Faced with three years of negative returns, underfunded pension plans and state budget shortfalls, a growing number of public plan sponsors are conducting soup-to-nuts reviews of their pension funds.
In recent months, several large plans have launched full-scale performance review audits, including:
* the $21 billion Pennsylvania State Employees' Retirement System and the $38 billion Public School Employees' Retirement System, both in Harrisburg;
* the $57 billion New Jersey Division of Investment, Trenton;
* the $11.8 billion Alaska State Pension Investment Board, Juneau;
* the $1.4 billion Nashville and Davidson County Metropolitan Government Benefit Board, Nashville;
* the $650 million Firefighters' Retirement System of Louisiana, Baton Rouge;
* the $23.6 billion State Retirement & Pension System of Maryland, Baltimore; and
* the $67 billion Teacher Retirement System of Texas, Austin.
And with 24 new governors taking office this year, industry observers expect to see much more audit activity. Already, the new governor of Oregon, Ted Kulongoski, has set the wheels in motion for a review of the $31.7 billion Oregon Public Employees Retirement Fund, Salem.
The Oregon Legislature is already considering two pension-related bills, one eliminating the 8% return for participants and the other reducing the board to five members, from 12. Both measures have been approved by the house and await the go-ahead from the state senate.
While financial audits have been commonplace among pension funds, performance review audits have not been - until now.
Driven by market
"The market is the driving factor," said Relmond Van Daniker, executive director of the National Association of State Auditors, Comptrollers and Treasurers, Lexington, Ky. "Pension funds are taking some major hits," he said. "When things are going well, people don't ask as many questions."
In Pennsylvania, where the state employees lost 13% in the past year and the school employees lost 20% in 15 months, the audit is a hot issue that's beginning to boil.
In August, the office of State Auditor General Bob Casey Jr. informed officials at both pension funds that his office was going to conduct an audit.
In November, the two systems issued a request for proposals for a firm to conduct investment fiduciary audits. The reviews are designed to look at investment policy, manager selection, organizational structure, oversight of investments, consultants' responsibilities, internal controls and risk management, and disaster preparedness.
"Our members depend on us," said Sean Sanderson, spokesman for the state employees' fund. "We're performing this performance audit to make sure we're doing the right thing." This is the first time the plan has conducted such a review, he said. The selection process is under way, but there is no timeline as to when a firm will be selected, said Mr. Sanderson.
But Mr. Casey continued to push his own audit. In January, he issued subpoenas to Barbara Hafer, chairwoman of the public school employees' fund, and Nicholas Maiale, chairman of the state employees' fund, seeking documents related to expenditures on external investment managers.
Pension fund officials were "surprised and disappointed" in the auditor general's actions, according to a joint statement issued by the funds. The statement said the office does not have the legal authority to conduct a fiduciary audit or review of the pension systems. The systems subsequently rejected the state auditors' subpoena as "invalid."
But the battle between the pension systems and the state auditor isn't over, as Mr. Casey has appealed to the state courts to step in.
Ms. Hafer has accused Mr. Casey of undertaking the audit to further his political career, according to news reports.
Observers say politics often comes into play, particularly at large state pension funds, where politician are looking for answers and someone to blame.
But in most cases, performance reviews are a good idea, said Howard Crane, national practice director at Watson Wyatt Investment Consulting in Seattle. "If motivated by a desire to improve operations, assess effectiveness, and make necessary changes related to the continued improvement of the pension, then it's a good thing," said Mr. Crane.
But he added: "An audit which points fingers at people in control for events over which they have no control is not likely to produce an effective change."
While the number of operational audits has increased in recent years, most plan sponsors do not conduct such reviews. And because these reviews are not standard practice, there aren't a lot of firms that specialize in this area. Independent Fiduciary Services, Washington, is one of the few. It is now conducting two audits - for the New Jersey Division of Investment and the Alaska state pension board. In the past few years, it has also done such audits for the $45 billion Public Employees Retirement System of Ohio, Columbus; $20 billion Teachers' Retirement System of Illinois, Springfield; and $42 billion State of Michigan Retirement Board, Lansing.
While work has been steady over the years, Samuel "Skip" Halpern, executive vice president at IFS, said activity has increased in the last few years.
"The down market makes it more important for plan sponsors to keep their eye on the ball," said Mr. Halpern. Corporate scandals, a sputtering economy and state budget deficits are all contributing to the pressure on pension executives, he said. The influx of new governors also has an influence, as newly elected state leaders find themselves under the gun to fix the problems they inherited.
In New Jersey, the audit being conducted by IFS is part of an overhaul, spearheaded by state Treasurer John McCormac, that may result in moving some internally managed assets outside. Mr. McCormac said the audit looks to evaluate the decisions and conditions that have led to poor investment performance.
Toronto-based Cortex Applied Research Inc., which will conduct a fiduciary review for the Maryland state pension fund, is another firm that specializes in fiduciary audits. Cortex will review the system's decision-making and accountability processes, as well as its corporate governance practices, to make sure they meet industry standards.
And Benchmark Financial Services Inc., Lighthouse Point, Fla., another specialist in this area, saw business start to pick up in 2001, with that demand increasing throughout 2002.
Ted Siedle, president of Benchmark, said the environment is forcing more plan sponsors to examine longstanding problems that were shrouded by a bull market. Now that plan sponsors have to explain the negative numbers and unfunded liabilities, they are looking for answers, he said. "The embarrassment of the hard numbers forces people to make these decisions," he said.
A hot-button issue for plan sponsors right now is the fees being paid to money managers, said Mr. Siedle. His firm is conducting the audit for the Nashville & Davidson County plan, which is focusing on fees paid to investment managers. Karl Dean, director of law for the pension fund, said the board wants to make sure it is paying fees as contracted and not being overcharged.