Court Tells San Francisco Pension System to Change its Strategy

A civil grand jury in San Francisco has told the city’s employee pension system to change its investment strategy, assumed rate of return, and transparency policies.

(August 17, 2012) – In reaction to weak returns and losses over the last five years–including the 2008 financial crisis–a civil grand jury has investigated the San Francisco Employees’ Retirement System’s (SFERS) investment strategy, and is not impressed. 

Investment Policies and Practices of the San Francisco Employees’ Retirement Fund, the report detailing the results of the investigation, rails against SFERS for its “volatile and risky investment policies,” “unrealistically high, assumed investment return rate of 7.66%,” and for not undertaking a formal “‘failure analysis” subsequent to the funding loss suffered in 2008-2009.” 

The $16 billion public plan is 83.9% funded as of July 2011, with $3 billion in outstanding liabilities, but San Francisco’s city charter requires that the public pension be fully funded. Contributions from the city have increased since the 2008 financial crisis, topping out at $433 million this year. However, from 2004 to 2007, city employees made no contributions to the overflowing fund.

The 19-member civil grand jury issued a list of six recommendations for the SFERS’ investment team in its report: 

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1. Address the $2 billion dollar underfunding of the San Francisco Employees’ Retirement System Pension Fund by forming a high-level task force with city officials, a panel of experts, community groups, and the public to develop courses of action.

2. Adopt a realistic and consistent formula for estimating the assumed expected investment return rate. 

3. The San Francisco Employees’ Retirement System Board undertake an in-depth investigation and “failure analysis” study of its investment policy and report its findings to its members and to the public. 

4. Investigate, quantify and address all the major risks in the portfolio and make this information public.

5. Investigate less volatile and risky investment policies that would attain sufficient returns for the San Francisco Employees’ Retirement System Pension Fund.  

6. Replicate the Stanford, Upjohn, and The New York Times evidence-based comparison studies using San Francisco data, to apply their findings to the San Francisco Employees’ Retirement System Pension Fund. 

SFERS sent aiCIO the following statement in response to the jury’s report:

“Members of the SFERS Retirement Board and the executive director have received the San Francisco Civil Grand Jury Report on SFERS investment policies and practices. As pointed out in the report, by authority of the California Constitution and the City Charter, the Retirement Board has the plenary authority and fiduciary responsibility for the investment of the SFERS Trust. As it has over the past decades, through sometimes difficult financial markets, the SFERS Retirement Board and staff are singularly dedicated to securing, protecting and prudently investing the pension trust assets, administering mandated benefit programs, and providing promised benefits to SFERS members and beneficiaries. The SFERS Retirement Board and staff will provide responses to the Civil Grand Jury’s findings and recommendations as required by law.”

North American DB Funds ‘Sliding into the Danger Zone’

A DBRS study of 451 defined benefit plans’ performance between 2002 and 2011 found the majority of funds are in worse shape than previous years.

(August 17, 2012) – Defined benefit (DB) pension funds are sliding into the “danger zone” of underfunding, according to a comprehensive study of 451 large Canadian and American plans by ratings agency and research firm DBRS. 

More than two-thirds of plans did not meet the researchers’ “reasonable funding” threshold of 80%. (And that’s lowballing, according to a major actuarial group.) In total, 69% of plans’ funded status fell in 2011, making it the second-worst year behind 2008 in the study’s 10-year analysis. 

“In order for companies to address this funding gap, employers will have to maintain high levels of contributions, as many plans have now entered the danger zone of funded status,” said James Jung, a senior vice president at DBRS, in a statement. 

At 81.7%, the aggregate funded status of all 451 plans is not as low as one might expect. However, that’s down from 85.1% in 2010, and exactly on par with the 2002 level. The aggregate funded status “has not recovered since the 2008 economic downturn as the low interest rate environment has more than offset the benefits from asset performance and sponsor contributions,” according to the report. Over the last two years, “persistent weakness in the global economy, despite stimulus efforts and considerable liquidity injections, decreased returns on assets and drove down interest rates. As a result, pension deficits skyrocketed.” 

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In last year’s study, DBRS concluded fully funded status was possible by 2012. They have since revised their optimistic outlook, and consider full funding not achievable until at least 2014. Nevertheless, the researchers concluded that four factors will likely lead to the health of DB pension funds to improving over time: 

1. Interest rates will eventually rise, which will reduce the obligation side of the balance sheet through higher discount rates 

2. Companies have maintained strong balance sheets, which should allow for greater contributions. 

3. The evolution of regulatory changes requires companies to eliminate plan deficits over the long term. 

4. The relative size of a company’s obligation should gradually fall as fewer employees are added to the plans because of a shift to defined contributions, outsourcing and/or reduced labour requirements. 

North American DB plans may improve in health, but are not likely to grow in number. “We’re seeing fewer companies offering defined benefits to new employees,” said Jung. “These plans are difficult to manage and they are overly burdensome.” Somewhere, a few CIOs are nodding vigorously.

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