Commission places its funds with the Office of Financial Management and Economic Analysis for short term investments. You state that OFMEA "combines" the Commission's funds with funds from other state agencies and invests the combined funds in overnight investments. You note that although the funds are combined, OFMEA keeps a separate accounting of the funds belonging to the Commission and other agencies.
KRS 342.1223(4) provides that the Commission "shall" use the financial investment expertise and advice of OFMEA rather than entering into a consulting contract for investment counseling. Thus, the Commission is statutorily required to utilize the investment services offered by OFMEA. The functions and duties of OFMEA are governed by state law and set forth in KRS 42.410. Included among its duties, OFMEA is required to provide analysis and management of short and long-term cash flow requirements and to maximize the return on state investments given the cash flow and liquidity requirements. KRS 42.410(1)(a) and (b).
Your first question asks if OFMEA's combining the Commission's funds for overnight investment violates KRS 342.1223(2)(a) relating to keeping the funds separate and apart from all other state funds.
We do not believe that OFMEA's overnight investment of the Commission's funds is impermissible under KRS 342.1223(2)(a). OFMEA invests a large pool of state funds, which includes the Commission's funds, and is able to obtain a larger return on the short term investments for the state funds and Commission funds. The Commission's funds are not considered part of the state's general fund and the funds are statutorily restricted pursuant to KRS 342.1227. OFMEA maintains separate accounts and records for the funds of the Commission. The funds are not commingled with the state funds any more than a bank depositor's funds are commingled with other depositor's funds. The bank does not segregate each depositor's money and instead combines all deposits to obtain the best return of investment. The bank maintains separate account balances for all customers and customers may withdraw their funds at any time. Like a bank depositor, OFMEA keeps the Commission's investment funds in a separate account and the Commission has the power to control its investment portfolio.
The overnight investment of the Commission's funds is fully protected as it is 102% collateralized and the Commission may direct any change in the investment of their funds in a one day time period. Since OFMEA maintains separate accounts for the Commission funds, and since the funds are 102% collateralized and under the ultimate investment control of the Commission, we believe that OFMEA's short-term investment of Commission funds does not violate KRS 342.1223(2)(a). Additionally, OFMEA's investment of the Commission's funds together with the state funds is a wise economic investment and enables the Commission to obtain a greater return on its investment without an increased risk.
At this point we emphasize that the Commission's funds are private funds and not subject to state control. KRS 342.122 and KRS 342.1227. In a case dealing with the predecessor to the Commission, the Kentucky Supreme Court clearly stated that the premiums collected by the Kentucky Reinsurance Association (now called the Workers' Compensation Funding Commission) are private funds and not public funds.
Thompson v. Kentucky Reinsurance Association, Ky., 710 S.W.2d 855, 858 (1986). Thus, the Commission has ultimate control and discretion over the investment of its funds.
You also inquire if OFMEA'S "lending" of the Commission's securities constitutes a violation of KRS 342.1227 regarding prohibiting the loan or transfer of Commission funds. You explain that OFMEA frequently uses the Commission's long-term investments such as government securities and "lends" them to New York financial institutions on an overnight or short-term basis. It is your understanding that the loans are collateralized by the financial institutions putting up their own government securities.
The Commission's funds are statutorily restricted in KRS 342.1227 which provides:
Funds which are under the jurisdiction of the commission shall not:
(1) Be loaned to the Commonwealth or any instrumentality or agency thereof;
(2) Be subject to transfer to the Commonwealth or any agency or instrumentality thereof, except for purposes specifically authorized by this chapter;
(3) Be expended for any other purpose than one authorized by this chapter.
The State Investment Commission has the statutory authority to invest state monies pursuant to KRS 42.500 and KRS 42.505; however, OFMEA is required to provide staff assistance to the State Investment Commission and to execute all investments on behalf of the Commission. KRS 42.410(1)(h) and 200 KAR 14:081E Section 3.
The securities lending program that you have questioned is also referred to as a "repurchase agreement" or "repo" and is statutorily authorized in KRS 42.500(8) which provides:
Any investment in obligations and securities pursuant to subsection (6) of this section shall satisfy this section if these obligations are subject to repurchase agreements, provided that delivery of these obligations is taken either directly or through an authorized custodian.
A repurchase agreement is defined in 200 KAR 14:081E Sections 1 and 2 which state:
(3) "Repurchase agreement" means an actual, conditional purchase of securities of the United States Treasury, any agency instrumentality or corporation of the United States, or any other security authorized for investment pursuant to KRS 42.500(6), with an agreement to resell the securities to their original owner on a specific date in the future.
Section 2. General. The use of repurchase agreements as a vehicle by which to channel state investable funds into commercial banks and savings and loan associations provides distinct advantages to both parties. The banks and savings and loan associations do not have to post reserves against these funds in that they are not defined as deposits by their regulatory agencies. Secondly, they do not have to bear increased premiums for deposit insurance. The result is that the state may receive a higher yield for its investment. Further, repurchase agreements, in general, provide the maximum available yield to the state's portfolio of the alternatives statutorily available to the commission in managing short-term funds.
We do not believe that the repurchase agreements used by OFMEA to invest the Commission's funds are a loan or transfer to the Commonwealth pursuant to KRS 342.1227. The repurchase agreement is a statutorily recognized method of investment pursuant to KRS 42.500(8) and 200 KAR 14:081E. The repurchase agreements utilizing Commission funds are 102% collateralized with separate accounts established at the custodian bank as well as for the OFMEA internal accounts.
In summary, we do not believe that OFMEA's lending of the Commission's securities constitutes a violation of KRS 342.1227 based on the statutory authority for OFMEA to invest funds in repurchase agreements combined with the separate accounting and full collateralization of the Commission funds.