The $1.2 billion mistake Towers Perrin apparently made in its actuarial work for the Los Angeles County Employees Retirement Association should be a lesson to and a warning for all large funds.
People, even at the best companies, can make mistakes. Outside review of any vendor's work in critical areas should be routine.
The apparent Towers Perrin error is humbling, embarrassing and distressing. But it's not surprising an error can be made in thousands of lines of computer code. What is surprising is that actuarial audits are rare, according to industry experts.
Fortunately, LACERA initiated one at last, discovering an actuarial error.
Towers Perrin now could face the issue of to what extent, if any, it should be liable for the errors in its actuarial work. The error raises a fundamental question as to whether an actuary is a fiduciary. Can it be one, when it doesn't control the assets? Marsha Richter, LACERA chief executive officer, said she isn't sure if Towers Perrin is a fiduciary, although she expects it to act without any conflicts of interest. She said LACERA is examining Towers Perrin's potential liability, if any.
The error notwithstanding, Towers Perrin is regarded as a fine actuarial firm, as witnessed by the many major pension funds around the country that employ it. But mistakes can happen in any line of work, even at the best of organizations.
The errors in the actuarial computer coding Towers Perrin used for LACERA probably have existed since 1977, Ms. Richter acknowledged in a Pensions & Investments story.
An actuarial audit, performed by Milliman & Robertson Consulting Actuaries Inc., uncovered the errors.
Nothing in the LACERA problem presumes similar problems exist at other pension funds. Nonetheless, such actuarial audits should be performed periodically.
When pension funds deal with such large amounts of money, they need to have more checks, more controls. Even a small miscalculation can affect a large amount of money and have dire consequences. The county was putting a lot of faith in its actuarial numbers, in order to shift what might have been pension contributions to other areas of county spending. With expectation of near funding of the pension liability, the county is allowed to forgo increasing its pension contribution.
An actuarial audit essentially would double the cost of the original actuarial work. The added cost might pose a financial burden for smaller pension funds. But when sponsors place as high stakes on correct numbers as Los Angeles County had, the extra cost might turn out small compared to the risk of a mistake.
Now, with the actuarial audit adding unexpected pension liabilities, the county will have to find money to bolster its pension plan. It's likely the errors could affect the county for years, if it amortizes the funding of the actuarial shortfall, which amounts to about 5% of its total $22 billion in assets.
While Towers Perrin should have double-checked the program itself, the county also should have commissioned periodic actuarial audits long ago.
Ms. Richter said she suggested the actuarial audit, inspired by a model administration proposal recommended by the Public Pension Coordinating Council several years ago. She said she will propose LACERA adopt a policy to commission an actuarial audit every five years. It should, and other large funds should adopt such a policy to do the audits periodically as well.
