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Benefits and Pensions MonitorLearning From Pension MistakesBy: Jim Helik Good governance of pension plans may be difficult to define, but, to paraphrase a famous court ruling, “You know it when you see it.” You can also learn about governance when you ʻdonʼt see itʼ – when a pension plan is so full of conflicts, political expediency, self-dealing, poor financial reporting, and general incompetence that it can make for a great case study of what not to do. The city of San Diegoʼs pension system fits that bill. San Diegoʼs Employeesʼ Retirement System has had problems for more than a decade, but more information is coming to light with the resignation last year of the mayor, the indictment early this year of five former pension fund officials, and the release of a massive report in August by Kroll Inc. (up-to-date information can be found at the San Diego newspaperʼs website http://www.signonsandiego.com). The whole story began with extended contract negotiations in 1995 and 1996 between the city (the plan sponsor) and its employees. The pension board and city officials at the time came up with a ʻwinwin ʼ scenario – increase retirement benefits to employees at no cost to the city by deliberately underfunding the pension plan. A ʻsafety netʼ of a minimum ratio of assets to liabilities was established at this time to theoretically make sure that the underfunding never got out of control. Deficits Grew You can guess what happened next. As deficits grew over the years (and as, to their credit, some trustees and committee members started to issue warnings that the system was at risk), the mayor and city council voted to do away with the safety net, establish a new underfunded plan, and, in what must have also been a popular move, voted to approve a benefit increase. A sideshow to all of this is an almost unbelievable amount of cover-ups; false, misleading, and incomplete statements; lack of disclosure; and conflicts of interest. As just one example, one of the numerous pension system modifications adopted during the years included “the award of new retiree pension system ʻbenefits,ʼ one of which, when stripped of its descriptive veneer, was made available only to a single individual then serving on the pension board whose support was viewed as critical to the passage of the (plan) modifications,” says Arthur Levitt, author of the Kroll Inc. report.
Where were the pension professionals in all of this? Many were crying “stop” over the years. They faced repeated pressure from other staff, board members, and politicians to change, moderate, or silence their opinions. Some did and some didnʼt. The report notes, “Pension fund actuary Rick Roeder, to his credit, initially offered resistance (to a proposed plan modification) in correctly asserting that the pension boardʼs role should be independent of the establishment of pension benefits and that the proposal itself was outside the norm for generally accepted actuarial funding policies. But under pressure from city officials, the clarity of this resistance melted away and, by the end, Roeder had not only given up his opposition, but acquiesced in providing tepid endorsement … One gatekeeper that did not surrender the strength of its convictions was the law firm Morrison & Foerster, which refused to go along with the cityʼs demands. Pension officials had it replaced.” ‘Tone At The Top’ What can we learn here? Levitt calls for the establishment of new committees (such as a permanent audit committee and an independent auditor general), a stronger role for some (such as the CFO), more frequent reporting, and more pension board independence. Previous studies added to this list by stressing the importance of setting a strong ethical ʻtone at the topʼ that would filter down through the organization, clarifying reporting relationships, documenting major decisions, and retaining these documents. All of this is welcome, but none of these measures can insure that fiscal irresponsibility wonʼt happen again. Without being overly pessimistic, deliberate fraud and cover-ups will always be with us. Individuals will always be tempted to make the convenient choice, not the right choice. This will never change. As a cause for optimism, you can say that in some ways the current system of external checks and balances did work, albeit slowly, and with lots of delay. A series of high-ranking officials were forced to resign as the media and other officials made matters public. San Diegoʼs credit rating was suspended as a result of major concerns raised by credit rating agencies. And the cityʼs latest auditor refused to sign off on San Diegoʼs financial statements which lead, at least indirectly, to the Levitt report. It may not be a clear victory for the good guys, but real life is like that. Letʼs continue to suggest governance reforms and, until then, continue to act as the pension professionals we are. Jim Helik is co-author of ʻEnergy Markets Risk Management,ʼ a textbook published by the Canadian Securities Institute. He also teaches at the School of Business, Ryerson University in Toronto. |
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