For the last month, the state’s largest pension fund has been embroiled in a scandal of its own making.
The fund’s board admitted on March 12 that it had made a potentially costly mistake, endorsing an inflated figure for its return on investments, an error that could affect future funding for one of the state’s most expensive programs.
The $64 billion plan’s woes deepened later in the month when The Inquirer reported that the FBI had been looking into the fund. On Friday PSERS confirmed it faces a federal grand jury probe.
The plan oversees the pensions for around 250,000 retired teachers and other local school workers, and an equal number of working educators who pay into it. It has been underfunded since state leaders in the early 2000s boosted benefits without putting aside money to pay for them, leaving a deficit that has grown to more than $40 billion, despite growing public subsidies. PSERS managers have invested aggressively to fill the gap; poor results have sparked increasing resistance from its own board.
Here are some key facts about the fund.
What is PSERS?
PSERS is an acronym for the Pennsylvania Public School Employees’ Retirement System.
It’s often confused with a smaller sister fund with a similar name, SERS — the $35 billion State Employment Retirement System for 133,000 retirees.
Both are independent public agencies. PSERS is run by a 15-member board, whose ranks include a governor appointee, the governor’s secretaries of education and banking, the elected state treasurer, two state representatives and two senators (one from each party), two representatives of school boards and five working or retired school employees.
Its chief investment officer, James Grossman, is the highest paid person in state government, making $485,000 a year.
What was the mistake PSERS made on its investment performance?
The board in December found that PSERS yearly investment returns had averaged 6.38% over the last nine years — just above the 6.36% threshold needed to avoid an increase in pension payments from 100,000 school employees hired since 2011.
In 2010, the state adopted a so-called “risk sharing” mandate that requires school staff to pay more, as taxpayers do, when PSERS investments underperform. The law mandated that the review in 2020 look at average returns over the past nine years.
But then, in the terse March 12 announcement, the PSERS board said its 6.38% figure was wrong.
PSERS executives blamed the error on an unnamed outside consultant but it isn’t clear if the consultant was acting, in turn, on incorrect information from the staff.
Only teachers and staff hired since 2011 face a possible hike in their pension payments if the performance falls under 6.36%.
How did the mistake happen?
The board has said little about that. In late March, it said it was looking into the conduct of both its own staff and outside consultants that advise PSERS.
It said that a consultant who helped come up with the performance figure had come forward sometime later to tell the board that its calculation was incorrect. The board said it was looking into a possible cover-up by staff.
The original performance figure was derived by New York-based Buck Global LLC, drawing upon PSERS data supplied it by another consultant, Aon Investment Consulting Inc., a Chicago company.
The board knew that the performance in the last year was poor, and that the performance number was going to be very close to the threshold that might trigger payment hikes for teachers. For that reason, it has said, it hired a back-up consultant. This back-up check was done by ACA Compliance Group of New York.
PSERS said in a Dec. 3 statement that it hired ACA “to conduct the verification of the investment return for the nine years.... ACA confirmed the 9-year market value return as 6.38%, which is higher than the 6.36% risk share threshold.”
However, ACA disputed that. It said separately that its job was only to “validate the calculation methodology through spot-checking performance over a defined period and not to validate or calculate the performance number.”
“We are confident the review of the calculation methodology with the data provided was performed correctly,” the consulting firm added.
Who on the board questioned the figure?
Former Pennsylvania Treasurer Joe Torsella and state Rep. Frank Ryan (R., Lebanon) were unnerved about the how close the profit figure was to the target. They both complained in December about a rushed process and abstained from the vote, as did another reform-minded trustee, Richard Vague, the state banking secretary.
Board chairman Chris Santa Maria, a Lower Merion teacher, and the pension staff assured them the numbers were good. “We did our due diligence,” added Grossman, the chief investment officer, at the December meeting. “We covered it. I’m not worried about it.”
However, Torsella’s staff had warned PSERS last summer about “discrepancies” between its financial documents and outside reports on investment performance, his successor, state Treasurer Stacy Garrity, told a legislative committee last week. She did not elaborate.
How has PSERS responded?
It has hired lawyers. The Anglo-American law firm Womble Bond Dickinson is investigating how the error occurred. Philadelphia-based Morgan Lewis & Bockius, is looking at what the correct performance figure should be and how it might affect taxpayer and teacher payments to PSERS, and any impact on federal taxes. Retirement investments are typically tax-free, unless money has ben invested in ways not approved by the IRS.
How does the federal probe figure in?
It’s not clear. The fund acknowledged it was under federal investigation on April 6, about three weeks after the mistake was revealed.
Federal authorities have subpoenaed records from PSERS executives, Treasurer Garrity told the State Senate hearing, calling the case “extremely troubling.” The FBI has not commented. On April 6, PSERS hired yet another firm, New York-based Pillsbury Winthrop Shaw Pittman LLP, to deal with the federal investigation.
And on Friday PSERS hired the Sidley Austin LLP law firm, of New York, apparently primarily to assist its employees in their dealings with investigators.
For those keeping count, that’s the fourth outside law firm that the fund has hired in a month.
How is PSERS doing overall?
PSERS has less than 60 cents set aside for every dollar of pensions that it’s obligated to pay when today’s public school workers retire. PSERS is one of the largest and steadiest-growing expenses in the Pennsylvania state and local school district budgets, consuming $5 billion in taxpayer payments this year, up from $0 in the early 2000s.
Blame the shortfall on former Gov. Tom Ridge, backed by both parties, who in 2001 boosted pensions and cut funding, expecting that dot.com investments would keep PSERS solvent. And former Gov. Ed Rendell, who signed laws delaying pension funding.
However, Rendell also signed a bill cutting benefits for newer hires. More recently, Gov. Tom Wolf approved limits to taxpayer-guaranteed pensions and moved employees toward a 401k system. These moves have slowed the growth of PSERS’ deficit and should in time reduce it.
But the shortfall leaves the fund heavily dependent on investments. Along with the $5 billion in taxpayer aid and $1.1 billion from teachers, investment profits have pumped an average of $3.7 billion yearly into the fund over the past decade. But returns fell below that figure last year. Since the Ridge giveaway, taxpayers have been asked routinely to pay more into the underfinanced pension plan.
What is the main dispute about PSERS’ investments?
In recent years, the fund has been criticized for its lagging investment performance, especially given the plan’s underfunded condition. PSERS makes many high-fee investments, spending $740 million in 2019 on money managers, and putting much money into private-equity investments, in companies not available on the stock market.
A growing group of board members thinks that PSERS would be better off buying low-fee Vanguard-style funds instead. At its first bimonthly meeting of 2021, five of the 14 current board members (one seat is vacant) voted against the staff’s latest investment proposals.
Gov. Tom Wolf has reappointed PSERS critic Joe Torsella to the board. He is awaiting Senate approval.
What the concern about outside money managers?
Critics say the staff is too cozy with them. The plan spent more than $1.5 million over three years on staff travel before COVID-19 kept everyone home. Most of the money went to cover about 500 trips by about 40 staffers in the investment office, a unit with some of the most highly paid employees on the state payroll.
Most of the trips were booked by the outside money managers — and their choices were extravagant. In a not atypical example, one taxpayer-paid investment manager flew to London in 2019. His fare was $15,627.
At the same time, critics question their investment choices of staff and consultants. Last fiscal year (July 1 to June 30), PSERS’investment rate of return was just 1.1%, compared to more than 7% for the S&P 500.
This story has been updated with comment from ACA.