PATTI'S NOTES
SDCERS BOARD AND COMMITTEE MEETINGS MARCH 4-5, 2010
Submitted by Patricia Karnes

Special thanks to SDCERS Interim Administrator/CEO Mark Hovey for reviewing my numbers and explanations.

Check the City web site for the March 6:00PM replay of the City Council's approval of "David Wescoe Day". Wescoe, SDCERS former Administrator/CEO, returned briefly from the Motion Picture pension fund, to award mini-Oscars to Sherri Lightner for producing his recognition day, to Ben Hueso, and to Donna Frye, for the quality of her preparation as a Council Member.

(These notes are from the SDCERS Board and committee meetings on Thursday, March 4, and on Friday, March 5. Notes are by subject. They are my understanding of what happened.)
SDCERS web access - Board meetings, with subject access, are available for viewing at www.sdcers.org
Television- If you live in the city limits, Board meetings are on City Channel 24 usually at 6pm following meeting days, and usually repeat on the following Sunday.
Official CDs of SDCERS' committees and Board meetings are available through the Board Secretary; visual recordings are available through City Channel 24. Motions and votes are in SDCERS monthly summaries of Board meetings.

Committee meetings, not televised yet:
on the Thursday before the regularly scheduled board meeting:
Disability Committee will meet from 8:30 am - 10:00 am
Business & Governance will meet 10:30 am - 12:00 PM
Investment Committee will meet 1:30 PM - 4:00 PM

Audit Committee will continue to meet quarterly on Wednesdays at 9:00 am.
on April 7, June 30, Sept 29, and December 15, 2010.

SDCERS MEMBERSHIP THROUGH JANUARY 31, 2010
These Members grow shocked and numb. Retirees don't feel retired. The SDCERS staff and the SDCERS Board have a heroic role in this turmoil to deal with the funding of SDCERS and service to Members.
Retired, including drop - 6544
1981 pension plan - 2
Continuance - 955
Domestic relation order - 210
Active - 9264
Enrolled - 9
Deferred/ inactive - 2951

INVESTMENT RETURNS- Good News!
Assistant Investment Officer Amanda Montgomery described the difference between 2008 returns versus 2009 returns, calling it a "dramatic whipsaw".

Sara Jimenez, SDCERS' Principal Accountant, reported net assets as of January 31, 2010 are now up approximately $700 million from January 31, 2009.

Jimenez pointed out the net investment earnings for the seven months ended January 31, 2010 were a positive $643,387,000 compared to last year's loss at January 31, 2009 when losses were a negative $1,104,618,000.
___________
SDCERS QUARTERLY REVIEW, DECEMBER 31, 2009 BY CALLAN ASSOCIATES
Executive summary, page 3 "total fund performance
SDCERS' fourth quarter return of 3.2% (private real estate valuations are lagged one quarter) was ahead of the total fund benchmark's 2.8% return and ranked 57th percentile against public fund peers. Fiscal year-to-date returns were up 15.8%. Given strong equity markets, the calendar year return was up 22.0% ranking 32nd percentile. The cash overlay program added 1.4% over the calendar year. Longer-term results for the system are strong relative to the benchmark and the public fund universe. For he trailing ten-years ended December, the fund has returned 5.1% on an annualized basis, which ranks in the 8th percentile in the public fund universe and exceeds the total fund benchmark by approximately 0.4% on an annualized basis."

POWER POINT PRESENTATION MATERIALS - HANDOUT IN BOARD PACKET
From page 8, under Callan's Outlook,
"Callan's capital market expectations are lower across both public and private markets from projections in 2009."

ASSETS
There was an upswing in December 2009 and declines in January 2010, reported Principal Accountant Sara Jimenez. The result is that the January 31, 2010 statement is similar to the November 30, 2009 statement.

Note on numbers below: Mark Hovey, Interim Chief Administrative Officer/CEO commented on the two different fund asset values reported below for January 31, 2010: "they're both correct, as they measure different things. The Jimenez statement reflects net assets, which is the net of total assets less total liabilities. The Executive Summary reflects our investments, which are a subset of total assets."

I. EXECUTIVE SUMMARY OF STAFF REPORTS - dated March 4, 2010 for SDCERS' Investment Committee
Page 2, Trust Fund Status For Investments
"The reconciled market valuation of net assets as of January 31st, as reported by the custodial bank, was $4,243,335,247."

II. GROUP TRUST FINANCIAL STATEMENTS FOR NET ASSETS- ended January 31, 2010 as reported Feb. 19, 2010 to SDCERS Board, by Sara Jimenez
Net assets at January 31, 2010
City- $3,538,925,000
Port- $205,479,000
Airport- $57,661,000
Total for SDCERS: $3,802,065,000 on January 31, 2010, compared to $3,090,845,000 in January 31, 2009.

PROJECTED FINANCIAL TRENDS- JUNE 30, 2009 ACTUARIAL VALUATION REPORT- Gene Kalwarski from Cheiron
OVERVIEW: The Projections report is a tool for the Board to evaluate how they will achieve full funding in the future. The new retirement plan saved the City $500,000 on the FY 2011 Annual Required Contribution (ARC), according to SDCERS actuary, Gene from Cheiron. The Unfunded Actuarial Liability (UAL) is still growing because the market losses are smoothed.

ACTUARY VIEW: Gene looks to see what emerges as unusual. Gene frequently says that it isn't the current numbers that tell the story, but where those numbers are going matters when the SDCERS board makes decisions.

GENE'S CONCERNS:
1) In the future, the City faces an Annual Required Contribution (ARC) that will almost double in size. His chart shows that this year the City's ARC is $154.2 million, climbing to $511.62 million by the year 2025.

2) The UAL will continue to increase because of the averaging (25% smoothing) of the FY 2008 and the FY2009 investment losses. UAL gains and losses from each year are being amortized over a fifteen-year period. If the assumed rate of return remains at 7.75%, the UAL, which was $1.3 billion last year, will peak at $2.74 billion in 2017.

3) Gene's power point included "Pay down of UAL At 7.75% Returns", "SDCERS Projections With Varying Returns", as well as the relatively little impact of the City's new retirement plan.
Actuarial projections are done at SDCERS assumed 7.75% investment return, and do not reflect that actual returns will vary both above and below the assumed 7.75% return.

CLOSING THE PLAN: Nothing was said about the financial effect on the UAL from "closing" the old retirement plan, resulting in fewer and fewer employees to make contributions.

RISK AND SDCERS BOARD CONCERNS: Trustee Richard Tartre said the crucial consideration was the assumed rate of return of the fund. Tartre noted that CALPers was discussing going to 5%. Gene responded that there are currently two opposing views in the accounting world, and no decision, from the national accounting board, is imminent:

1) There is an idea out there that the assumed rate should reflect the "risk free rate of return", and therefore the rate should be 5%. There is also a concern that investment returns may drop lower than they are currently.

2) The "ostrich" position says to continue to use 8%.

Gene illustrated his point with an idea that is floating around: A state could issue bonds, paying 6%, and invest in the stock market for 8% and earn the way out of pension debts. He asked the Board why that was a problem? The answer was RISK.
Regarding "smoothing" of investment gains and losses, Gene said that the SDCERS was already up to private standards.
If you want to be right 90% of the time and wrong 10% of the time, then be conservative, said Gene. Then he asked the Board how often did they want to be right?

Trustee Mark Oemcke noted that the rate of return has one of the greatest impacts on the ARC. He also noted the need to make progress against the UAL. (This is what I understand Oemcke meant: The lower the investment returns, the longer it takes to earn money to pay pensions. The size of the UAL is partly determined by how long it takes investments and contributions to cover promised benefits. According to Gene at the March 8th council presentation, the size of the UAL would double or triple to $5 or $6 billion if the assumed rate of return dropped to 5%. In the past, approximately 70% of pensions were paid for by investment returns, and 30% by employer/employee retirement contributions.)

TIME TO AUDIT THE ACTUARY
The Board is issuing a Request For Proposal for a one time independent outside actuarial firm to validate the results of Cheiron's June 30, 2009 valuation.
Cheiron, SDCERS' outside actuary, has just completed their 5th valuation for SDCERS. So Board Rules and the Kroll report recommendations, call for a new actuary to be hired, or an independent auditor to review the current actuary every five years as a "best practice".
SDCERS' Interim Administrator, Mark Hovey would like the outside audit to be done on all three plan valuations for June 30, 2009: City, Port and Airport. The cost may run to $100,000.

STUDY ON DETERMINING SUBSTANTIALLY EQUAL CONTRIBUTION RATES - Gene Kalwarski from Cheiron and Ashley Dunning fiduciary attorney from Manatt.
(This does not apply to retirees, as they no longer pay substantially equal retirement contributions from their pay, because they are not working for the City. Retiree interests are the funding consequences to the UAL and ARC.)
(Patti's Note: Determining "substantially equal" retirement contribution rates means something different to SDCERS, than it does to the City Attorney. See Patti's three other Notes below).

SDCERS is considering whether death and disability rates should be added in the employees share of substantially equal retirement contribution rates, or not. The difference, for police, would be an increase of approximately $200 a month.
(Patti's Note #1: Contrast that with the City Attorney's concept in which an employee would additionally contribute thousands of dollars more a month in order to pay off SDCERS investment losses.)

NEXT STEPS ON APRIL 16TH: The Board will look at fiduciary opinions, and consider adopting a Board Rule and determine methodology to apply that Rule.
The review and possible action on this issue continue to April 16th at 8:30AM, said SDCERS General Counsel Elaine Reagan.
The Board will exercise its discretion and if necessary act. First the SDCERS Board will listen to SDCERS fiduciary attorneys, other attorneys, stakeholders and the public, and may, or may not, act then on which legal direction to follow. Retirement contribution rates are due to the city effective July 1st.

BOARD'S RESPONSIBILITY: It's the Board's obligation to set the contribution rates for both the city and employees, according to Manatt. The Board decides what is included in the substantially equal contribution bucket based on Ordinances and the City Charter.
If the Board adopts Manatt's interpretation of what is included in the City's and employees' share of the substantially equal, Gene will prepare an alternative Valuation for June 30, 2009 showing the impact of adopting Manatt's opinion, and then re-calculate the City's July 1st ARC, for Board consideration at their April 16th meeting.
Ashley Dunning from Manatt, said the Board must see that the pension system is funded properly and from proper sources, regardless of impacts on the City, or employees. Board Vice President Trustee Ray Ellis commented that if the City has something to say, that the City needs to come to the Board and say it.
Elaine Reagan said the City could do a new Ordinance clarifying their intention on substantially equal, if it was worded carefully.
The Board cannot reopen past rates as they are "conclusive" rates that the Board set, said Elaine Reagan.

EARLIER THAN EXPECTED RETIREMENTS INCREASE THE CITY'S ARC: The City had expected savings when more than 600 employees retired earlier than expected last year. But instead of savings, those earlier than expected retirements produced a bigger ARC for the City to pay, said Board President Mark Sullivan.
Sullivan was concerned whether the City understood that the ARC would spike up again if another wave of employees retired earlier than expected. Employees could find it is better to retire early, than pay increased employee retirement contributions.
Gene added that if the City increases pay to keep safety members, and/or safety members retire earlier than expected, the result may be that instead of the City savings $3 million, it might cost the City more.

REASON FOR THE STUDY: SDCERS Board changed actuarial assumptions in 2007 to use in this 2009 valuation. As a result, SDCERS' actuary Gene from Cheiron recommended this substantially equal study of retirement contributions. He asked for clarification on how to split disability costs, death benefits, COLA, spouse benefit, etc., between the employees and employer.

Cheiron has worked closely with Elaine Reagan, SDCERS General Council, and SDCERS' outside fiduciary counsel on this issue. The language of the City Charter did not anticipate the complexity of the benefit plans now in place.

WHO IS TO PAY WHAT? The City can opt to pay more than substantially equal, but is not required to do so, said Ashley Dunning from Manatt.
Trustee Alan Arrollado inquired into the Legislative members' contribution rate and was told the City picks up those members' contributions.
When the City went from a Defined Contribution Plan to a Defined Benefit Plan in 1954, did it mean to permanently pick up all costs of retroactive new employee benefits and any gains or losses to pension plan investments? SDCERS fiduciary attorneys says yes.
(Patti's Note #2 Goldsmith said no to the City continuing to cover losses.)

WHICH OPINION TO ACCEPT? SDCERS' plan is complex. However, two fiduciary attorneys for SDCERS differ only on whether the city or employees contribute for the disability and death benefits. Manatt's argument is that the normal cost of the portion of the disability allowance, that is based on accrued service, is split between members and the City, but that the normal cost of any portion of the disability allowance that exceeds accrued service is paid 100% by the City.

Differing opinions from SDCERS fiduciary counsels:
• 2006 letter from Harvey Leiderman of Reed Smith LLP in which "substantially equal" meant the gross normal cost less full cost for death and disability. (Read this letter if you want to understand the retirement plan better.)

• 2010 letter from Michael Tourmanoff of Manatt, Phelps & Phillips LLP in which "substantially equal" is accrued service retirement benefit in the form of a straight life annuity. " the substantially equal contribution provision would not apply where an alternative contribution allocation is specified or implied …or where the benefit is paid in a lump sum (rather than as an allowance). The unfunded actuarial accrued liability ('UAAL' or 'UAL') reflecting experience and investment gains or losses and accrued past service liabilities is excluded from the substantially equal contribution provision, as it is, and always has been, the City's sole funding responsibility."

CITY ATTORNEY'S CONCEPT: City Attorney Goldsmith was at the presentation to the SDCERS Board on Friday March 5th, and was busy making notes.
(Patti's Note #3: At the March 8th's Council meeting, Goldsmith brought up the idea that employees should also share SDCERS' investment losses as well. Goldsmith would split SDCERS investment losses between employees and the City. Would the City force 9264 employees to pay an extra $34 million from their earnings to cover losses next year, with the City paying the other $34 million? This could result for instance in each police officer's retirement contributions increasing to thousands of dollars each month in addition to his normal retirement contributions. Or is the City going to pay the whole $68 million as part of the City's ARC on July 1, 2010? See Patti's Notes on the City Council's March 8th meeting on REA's web site.)

FINAL COMMENT: SDCERS fiduciary attorney, Ashley Dunning said in her presentation that no employees of any other pension plan in the State pays toward the UAL.

DROP COST NEUTRALITY STUDY
SDCERS' Interim Administrator/CEO, Mark Hovey said that the City has hired Buck to do a study of the costs of DROP to the City. Cheiron has also been assisting the City with numbers.
(Patti's Note: In one of the televised Council sessions, Goldstone said the costs or savings of DROP, to the City, look to be driven by investment returns.)

CITY'S SAP PROBLEMS
Trustee Steve Meyer said the City is not even cataloguing all the conversion problems to the City's new computer system, SAP. Employees are even checking their paychecks as some employees are being underpaid. A smaller number of staff, than previously, are working on 10-12 SAP-related issues that pertain to SDCERS, said Hovey. He noted that currently some manual solutions are being done that will not work for the long term.

CONFLICT OF INTEREST ISSUES AND POLITICAL REFORM ACT- Ashley Dunning- Manatt
The general rule on conflict of interest: Are there personal financial gains and/or are the pension gains being voted on different from other members' gains? Board members must disclose why they recuse when they recuse. Board members must ask themselves if they are serving two masters.

Power point presentation focusing on:
1) The State of California case: Implications of the Lexin case, involving former SDCERS Trustees, including Ron Saathoff. The California Supreme Court decision was unanimous at this pleading stage and focused on one issue. Former Fire Union President and SDCERS Board Trustee, Ron Saathoff has appealed because other members had Union Presidents benefits. The County DA appealed to re-instate the case against Terri Webster relating to the grandfather clause for Webster's extra benefits for being in a small group who had worked longer than most employees do.

2) The Federal case: "Theft of Honest Government Services".
This presentation covered "government salary", "public services generally provided", "critical nondiscrimination principle", "serving the board's constituency", "public services exception applied to SDCERS Board", "open issues", "remote issues", "violations of contract law", common law conflicts of interest", "theft of honest government services", "conflicts of interest after leaving office", and "conflict of interest rules for public officials".

PORT'S ACTUARIAL VALUATION JUNE 30, 2009 was approved.

INVESTMENT POLICY FOR SDCERS' PLACEMENT AGENTS- Investment Officer, Corey Buu-Hoan
Board approved staff recommendation to do the following:
"California Government Code, Section 7513.85, requires all California public retirement systems to develop and implement no later than June 30, 2010 a policy requiring disclosure of payments to placement agencies."

" 'Placement agent' means any person or entity hired by or acting on behalf of an investing manager to market, solicit, or raise money either directly or indirectly from the San Diego City Employees Retirement System…."

CHANGES TO SD CERS' REBALANCING POLICY - report by Assistant Investment Officer Amanda Montgomery.
The Board approved:
1) "Updated rebalancing ranges as recommended by Blackrock (the investment firm): bands proportional to volatility, target weight and transaction costs vs. SDCERS' current bands which are proportional to volatility and target weight."

2) "Decision to rebalance halfway between target and rebalancing range edge vs. target."

DISABILITY APPLICATION PROCESS PRESENTATION- Member Services Director Cynthia Queen, reported staffs' outreach to various member groups to further improve guidance for disability applicants in addition to individual counseling and group orientation meetings. Trustee Franklin Lamberth applauded their efforts of giving the real picture to members. Trustee Steve Meyer said this is the first time he has seen real customer services in this area.

Remaining to be resolved is the issue of SDCERS regarding considering whether a "light-duty" position has become a "permanent" accommodated position if it lasts over a year, colliding with the fact that approval of disability applications takes up to an average of two years.

On February 16th, SDCERS General Counsel Elaine Reagan and Disability Review Officer Sandra Claussen did a special presentation on the legal background for changes in evaluating disability applications, particularly how "light-duty" vs. permanent position is determined by SDCERS staff.
Representatives came from the Port, Airport, two SDCERS Trustees, unions, police officers association, staff from police department and a private attorney who represents their cases, a city attorney who works with the police department, Retiree Task Force member/ former SDCERS Trustee Joe Flynn and myself.
Joe commented that people don't always know when they will get better and are put at risk if they take light-duty.

A union representative asked how SDCERS can expect an applicant to make a rational decision when accepting a light duty position, when SDCERS has such a nuanced determination and may see that position as the City's offer of permanent accommodation? Elaine noted that when an injured worker is in a light duty position for over a year, SDCERS looks at the facts and circumstances to determine whether the position has become a permanent assignment and thus emcompasses their usual and customary duties. Later she added that often times, evidence goes to an adjudicator to determine what is light duty.

The police argued that their department has no permanent assignments, only a classification. They added that SDCERS is seeing light duty assignments as permanent due to the length of time it takes to process applications. The financial reality of the injured paying for mortgages while they wait for their applications to be processed, must be considered.

Cynthia noted that SDCERS has reduced the disability processing time. It had been up to three years before disability applications were determined and disability applicants would know for certainty if they could afford to keep paying their mortgage. SDCERS hopes to achieve determination by 12-18 months. Elaine explained the delay is often due to the time the injured need to recover from surgeries before their permanent and stationary status can be determined, or they have no money to travel to hearings, etc.

Other topics included the impact of DROP on disability approvals, the difference between Workers' Compensation and the disability retirement standards, the disability applicant having the burden of proof as to the facts, relevant evidence that a reasonable person might accept to support a conclusion, sufficient analysis by an expert, adequate medical history or examination, a doctor's statement including an "…explanation of the disease, its dynamics, how it occurred, developed…", and the applicant's need to rise to an adjudicator's standards for determining proof ( vs. Emotional presentations to SDCERS Disability Committee.)
Cynthia reported that progress had been made on the transparency of the process.
Also at that meeting, trustee Dave Hall, Chair of SDCERS Disability Committee, said an emotional element would be forever involved in the experience of being injured. He noted, "It would be helpful if employees had an advocate available to assist them through the initial steps of the application process", independent of whether the injury is qualified or non-qualified by SDCERS.

See Elaine's in-depth power- point presentation "disability retirement program overview" dated February 16, 2010 for more complete information.

2009 POPULAR ANNUAL FINANCIAL REPORT
SDCERS SCOOP - Cynthia Queen
The condensed popular annual financial report of SDCERS fiscal year 2009 "…accomplishments, highlights and condensed financial statements…" from the 2009 comprehensive annual financial report, will be sent to members along with the latest SDCERSCOOP for winter 2010.

TAX PROCEDURES - Chief Compliance Officer Roxanne Parks
Roxanne's February 19th report, page 2, says:
"I am working on internal procedures addressing required minimum distributions, and tax reporting and withholding on disability retirement and death benefit payments…."
She verbally reported that every rock she turns over has 10 details to trace down.