Attachment K - KWCFC FY21 Audited Financial Statements.pdf

KENTUCKY WORKERS’ COMPENSATION

FUNDING COMMISSION

FINANCIAL STATEMENTS

AND

REPORT OF INDEPENDENT AUDITORS

JUNE 30, 2021

KENTUCKY WORKERS’ COMPENSATION FUNDING COMMISSION

TABLE OF CONTENTS

Page

Report of Independent Auditors

Management’s Discussion and Analysis

Basic Financial Statements

Statements of Net Position

Statements of Revenues, Expenses, and Changes in Net Position

Statements of Cash Flows

Statement of Fiduciary Net Position-Custodial Fund

Statement of Changes in Fiduciary Net Position-Custodial Fund

Notes to Financial Statements

Required Supplementary Information

Schedule of Proportionate Share of the Net Pension Liability

Schedule of Pension Contributions

Schedule of Proportionate Share of the Net OPEB Liability

Schedule of OPEB Contributions

Report of Independent Auditors on Internal Control Over Financial Reporting and on Compliance and Other Matters Based on an Audit of Financial Statements Performed in Accordance with Government Auditing Standards

Schedule of Findings and Responses

Schedule of Prior Year Findings and Their Responses

Blue & Co., LLC / 250 West Main Street, Suite 2900 / Lexington, KY 40507 main 859.253.1100 fax 859.253.1384 email blue@blueandco.com

REPORT OF INDEPENDENT AUDITORS

To the Board of Directors Kentucky Workers’ Compensation Funding Commission

We have audited the accompanying financial statements of the Kentucky Workers' Compensation Funding Commission (the Funding Commission), as of and for the year ended June 30, 2021, and the related notes to the financial statements, which collectively comprise the Funding Commission’s basic financial statements as listed in the table of contents.

Management’s Responsibility for the Financial Statements

Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error.

Auditors’ Responsibility

Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditors’ judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

Opinion

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Funding Commission as of June 30, 2021, and the changes in its financial position, and its cash flows for the year then ended in accordance with accounting principles generally accepted in the United States of America.

Change in Accounting Principle

As described in Note 2 to the financial statements, the Funding Commission adopted Government Accounting Standards Board Statement No. 84 – Fiduciary Activities. Our opinion is not modified with respect to this matter.

Required Supplementary Information

Accounting principles generally accepted in the United States of America require that the management’s discussion and analysis, on pages 3-10, the schedule of proportionate share of the net pension liability and the schedule of pension contributions on pages 44-45, and the schedule of proportionate share of the net OPEB liability and the schedule of OPEB contributions on pages 46-47, be presented to supplement the basic financial statements. Such information, although not a part of the basic financial statements, is required by the Governmental Accounting Standards Board, who considers it to be an essential part of financial reporting for placing the basic financial statements in an appropriate operational, economic, or historical context. We have applied certain limited procedures to the required supplementary information in accordance with auditing standards generally accepted in the United States of America, which consisted of inquiries of management about the methods of preparing the information and comparing the information for consistency with management’s responses to our inquiries, the basic financial statements, and other knowledge we obtained during our audit of the basic financial statements. We do not express an opinion or provide any assurance on the information because the limited procedures do not provide us with sufficient audit evidence to express an opinion or provide any assurance.

Other Reporting Required by Government Auditing Standards

In accordance with Government Auditing Standards, we have also issued our report dated September 21, 2021, on our consideration of the Funding Commission's internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts, grant agreements, and other matters. The purpose of that report is to describe the scope of our testing of internal control over financial reporting and compliance and the results of that testing, and not to provide an opinion on internal control over financial reporting or on compliance. That report is an integral part of an audit performed in accordance with Government Auditing Standards in considering the Funding Commission’s internal control over financial reporting and compliance.

Lexington, Kentucky September 21, 2021

MANAGEMENT’S DISCUSSION AND ANALYSIS

This narrative presents management’s perspective of the fiscal year 2021 audit of the Special Fund, Coal Workers’ Pneumoconiosis Fund (CWPF), and the Self Insurance Fund. We hope our analysis will help readers understand the financial position and results of operations for these restricted funds.

Highlights of Fiscal Year 2021

Investments of the Special Fund increased to approximately $332.7 million at June 30, 2021 from approximately $326.9 million at June 30, 2020, primarily as a result of reinvested investment income.

Kentucky Workers’ Compensation Funding Commission

Special Fund

The Kentucky Workers’ Compensation Funding Commission (Funding Commission) was created through the enactment of House Bill No. 1 by the 1987 Extraordinary Session of the General Assembly, Commonwealth of Kentucky (Commonwealth) effective October 26, 1987, to act as an agency of the Commonwealth for the public purpose of controlling, investing, and managing the funds collected pursuant to House Bill No. 1, an act relating to workers’ compensation. The Funding Commission collects workers’ compensation Special Fund Assessments and uses such assessments to fund specific labor related programs, the Funding Commission, the Special Fund, and the Uninsured Employers’ Fund. Accumulated assessments in excess of required transfers remain in the Benefit Reserve Fund and are invested in fixed income securities as recommended by the Funding Commission’s investment advisory firm. In 2010, the General Assembly approved an extension of the sunset date from 2018 to 2029 for accumulating sufficient reserves to fund outstanding claims.

Coal Workers’ Pneumoconiosis Fund

The CWPF was created through the enactment of House Bill No. 1 by the December 1996 Special Session of the General Assembly. The CWPF was originally established to be liable for one-half of the income benefits and retraining incentive benefits for pneumoconiosis claims with date of last exposure on or after December 12, 1996. To fund the pneumoconiosis claims, and to finance its administration and operation, assessments were imposed upon workers’ compensation premiums received on or after January 1, 1997, through December 31, 2019 from employers, insurance carriers and self-insured engaged in the severance or processing of coal. An additional CWPF assessment was imposed on the tonnage of coal severed on or after January 1, 1997 through December 31, 2019. Pursuant to House Bill No. 377, An Act Relating to the Workers’ Compensation Funding Commission, the CWPF ended its liability for income benefits for coal workers pneumoconiosis claims filed or reopened on or after July 1, 2017. Furthermore, the enacted bill mandated that all assets and liabilities of the CWPF be transferred to Kentucky Employers’ Mutual Insurance (KEMI) through a loss portfolio transfer agreement, which occurred at the start of fiscal 2018. Assessments continue to be collected by the Funding Commission, which are subsequently transferred to KEMI after the end of each quarter. The

Funding Commission has re-categorized the CWPF from a fiduciary fund to an enterprise fund during fiscal 2021 due to GASB 84. See Note 2.

Self-Insurance Fund

The Self-Insurance Fund was established by Kentucky Revised Statute (KRS) 342.920 to protect employees of workers’ compensation self-insured employers who had claims for injuries that occurred prior to the creation of the workers’ compensation self-insurance guaranty funds. The Self-Insurance Fund was established for the purpose of making payments to workers’ compensation claimants injured prior to March 1, 1997, when the security of a former self-insured employer has been depleted. All amounts collected after July 12, 2006, as fines and penalties under KRS 342.267 and 342.990 are paid into the Self Insurance Fund. The Department of Workers Claims has collected fines and penalties which have been remitted to the Funding Commission for the purpose of investment. The Funding Commission has established a custodial fund, the Self Insurance Fund, to account for the funds held and invested on behalf of the Department of Workers Claims.

Financial Statements

The audited financial statements include a statement of net position, a statement of revenues, expenses, and changes in net position and a statement of cash flows for the year ended June 30, 2021.

The Funding Commission financial statements are blended with the Department of Workers’ Claims and add the outstanding claim liabilities for the Special Fund in the Commonwealth of Kentucky financial statements.

The statement of net position presents information on all of the Funding Commission’s assets and liabilities, with the difference between the two reported as net position. Over time, increases or decreases in net position may serve as a useful indicator of whether the financial position of the Funding Commission is improving or deteriorating.

The statement of revenues, expenses, and changes in net position presents information showing how the Funding Commission’s net position changed during the most recent fiscal year. All changes in net position are reported as soon as the underlying event giving rise to the change occurs, regardless of the timing of the related cash flows. Thus, revenues and expenses are reported in this statement for some items that will only result in cash flows in future fiscal periods.

The statement of cash flows provides relevant information about the cash receipts and cash payments of the Funding Commission during the fiscal year. The statement should help users assess the Funding Commission’s ability to generate future net cash flows, meet future obligations as they become due, the Funding Commission’s need for future external financing, the reasons for the differences in operating and related cash receipts and payments, and the effects on the financial position of cash and non-cash investing, capital, non-capital, and financing activities.

The notes to the financial statements provide additional information that is essential to a full understanding of the data provided in the basic financial statements.

Financial Analysis of the Funding Commission as a Whole

Each of the funds managed by the Funding Commission are restricted for payment of specific types of claim liabilities. Therefore, an overall analysis of the Funding Commission financial statements must focus on each fund rather than the Funding Commission as a whole.

However, all investments of the Funding Commission are managed using the same Investment Policy Statement which establishes the following principles:

Adherence to the “prudent man” rule that requires exercising that degree of judgment and care under the circumstances then prevailing which persons of prudence, discretion, and intelligence, who are familiar with such matters would follow in management of their own affairs in investment matters.

Invest funds in a manner which will meet the unique objectives of each fund while minimizing the investment risk exposure of the funds; the primary goal being the safety of the principal and liquidity of the investments while providing the financial wherewithal to meet future benefit obligations.

Utilize the Office of Financial Management and/or an investment consulting firm to provide expert, professional judgment related to investment decisions.

Adoption of specific guidance for each category of assets to ensure a framework for monitoring quality, diversification, and liquidity.

Note 4 on pages 22 - 26 provides more details about risk management of the Funding Commission’s investments. KRS 342.1223(2)(b) directs the Funding Commission to follow guidance in KRS Chapter 386 for investing the funds collected to finance the workers’ compensation liabilities. KRS 386.020 outlines a variety of allowable investments for the funds administered by the Funding Commission.

Financial Analysis of Restricted Funds

Special Fund

Table 1 summarizes the net position of the Special Fund and Table 2 outlines the changes in net position for 2021 and 2020.

TABLE 1

KENTUCKY WORKERS' COMPENSATION FUNDING COMMISSION

SPECIAL FUND SUMMARY OF NET POSITION AS OF JUNE 30, 2021 AND 2020

(In Thousands)

2021 2020 PCT CHG

Current assets 22,529$ 29,785$ -24.4% Restricted investments 332,740 326,907 1.8%

Total assets 355,269 356,692 -0.4%

Deferred outflows of resources 1,312 1,762 -25.5%

Total assets and deferrals 356,581$ 358,454$ -0.5%

Current liabilities 1,373$ 1,366$ 0.5% Long-term liabilities 8,690 8,838 -1.7%

Total liabilities 10,063 10,204 -1.4%

Deferred inflows of resources 336 345

Total liabilities and deferrals 10,399 10,549 -1.4%

Restricted net position 346,182$ 347,905$ -0.5%

Current assets decreased as a result of operating transfers exceeding operating income. Restricted investments increased due to the reinvestment of investment income, which was greater than the unrealized and realized losses recognized during the fiscal 2021. During the fiscal year, withdrawals from restricted investments were not required to fund operating transfers.

TABLE 2

KENTUCKY WORKERS' COMPENSATION FUNDING COMMISSION

SPECIAL FUND SUMMARY OF CHANGES IN NET POSITION FOR THE YEARS ENDED JUNE 30, 2021 AND 2020

(In Thousands)

2021 2020 PCT CHG

Operating revenues 63,535$ 67,777$ -6.3% Operating expenses (1,829) (2,326) 21.4% Nonoperating revenues (expenses) 5,213 27,818 -81.3% Transfers-claims (40,131) (46,823) 14.3% Transfers-administrative costs (28,510) (30,004) 5.0%

Change in net position (1,722)$ 16,442$ -110.5%

Operating revenues include assessments, penalties, and interest imposed as a result of audits of insurance companies and self-insured entities.

Transfers for both claims and administrative costs represent cash balances transferred to the Labor Cabinet to fund actual payments. In addition, claim transfers also include amounts remitted to the Attorney General’s office for management of the Uninsured Employers Fund (claims and administrative costs). However, these amounts include changes in cash balances as well as shift in the underlying cost elements. Additional information about these amounts is provided in the Special Fund financial statements. Transfers to the Labor Cabinet and Kentucky Occupational Safety and Health were $28.5 and $30.0 million for each fiscal year ending in 2021 and 2020, respectively. These transfers are also based on the Commonwealth’s Enacted Budget.

Coal Workers’ Pneumoconiosis Fund

Table 3 summarizes the financial position of the CWPF and Table 4 outlines the changes in net position for 2021 and 2020.

TABLE 3

COAL WORKERS' FUND SUMMARY OF NET POSITION AS OF JUNE 30, 2021 AND 2020

(In Thousands)

2021 2020 PCT CHG

Current assets 882$ 2,526$ -65.1% Restricted investments 267 -0- 0.0%

Total assets 1,149$ 2,526$ -54.5%

Current liabilities -0-$ 1,789 -100.0%

Restricted net position 1,149$ 737$ 55.9%

Assets in the CWPF decreased as a result of the transfers to KEMI and refunds paid during the year.

TABLE 4

COAL WORKERS' FUND SUMMARY OF CHANGES IN NET POSITION FOR THE YEARS ENDED JUNE 30, 2021 AND 2020

(In Thousands)

2021 2020 PCT CHG

Operating revenues (808)$ 2,666 -130.3% Operating expenses (269) (102) -163.7% Nonoperating revenues (expenses) 1,489 (7,371) 120.2%

Change in net position 412$ (4,807)$ 108.6%

The Funding Commission earned CWPF assessments totaling $(808,000) as a result of refunds and credits exceeding assessments earned, which is significantly less than the prior fiscal year and is expected as the CWPF approaches closure. Effective on January 1, 2020, the CWPF assessment and tonnage rates were set to 0% and $0.00 cents per ton, respectively, since the related claims liability was actuarially determined to be fully funded. Accordingly, not only were transfers to KEMI of $617,000 significantly less than the prior fiscal year, but the Funding Commission also received $2.1 million from KEMI, which was refunded to insurers in the current fiscal year.

Self-Insurance Fund

Table 5 summarizes the financial position of the Self-Insurance Fund and Table 6 outlines the changes in net position for 2021 and 2020.

TABLE 5

SELF INSURANCE FUND SUMMARY OF NET POSITION

AS OF JUNE 30, 2021 AND 2020

(In Thousands)

2021 2020 PCT CHG

Current assets 8,650$ 3,905$ 121.5% Restricted investments 895 5,665 -84.2%

Total assets 9,545$ 9,570$ -0.3%

Restricted net position 9,545$ 9,570$ -0.3%

Restricted investments decreased as a result of selling three mutual funds in preparation for a change in investment strategy to begin in fiscal 2022.

TABLE 6

SELF INSURANCE FUND SUMMARY OF CHANGES IN NET POSITION FOR THE YEARS ENDED JUNE 30, 2021 AND 2020

(In Thousands)

2021 2020 PCT CHG

Penalty and interest collected for another government 589$ 885$ -33.4% Net investment earnings 185 317 -41.6% Distributions to another government (800) (1,300) 38.5%

Change in net position (26)$ (98)$ 73.5%

The change in net position of the Self Insurance Fund decreased as a result of penalty funds received in the amount of $589,172, interest and dividend income of $76,481, and the change in market value of $108,322, which were less than the amount of $800,000 transferred out to pay claims.

Current Year’s Budget

The Funding Commission’s operating budget, which includes transfers to Workers Claims, the Uninsured Employers Fund, Kentucky Occupational Safety and Health, and the Funding Commission (administrative expenses) for fiscal years 2021 and 2020 was $97 million and $107 million, respectively.

Actual expenditures were $71 million (73% of budget) in fiscal 2021 and $79 million (74% of budget) in fiscal 2020.

Fiduciary Funds

As described in Note 2 to the financial statements, the Funding Commission adopted Government Accounting Standards Board Statement No. 84 – Fiduciary Activities on July 1, 2020. Fiduciary funds are used to account for resources held for the benefit of individuals or units outside of the Funding Commission. The Funding Commission is the fiduciary responsible for the assets. The Funding Commission is responsible for ensuring that the assets reported in this fund are used for their intended purposes. All of the Funding Commisson’s fiduciary activities are reported in a separate statement of fiduciary net position and a statement of changes in fiduciary net position. The statement of fiduciary net position and the statement of changes in fiduciary net position can be found on pages 15 and 16, respectively, of this report.

Contacting the Funding Commission’s Financial Management

This discussion and analysis is intended to provide a general overview of the finances and operations of the Funding Commission. If further information is needed, please contact Kim C. Hay, Director of Fiscal Operations, Kentucky Workers’ Compensation Funding Commission, 42 Mill Creek Park, Frankfort, KY 40601, 502-931-1110.

Sincerely, Kim C. Hay Director of Fiscal Operations

Funding Commission

STATEMENTS OF NET POSITION

See accompanying notes to the financial statements.

Coal Workers' Pneumoconiosis

Special Fund Fund Totals Assets:

Current assets:

Cash and cash equivalents 4,005,586$ 829,088$ 4,834,674$ Accounts receivable 189,566 -0- 189,566 Assessments receivable 15,434,023 52,660 15,486,683 Accrued interest receivable 2,899,558 -0- 2,899,558

Total current assets 22,528,733 881,748 23,410,481

Restricted investments 332,739,442 267,195 333,006,637

Total assets 355,268,175 1,148,943 356,417,118

Deferred outflows of resources:

Deferred outflows - pension 893,556 -0- 893,556 Deferred outflows - OPEB 418,932 -0- 418,932

Total deferred outflows of resources 1,312,488 -0- 1,312,488

Total assets and deferrals 356,580,663$ 1,148,943$ 357,729,606$

Liabilities:

Current liabilities:

Accrued expenses 571,160$ -0-$ 571,160$ Compensated absences 86,938 -0- 86,938 Refunds payable 714,648 -0- 714,648

Total current liabilities 1,372,746 -0- 1,372,746

Noncurrent liabilities:

Long-term compensated absences 20,468 -0- 20,468 Net pension liability 7,351,597 -0- 7,351,597 Other post-employment benefits liability 1,317,719 -0- 1,317,719

Total noncurrent liabilities 8,689,784 -0- 8,689,784

Total liabilities 10,062,530 -0- 10,062,530

Deferred inflows of resources:

Deferred inflows - pension 144,462 -0- 144,462 Deferred inflows - OPEB 191,677 -0- 191,677

Total deferred inflows of resources 336,139 -0- 336,139

Total liabilities and deferrals 10,398,669 -0- 10,398,669

Net Position:

Restricted 346,181,994$ 1,148,943$ 347,330,937$

STATEMENTS OF REVENUES, EXPENSES, AND CHANGES IN NET POSITION

YEAR ENDED JUNE 30, 2021

Special Pneumoconiosis Fund Fund Totals

Operating revenues:

General assessments 61,209,549$ (808,045)$ 60,401,504$

Penalty and interest income 2,038,483 -0- 2,038,483 Audit reimbursements 287,267 -0- 287,267

Total operating revenues 63,535,299 (808,045) 62,727,254

Operating expenses 1,828,738 269,324 2,098,062

Net operating income (loss) 61,706,561 (1,077,369) 60,629,192

Nonoperating revenues (expenses):

Net decrease in the fair value of investments (6,596,412) -0- (6,596,412) Interest revenue 11,809,786 5,291 11,815,077

Net payment from Kentucky Employers' Mutual Insurance -0- 1,483,279 1,483,279

Total nonoperating revenues (expenses) 5,213,374 1,488,570 6,701,944

Income before operating transfers 66,919,935 411,201 67,331,136

Operating transfers:

Workers' compensation payments:

Office of workers claims (36,135,900) -0- (36,135,900) Uninsured employers fund (3,995,100) -0- (3,995,100)

Administrative expenses:

Labor Cabinet (27,839,800) -0- (27,839,800) Kentucky Occupational Safety and Health (670,800) -0- (670,800)

Total operating transfers (68,641,600) -0- (68,641,600)

Changes in net position (1,721,665) 411,201 (1,310,464)

Net position, beginning of year (as restated for CWPF) 347,903,659 737,742 348,641,401

Net position, end of year 346,181,994$ 1,148,943$ 347,330,937$

STATEMENTS OF CASH FLOWS

Pneumoconiosis Special Fund Fund Totals

Operating activities:

Assessments collected:

Special Fund-public 60,779,032$ (1,835,921)$ 58,943,111$ Special Fund-state 1,406,331 -0- 1,406,331 Penalty and interest collected 2,264,567 -0- 2,264,567 Audit expense reimbursements 287,267 -0- 287,267 Cash payments for:

Refunds (1,196,941) -0- (1,196,941) Goods and services (309,872) (768,781) (1,078,653) Employee salaries and benefits (1,199,637) -0- (1,199,637)

Net cash flows from operating activities 62,030,747 (2,604,702) 59,426,045

Noncapital financing activities:

Operating transfers to:

Workers compensation claims (40,131,000) -0- (40,131,000) Labor Cabinet (27,839,800) -0- (27,839,800) Kentucky Occupational Safety and Health Review Commission (670,800) -0- (670,800) Payment from Kentucky Employers' Mutual Insurance -0- 1,483,279 1,483,279

Net cash used in noncapital financing activities (68,641,600) 1,483,279 (67,158,321)

Investing activities:

Investment income 11,766,914 5,291 11,772,205 Investment purchases (101,272,313) (267,194) (101,539,507) Investment sales and maturities 89,074,565 -0- 89,074,565

Net cash flows from investing activities (430,834) (261,903) (692,737)

Net change in cash and cash equivalents (7,041,687) (1,383,326) (8,425,013)

Cash and cash equivalents, beginning of year 11,047,273 2,212,414 13,259,687

Cash and cash equivalents, end of year 4,005,586$ 829,088$ 4,834,674$

STATEMENTS OF CASH FLOWS

Pneumoconiosis Special Fund Fund Totals

Reconciliation of net operating income (loss) to net cash flows from operating activities

Net operating income (loss) 61,706,561$ (1,077,369)$ 60,629,192$ Adjustments to reconcile net operating income (loss) to net cash flows from operating activities (Increase) decrease in:

Accounts receivable 141,311 -0- 141,311 Assessments receivable 115,907 63,104 179,011 Interfund receivable -0- 198,188 198,188 Deferred outflows 449,843 -0- 449,843 Increase (decrease) in:

Accrued expenses 20,370 (499,457) (479,087) Compensated absences 23,290 -0- 23,290 Refunds payable (54,073) (1,289,168) (1,343,241) Interfund payable (198,188) -0- (198,188) Deferred inflows (9,449) -0- (9,449)

Other post-employment benefits liability 116,355 -0- 116,355 Net pension liability (281,180) -0- (281,180)

Net cash flows from operating activities 62,030,747$ (2,604,702)$ 59,426,045$

Supplemental disclosure of noncash investing activities:

Net change in fair value of investments (6,596,412)$

Due to broker within accrued expenses exchanged for investments 325,000$

STATEMENT OF FIDUCIARY NET POSITION–CUSTODIAL FUND

Self Insurance Fund

Assets:

Current assets:

Cash and cash equivalents 8,622,780$ Penalty receivable 27,086 Accrued interest receivable 17 Total current assets 8,649,883

Other assets:

Investments 894,785

Total assets 9,544,668$

Net Position:

Restricted for:

Organizations and other governments 9,544,668$

STATEMENT OF CHANGES IN FIDUCIARY NET POSITION–CUSTODIAL FUND

Self Insurance Fund

Additions:

Penalty and interest 589,172 Investment earnings:

Net increase in the fair value of investments 108,322 Interest 76,481

Total investment earnings 184,803 Total additions 773,975

Deductions:

Distributions to other organization 800,000

Total deductions 800,000

Change in net position (26,025)

Net Position - Beginning of year, as restated 9,570,693

Net Position - end of year 9,544,668$

NOTES TO FINANCIAL STATEMENTS

1. GENERAL INFORMATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Kentucky Worker’s Compensation Funding Commission

The Kentucky Workers’ Compensation Funding Commission (Funding Commission) was created by Kentucky Revised Statute (KRS) 342.1223 effective October 26, 1987, to act as an agency of the Commonwealth of Kentucky (Commonwealth) for the public purpose of controlling, investing and managing the funds collected pursuant to KRS 342.1222. The Funding Commission collects workers’ compensation Special Fund assessments and transfers such amounts as are necessary to pay administrative expenses and current claims of the Workers’ Compensation Special Fund (Special Fund) and the Uninsured Employers’ Fund. Accumulated Special Fund assessments in excess of required transfers remain in the Benefit Reserve Fund of the Funding Commission. The Funding Commission also collects Coal Workers’ Pneumoconiosis Fund (CWPF) assessments, which are required to be transferred to Kentucky Employers’ Mutual Insurance (KEMI) Authority each quarter.

Special Fund

The assessments authorized by the enabling legislation are intended to generate an amount projected to provide sufficient cash reserves to fund the Commonwealth’s workers’ compensation subsequent injury liability incurred prior to December 12, 1996, the liabilities of the Commonwealth’s Uninsured Employers’ Fund, plus the payment of various administrative costs for the Labor Cabinet. These assessments are accumulated and reported in the Special Fund in the accompanying financial statements. In accordance with KRS 342.122, the Funding Commission shall impose annually a Special Fund assessment rate, which was 7.02% and 6.41% for calendar years 2021 and 2020, respectively, upon the amount of workers’ compensation premiums received by insurance carriers writing workers’ compensation insurance in the Commonwealth, by every group of self-insurers operating under the provisions of KRS 342.350(4) and against the premium, as defined in KRS 342.0011, of every employer carrying his or her own risk. Each calendar year, the Funding Commission shall adjust the Special Fund assessment rate to produce enough revenue to amortize, on a level basis, the projected liability of the Special Fund. In January 2010, the Kentucky General Assembly revised this statute to extend the sunset date for achieving full-funded status from December 31, 2018, to December 31, 2029.

Coal Workers’ Pneumoconiosis Fund

The CWPF was created within the Labor Cabinet through the enactment of KRS 342.1242 by the December 1996 Special Session of the General Assembly. The CWPF was established to be liable for one-half of the income benefits and retraining incentive benefits for pneumoconiosis resulting from exposure to coal dust created in the severance or processing of coal. The employer was liable for the remaining one-half.

To fund and prefund the pneumoconiosis claims, and to finance its administration and operation, an assessment was imposed upon workers’ compensation premiums and tonnage of coal severed on or after January 1, 1997 through December 31, 2019, from employers, insurance carriers and self-insured companies engaged in the severance or processing of coal.

On April 10, 2017, Kentucky House Bill No. 377, An Act Relating to the Workers Compensation Funding Commission, was signed into law by the Governor. The provisions in the bill closed the CWPF effective July 1, 2017, to any coal workers’ pneumoconiosis claims filed after June 30, 2017. Assets and liabilities of the Kentucky Coal Workers Pneumoconiosis Fund were transferred through a loss portfolio transfer agreement to KEMI, which is a nonprofit, independent, self-supporting municipal corporation and political subdivision of the Commonwealth. Under the provisions of the loss portfolio transfer agreement, the Funding Commission will continue to collect assessments for the CWPF and forward them to KEMI. KEMI may also transfer funds to the CWPF as needed to cover refunds, credits, and settlements. KEMI transferred $2.1 million to the CWPF for such purposes, and the CWPF transferred $617,000 to KEMI in collected assessments during fiscal 2021. Furthermore, the Funding Commission has re-categorized the CWPF from a fiduciary fund to an enterprise fund due to the Government Accounting Standards Board’s (GASB) Statement No. 84. See Note 2.

Self-Insurance Fund

The Self-Insurance Fund was established by KRS 342.920 to protect employees of workers’ compensation self-insured employers who had claims for injuries that occurred prior to the creation of the workers’ compensation self-insurance guaranty funds. The Self-Insurance Fund was established for the purpose of making payments to workers’ compensation claimants injured prior to March 1, 1997, when the security of a former self-insured employer has been depleted.

All amounts collected after July 12, 2006, as fines and penalties under KRS 342.267 and 342.990 are paid into the Self-Insurance Fund. The Department of Claims has collected fines and penalties which have been remitted to the Funding Commission for the purpose of investment. The Funding Commission has established a custodial fund, the Self-Insurance Fund, to account for the funds held and invested.

Reporting Entity

The Funding Commission’s activities are combined with the workers’ compensation liability and activity of the Special Fund and the Uninsured Employers’ Fund and accounted for by the Commonwealth in a public entity risk sharing pool in the Commonwealth’s Annual Comprehensive Financial Report

(ACFR).

Measurement Focus, Basis of Accounting, and Financial Statement Presentation

The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for state governments as prescribed by the GASB.

The Special Fund and CWPF are presented as enterprise funds and are reported using the economic resources measurement focus and the accrual basis of accounting. Revenues are recorded when earned and expenses are recorded when a liability is incurred, regardless of the timing of related cash flows.

The Kentucky Workers’ Compensation Funding Commission reports the Special Fund and the CWPF as the only major proprietary funds.

Additionally, the Funding Commission reports the Self-Insurance Fund as a custodial fund, which account for funds held for custodial purposes only. The custodial fund is reported using the economic resources measurement focus and the accrual basis of accounting. The recognition of certain liabilities to beneficiaries occur when an event compels the government to disburse fiduciary resources such as when a demand for the resources has been made or when no further action, approval, or condition is required to be taken or met by the beneficiary to release the assets.

Proprietary funds distinguish operating revenues and expenses from non-operating items. Operating revenues and expenses generally result from providing services and producing and delivering goods in connection with a proprietary fund’s principal ongoing operations. The principal operating revenues of the Kentucky Workers’ Compensation Funding Commission are assessments levied on insurance companies and employers. Operating expenses for proprietary funds include administrative expenses.

Non-operating revenues and expenses include investment related transactions, including net changes in fair values, management fees, interest, and dividend income. Transfers to fund workers’ compensation claims and Labor Cabinet administrative expenses are also segregated in the statement of revenues, expenses, and changes in net position.

Use of Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the related disclosures. Certain estimates relate to unsettled transactions and events as of the date of the financial statements. Other estimates relate to assumptions about the ongoing operations and may impact future periods. Accordingly, upon settlement, actual results could differ from estimated amounts.

Description of Net Position Classes

Restricted net position is a component of net position with constraints placed on net position used through external restrictions imposed by creditors (such as through debt covenants), grantors, contributors, or laws or regulations of other governments or limitations imposed by law through constitutional provisions or enabling legislation. All assets of the Funding Commission’s proprietary fund are restricted by enabling legislation in KRS 342.1227, 342.1242, and 393.080 for the payment of workers’ compensation claims or Labor Cabinet administrative expenses.

Net investment in capital assets is a component of net position that consists of capital assets, including restricted capital assets, net of accumulated depreciation and reduced by the outstanding balances of any bonds, mortgages, notes, or other borrowings that are attributable to the acquisition, construction, or improvements of those assets.

Unrestricted net position is a component of net position that does not meet the definition of “restricted” or “net investment in capital assets.” However, all assets of the Funding Commission meet the definition of restricted net position.

Cash and Cash Equivalents

The Funding Commission considers all highly liquid investments with maturity of three months or less when purchased to be cash equivalents.

Accounts Receivable

Accounts receivables are reported at their net invoice amounts and are reduced by the estimated portion that is expected to be uncollectible, if appropriate. At June 30, 2021, management considered all receivables to be fully collectible. Accordingly, there was no allowance for uncollectible receivables.

Certain receivables result from premium audits performed by the Funding Commission. A receivable is recognized on all finalized premium audits where the amounts due for additional assessments, penalty, interest, and audit expenses are not in protest. Receivables are not recognized on premium audits where the amount due is under protest by the insurance carrier or self-insurer.

Assessments Receivable

Assessments receivable consists of amounts outstanding at the end of the year and expected to be collected within sixty days of the fiscal year-end.

Investments

Investments in marketable securities with readily determinable fair values and all investments in debt securities are reported at their fair values in the statement of net position. Changes in the fair value of investments are included in the change in net position in the accompanying statement of revenues, expenses, and changes in net position.

Operating and Nonoperating Revenues

The Funding Commission defines operating revenues as revenues incurred through the normal operations of the Funding Commission, which includes the premium assessments, penalties and interest, and billings for audit cost reimbursements. Non-operating revenues include investment earnings and changes in fair value, as well as transfers from other funds of the Commonwealth.

Pension and Post-employment Benefits Other Than Pensions (OPEB)

For purposes of measuring the net pension and OPEB liabilities, deferred outflows of resources and deferred inflows of resources related to the pension and OPEB, and pension and OPEB expense, information about the fiduciary net position of the Kentucky Employees’ Retirement System (KERS) and addition to/deductions from KERS’s fiduciary net position have been determined on the same basis as they are reported by the Funding Commission.

KERS recognizes benefit payments (including refunds of employee contributions) when due and payable in accordance with the benefit terms. Investments are reported at fair value, except for money market investments and participating interest earning investment contracts that have a maturity at the time of purchase of one year or less, which are reported at cost. The KERS Non-hazardous Insurance Funds are reported as OPEB trust funds and are accounted for on the accrual basis of accounting.

Fiduciary Funds

Following the Funding Commission’s financial statements are separate financial statements for fiduciary funds. Fiduciary funds are excluded from the Funding Commission’s financial statements as these assets are held in a custodial capacity for the various outside organizations and cannot be used to support the Funding Commission’s programs. The Funding Commission’s Self-Insurance Fund is reported under the fiduciary funds.

2. CHANGE IN ACCOUNTING PRINCIPLE

On July 1, 2020, the Funding Commission adopted GASB Statement No. 84 – Fiduciary Activities.

Generally, this statement requires governmental entities, who control assets of a fiduciary activity in which a fiduciary relationship exists with beneficiaries, to include those activities in two separate, interrelated financial statements, the statement of fiduciary net position and the statement of changes in fiduciary net position. Prior to the adoption of this statement, only the statement of fiduciary net position was presented for the Funding Commission’s fiduciary funds, and those funds did not report any net position at June 30, 2020. The changes adopted to conform to the provisions of this statement were applied by restating the beginning net position of the CWPF to $737,742 and the Self-Insurance Fund to $9,570,693. Further, the Funding Commission has re-categorized the CWPF from a fiduciary fund to an enterprise fund.

3. CASH AND CASH EQUIVALENTS

A portion of the restricted cash and cash equivalents managed by the Funding Commission are part of the Commonwealth’s cash and investments pool, which has statutory responsibility and authority to safeguard the funds. Legally authorized investments generally include obligations of or guaranteed by the United States; obligations of any corporation of the United States Government; asset backed securities; U.S. dollar denominated corporate securities; collateralized certificates of deposit; bankers’ acceptances; commercial paper; and repurchase agreements. The Commonwealth is also eligible to engage in reverse repurchase agreements. See the Commonwealth’s Comprehensive Annual Financial Report for the year ended June 30, 2021, for disclosure of the credit risk classifications of the cash and investment pool.

As of June 30, 2021, cash and cash equivalents consist of the following:

Custodial Fund

Special Self Insurance Fund CWPF Fund

Deposits in state pool 2,335,695$ 829,088$ 2,776,458$ State Street Institutional Liquid Reserves Fund 1,669,891 -0- 5,846,322

4,005,586$ 829,088$ 8,622,780$

4. INVESTMENTS

Investment Policy

KRS 342.1223(2)(b) directs the Funding Commission to follow guidance in KRS Chapter 386 for investing the funds collected to finance the workers’ compensation liabilities. KRS 386.020 outlines a variety of allowable investments for the funds administered by the Funding Commission. The Funding Commission uses the services of an investment consulting firm.

In November 2018, the Funding Commission Board of Directors updated their Investment Policy Statement which provides more specific guidance for staff, investment counsel, and individual investment managers. The Directors’ Policy Statement is based on the following key principles:

Adherence to the “prudent man” rule that requires exercising that degree of judgment and care under the circumstances then prevailing which persons of prudence, discretion, and intelligence, who are familiar with such matters would follow in management of their own affairs in investment matters.

Invest funds in a manner which will meet the unique objectives of each fund while minimizing the investment risk exposure of the funds; the primary goal being the safety of the principal and liquidity of the investments while providing the financial wherewithal to meet future benefit obligations.

Utilize the Office of Financial Management and/or an investment consulting firm to provide expert, professional judgment related to investment decisions.

Adoption of specific guidance for each category of assets to ensure a framework for monitoring quality, diversification, and liquidity.

The Investment Policy Statement also provides specific guidance for investment managers regarding reporting and other communications, diversification, risk management, asset allocation, statutory restrictions, safety, liquidity, and total return goals, plus a list of authorized investments. Authorized investments outlined in the Investment Policy Statement include:

Fixed Income Securities:

United States Treasury securities, agencies, and other obligations backed by the full faith and credit of the United States Government.

United States Government and United States Government Agency guaranteed mortgage pools.

Bank Certificates of Deposit rated A or better by a recognized rating service; limited to no more than 5% of the total fund assets.

Domestic and foreign corporate obligations with investment grade ratings by a recognized rating service at the time of purchase.

Bankers’ Acceptances which originated by a bank rated in one of the top 3 rating categories by a recognized rating service, subject to a limitation of 10% of fund assets and no more than 2.5% in a single issue. However, the combined total of Banker’s Acceptances and Commercial paper will not exceed 10% of total fund assets.

Repurchase Agreements, collateralized at 102% of market value with United States Treasuries and agencies. These agreements must be governed by the Public Securities Association Master Repurchase Agreement.

Money Market accounts and Mutual Funds approved by the Board.

Investments not subject to KRS 342.1227.

Other investments as approved by the Funding Commission.

Equity:

Each manager’s portfolio will hold at least 20 positions.

No single issuer shall exceed 12 percent of the manager's portfolio at cost or 15 percent at market.

There shall be no purchase which would cause a position in the portfolio to equal or exceed five percent of the issue outstanding.

Non-marketable securities are not allowed.

Derivatives are generally excluded for risk management or leveraging positions.

Balances among the asset classes and the percentages of the Special Fund, CWPF, and Self-Insurance Fund portfolios as of June 30, 2021 are outlined in the following table:

Types of Securities Balance Percentage Enterprise:

Special Fund:

Fixed income 331,987,766$ 99.8% Investments in state pool 751,676 0.2%

Restricted investments 332,739,442$ 100.0%

CWPF:

Investments in state pool 267,195$ 100.0%

Custodial:

Self-Insurance Fund:

Investments in state pool 894,785$ 100.0%

INVESTMENT ALLOCATIONS

June 30, 2021

Interest Rate Risk

Interest rate risk is the risk that changes in interest rates of investments will adversely affect the fair value of an investment. The following investment tables outline the weighted average maturities for each category of investments held by the respective funds. Fixed income security performance is evaluated against various Barclay’s indices net of management fees. The Funding Commission has elected to use the duration method to outline the potential interest rate risk in the fixed income portfolio. The Investment Policy Statement requires managers to maintain their portfolio’s effective duration within 25% of the benchmark’s effective duration. The following table details the effective duration by investment type for each investment in the fixed income portfolio of the Special Fund and Self-Insurance Fund.

Effective Investment Type Fair Value Duration

Enterprise:

Special Fund:

Corporate Bonds 167,425,851$ 6.62 U.S. Treasury Notes and Bonds 67,429,043 7.41 Taxable Municipals 40,431,763 7.99 U.S. Agency Mortgage-Backed Securities 23,045,328 2.68 Asset Backed Securities 16,645,113 3.58 Collateralized Mortgage Obligations 11,437,126 7.76 Collateralized Mortgage-Backed Securities 5,243,673 6.14 Local Government 329,869 12.94

Total Special Fund Fixed Income Securities 331,987,766$

INTEREST RATE RISK

Credit Risk of Securities

Credit risk is the risk that an issuer or other counterparty to an investment will not fulfill its obligations.

The investment policy limits credit risks on investments by prescribing allowable credit ratings for specific types of investments as described above. The following investment tables present the credit ratings for each investment type held in the fixed income portfolio by the respective funds.

CREDIT RISK

Investment Type Market Value Ratings Percent Enterprise:

Special Fund:

Corporate Bonds 167,425,851$ BBB- through AA 50.4% U.S. Treasury Notes and Bonds 67,429,043 U. S. Treasuries 20.3% Taxable Municipals 40,431,763 A through AAA 12.2% U.S. Agency Mortgage-Backed Securities 23,045,328 AAA 6.9% Asset Backed Securities 16,645,113 A- through AAA 5.0% Collateralized Mortgage Obligations 11,437,126 AAA 3.4% Collateralized Mortgage-Backed Securities 5,243,673 A- through AA- 1.6% Local Government 329,869 AA- 0.1% Total Special Fund Fixed Income Securities 331,987,766$ 100.0%

Concentration of Credit Risk

Concentration of credit risk is the risk of loss attributed to the magnitude of a government’s investment in a single issuer. The Funding Commission’s investment policy specifically outlines a strategy to manage the concentration of credit risk:

Other than specified below, the maximum allocations per issuer by credit ratings for corporate bonds, non-agency residential and commercial backed mortgages and asset backed securities as follows: AAA, 5%; AA, 4%; A, 3%; and BBB, 2%.

No more than 10% of the total fund may be invested in any one U.S. government agency issuer.

No more than 3% of the total fund may be invested in any one issue of a GNMA mortgage-backed security or agency mortgage-backed security.

No more than 10% of the total fund may be invested in securities of foreign countries.

Custodial Credit Risk

For an investment, custodial credit risk is the risk that in the event of failure of the counter party, the Funding Commission will be able to recover the value of its investments or collateral securities that are in possession of an outside party. As of June 30, 2021, the Funding Commission’s investments are either insured or held by the Funding Commission’s custodian in the Funding Commission’s name.