Los Angeles City Controller Ron Galperin released audit reports Wednesday that show that during the fiscal years 2008-2012, the economic health of both the Los Angeles City Employees’ Retirement System (LACERS) and Los Angeles Fire and Police Pensions (LAFPP) was hindered by economic recession and below-market returns.
Galperin said addressing the city’s current and future pension obligations was among the most challenging issues the city faces.
“These audits demonstrate that there is room to improve investment strategies, which could result in lower costs for the City,” Galperin said.
Together, LACERS and LAFPP, two of the City’s three pension systems, provide services and benefits to 37,000 active city employees and to 30,000 retirees and their beneficiaries.
According to the audit reports, between 2008 and 2012, the City’s contributions to LACERS and to LAFPP rose from $737 million to $869 million, an increase of 18 percent. Among the factors contributing to that rise were economic recession and an adjustment in the funds’ assumed rates of return, from 8 percent to 7.75 percent. According to the City budget, employer contributions for FY 2013-2014 will exceed $1 billion.
During the same period, between 2008 and 2012, LACERS’ investment portfolio underperformed the funds’ assumed investment returns by $4.9 billion. LAFPP’s underperformed by approximately $2.4 billion. Following the audit period, rates of return went up significantly and the funds’ performances both improved.
“That is welcome news,” said Galperin, “but these reports demonstrate that there are lessons to be learned for the future.”
Both pension systems spent approximately $50 million each on investment management fees during the audit review period.
While the fees were mostly in line with those charged to other pension systems, said Galperin, “it does not seem to follow that the asset management fees translated into high rates of return.”
Overall, the audits reported that LACERS’ and LAFPP’s management, planning and accounting practices generally comported with those of comparable public pension funds.
Still, the reports highlight areas for improvements:
The audit reports suggest that placing more funds under passive management could save the pension systems substantial fees and possibly generate greater investment returns. But to understand why, one has to pay attention to seemingly small numbers that turn out to be significant. For instance, LACERS’ actively invested assets underperformed as compared to benchmarks for passive investment by just 0.6 percent. However, that 0.6 percent totaled $160 million during the audit period.
Likewise, in FY 2011-2012, LAFPP paid approximately $23.5 million to investment managers to actively manage the public equity and fixed income portions of its portfolio. But according to the LAFPP audit, which was conducted by a firm specializing in pension management and investment analysis, if LAFPP had implemented an all-passive approach to the same portfolio, it could have reduced its investment management fees by $20 million.
When measured on a cost per member basis, both systems’ administrative expenses were higher than those of similarly situated plans. These costs added up. For example, had LACERS been able to lower expenses to the same levels as some of its peers, total administrative expenses would have been reduced by approximately $4.7 million per year, or $23.5 million over the duration of the review period.
Both LACERS and LAFPP serve members of the same city family. As a means to reduce administrative expenses and investment management fees, the audits recommend that the City consider consolidating the systems and/or implement heightened collaboration to capitalize on economies of scale.
City and contribution rates were determined based on budgeted salaries. This method omitted part-time and as-needed employees, as well as personnel who work for the two retirement systems. It is recommended that all pension-eligible members be included when determining contribution rates in order to increase accuracy and transparency.
Two of the audit reports were management audits of the Los Angeles City Employees’ Retirement System (LACERS) and the Los Angeles Fire and Police Pensions (LAFPP). These audits were conducted by independent firms and were commissioned jointly with the Mayor and Council in accordance with the City Charter. A third compliance audit, conducted by the Office of the Controller, examined the City’s contributions to LACERS and LAFPP.
The Controller’s office will lead a management audit of the DWP retirement system within the year.
The audit reports can be found online at http://controller.lacity.org/
