10/22/2007 - Workshop
TRUSTEES OF THE EMPLOYEES' PENSION FUND/PENSION ADVISORY COMMITTEE
WORKSHOP MINUTES
CITY OF CLEARWATER
October 22, 2007
Present: Frank Hibbard Pension Fund Trustee Chair
Carlen Petersen Pension Fund Trustee/PAC Member
John Doran Pension Fund Trustee/PAC Member
George N. Cretekos Pension Fund Trustee
Paul Gibson Pension Fund Trustee/PAC Member
J. Nathan Hightower Pension Advisory Committee Member
Stephen Sarnoff Pension Advisory Committee Member
Absent: Tom Jensen Pension Advisory Committee Member
John Schmalzbauer Pension Advisory Committee Member
Also Present: William B. Horne, II City Manager
Joe Roseto Acting Assistant City Manager
Pamela K. Akin City Attorney
Stuart A. Kaufman Pension Plan Attorney
Patricia O. Sullivan Board Reporter
The Chair called the workshop to order at 1:00 p.m. at City Hall.
To provide continuity for research, items are in agenda order although not
necessarily discussed in that order.
2 – Fiduciary Mandate
Pension Plan Attorney Stuart Kaufman provided a PowerPoint presentation. See
Exhibit – Fiduciary Mandate – October 22, 2007.
While the Pension Plan is not bound by ERISA (Employee Retirement Income Security
Act) standards, Mr. Kaufman recommended using them for guidance. As Florida Statute
112.656 references full-time staff, Mr. Kaufman said plan contracts should detail professionals’
fiduciary responsibilities.
In response to questions, Mr. Kaufman said fiduciaries are obligated to do their due
diligence when hiring experts and to seek the advise of experts when making decisions. He
said fiduciaries are obligated to follow the recommendations of experts unless they sit in all
meetings with consultants and managers. Fiduciaries should read quarterly investment reports
and discuss any concerns with consultants Paul Troup or John Willoughby. Pension Trustees
are required to make decisions that benefit the plan and its beneficiaries, even if those
decisions have a negative effect on the City. Mr. Kaufman recommended the Pension
Trustees consult with the plan’s finance and investment committees regarding investments.
He said plan assumptions should be based on actuary and investment consultant
Pension Trustees Pension Advisory Training Workshop 2007-10-22 1
recommendations. Concern was expressed that taxpayers must cover the cost of mistakes.
Mr. Kaufman said while Trustees are responsible for the administration of the pension fund,
they are immune from prosecution as long as they applied due diligence. Trustees have no
basis for recusal from pension fund issues.
Florida Statute 112.656 also allows the purchase of insurance for named fiduciaries to
cover liability or losses. See Exhibit – Fiduciary Liability Insurance – October 22, 2007. Mr.
Kaufman encouraged the Trustees to consider fiduciary liability insurance or determine that
sovereign immunity is sufficient. Risk Manager Sharon Walton said the City had considered
and decided against fiduciary liability insurance twice before due to high costs. The last quote
was $45,000 annually for $1-million insurance, per incident. Ms. Simmons said PAC (Pension
Advisory Committee) members are exempt from liability if they do not act maliciously. In
response to a question, the City Attorney said litigation could have high defense costs. It was
stated that most suits are settled for less than legal costs. It was felt the cost of the insurance
is high and the City does not have significant exposure.
Mr. Kaufman encouraged Pension Trustees and PAC members to attend his law firm’s
education conference in Ft. Lauderdale on March 9 – 12, 2008. He said the conference
includes legal updates and provides participants the opportunity to network and discuss
pension issues with others. On July 1 of each year, fiduciaries must submit financial
disclosure forms to the Supervisor of Elections. Fines are $25 per day following a 60-day
grace period. The plan cannot pay fines on behalf of its fiduciaries. In response to a question,
Mr. Kaufman reviewed his firm’s duty as independent counsel and plan fiduciary.
Additional data was requested regarding new plan manager finalists. Ms. Simmons
said staff will provide quarterly investment reports and information on the manager search
process. She requested that members contact staff with their questions.
The Pension Trustees and PAC recessed from 1:57 to 2:05 p.m.
Asset Allocation
Cash & Investments Manager Steve Moskun said two manager searches are
underway: emerging markets and Real Estate. He said recent market volatility had affected
the plan’s portfolio.
Paul V. Troup provided a PowerPoint presentation. See Exhibit – Asset Allocation –
October 22, 2007.
Emerging Markets Equity
Mr. Troup provided a PowerPoint presentation. See Exhibit – Emerging Markets Equity
– October 22, 2007.
In response to a question, Mr. Troup said the weak dollar does not affect emerging
markets not tied to the dollar. He said diversification allows the plan to benefit whether or not
Pension Trustees Pension Advisory Training Workshop 2007-10-22 2
the dollar is strong. Mr. Moskun said to reduce risk, staff plans to begin investing in Real
Estate and emerging markets with small amounts of money at first.
Real Estate
Mr. Troup provided a PowerPoint presentation. See Exhibit – Real Estate – October
22, 2007.
The next meeting is scheduled for October 31, 2007.
Adjourn
The workshop adjourned at 3:03 p.m.
Pension Trustees Pension Advisory Training Workshop 2007-10-22 3
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CITY OF CLEARWATER
EMPLOYEE'S PENSION FUND
THE FIDUCIARY
MANDATE
OCTOBER 22, 2007
Stuart A. Kaufman
Klausner & Kaufman, P.A.
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SUMMARY OF PRESENTATION
KEY TERMS
. Fiduciary defined
. Fiduciary laws
. 112.656
. ERISA
· Sovereign Immunity
. Fiduciary liability
· Fiduciary liability insurance
· Investment Issues
· Prudent Investor Rule
. Duty of Loyalty
· Duty of Prudence
· Florida Ethics statutes
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FIDUCIARY DEFINED
· A person is a fiduciary with respect to an
employee benefit plan to the extent
he/she exercises discretionary authority
with respect to plan and assets.
· Exercise of discretion is the key.
· Can include more than just the trustees.
· Extends to investment management and
benefit administration.
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FIDUCIARY LAWS
112.656, Fla.Statutes:
· (1) A fiduciary shall discharge his or her
duties with respect to a plan solely in the
interest of the participants and
beneficiaries for the exclusive purpose of
providing benefits to participants and
their beneficiaries and defraying
reasonable expenses of administering
the plan.
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FIDUCIARY LAWS
112.656, Fla.Statutes:
· (2) Each retirement system shall have one or
more named fiduciaries with authority to control
and manage the administration and operation
of the retirement system. However, the plan
administrator, and any officer, trustee, and
custodian, and any counsel, accountant, and
actuary of the retirement system who is
employed on a full-time basis, shall be included
as fiduciaries of such system.
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FIDUCIARY LAWS
112.656, Fla.Statutes:
. (3) A retirement system may purchase
insurance for its named fiduciary to cover
liability or losses incurred by reason of
act or omission of the fiduciary.
FIDUCIARY LAWS - ERISA
ERISA STANDARD, Section 1104:
. Prudent Man Standard of Care
· A fiduciary shall discharge his duties with respect
for the plan solely in the interest of the
participants and beneficiaries and -
(A) for the exclusive purpose of:
· (i) providing benefits to participants and their
beneficiaries and defraying reasonable expenses
of administering the plan;
. (ii) defraying reasonable expenses of
administering the plan;
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FIDUCIARY LAWS - ERISA
ERISA STANDARD - Prudent Man Standard
· A fiduciary shall discharge his duties with respect
for the plan solely in the interest of the
participants and beneficiaries and -
(B) with the care, skill, prudence and diligence under
the circumstances then prevailing that a prudent
man acting in like capacity and familiar with such
matters would use in the conduct of an enterprise
of a like character with like aims;
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FIDUCIARY LAWS - ERISA
ERISA STANDARD - Prudent Man Standard
· A fiduciary shall discharge his duties with respect
for the plan solely in the interest of the
participants and beneficiaries and -
(C) by diversifying the investments of the plan so as
to minimize the risk of large losses, unless under
the circumstances it is clearly prudent not to do
so; and
(0) in accordance with the documents and
instruments governing the plan insofar as such
documents are consistent with ERISA.
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JUDICIAL STANDARDS
· Meinhard v. Salmon, 164 NE 545 (NY.
Ct. App. 1928).
· Court determines that common standard
of the marketplace is unacceptable to
fiduciaries. General trust standard was
expanded for pension trustees to include
a definition of "undivided loyalty" to be
applied with "uncompromising rigidity."
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JUDICIAL STANDARDS
· NLRB v. Amax Coal Co., 453 U.S. 322
(1981).
· u.s. Supreme Court holds that plan trustees
have an "unwavering duty of complete loyalty"
to members and beneficiaries. Trustees
cannot serve any master other than the fund.
The pressures of undivided loyalty are
inconsistent with the give and take of
collective bargaining.
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FIDUCIARY LIABILITY
A. LIMITS OF EXPOSURE
· Generally, public officials are not subject to
personal liability unless they act willfully,
wantonly and in reckless disregard of human
life, safety and property. Such circumstances
are never protected by waiver of immunity
statutes because they are not considered
conduct in the interest of the public good.
FIDUCIARY LIABILITY
B. TYPES OF CLAIMS
· Claims against retirement plans fall into
several categories:
1. Contract Claims
· The great majority of claims for denial of benefits are
contractual in nature. Denial of benefits in essence
involves an interpretation of the pension contract.
Therefore contract law applies and damages are
limited to providing the benefit which was denied
together with interest
FIDUCIARY LIABILITY
2. CIVIL RIGHTS VIOLATIONS
· Failing to provide a plan member with a due process
hearing before action is taken to deny benefits can
result in a civil rights claim under the provisions of the
federal Civil Rights Act of 1871,42 USC ~1983.
· This means that a member has been deprived of
property rights (contract rights) without due process of
law. Such claims can result not only in a make-whole
remedy but also compensatory damages associated
with the loss of the contract right. Punitive damages
are not available against a state.
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FIDUCIARY LIABILITY
3. TORT CLAIMS
It could be argued that if a member was misled as to rights under
the plan through negligent misrepresentation that the fund could
be sued for its negligence in explaining those benefits. The
greater likelihood of a negligence claim is one which would arise
from the negligent management of plan assets. While ERISA
provides for liability exposure to trustees of private sector plans,
such negligence claims against a government plan could be
argued to fall within the state's governmental immunity statute.
This would mean that employees and officers sued for negligent
activity would be entitled to a defense and indemnity by the
entity. Prior actions against the Board members have been
dismissed under the state sovereign immunity statute.
FIDUCIARY LIABILITY
4. PLANNING FOR RISK AVOIDANCE
Risk avoidance is in most instances simply good advance
planning. In a case for avoiding claims for denial of benefits
arising out of evidentiary hearings, it is important to have a
written due process procedure. The due process procedure
should provide notice, an opportunity to be heard and set forth a
standard of proof. Trustees who will be deciding contested
issues should not discuss the matter with the applicant or any
other interested person prior to a hearing. All decisions should
be based solely on the evidence presented at a hearing and the
law applicable to the claim. All administrative orders and
decisions should be reduced to writing setting forth in detail the
reasoning of the trustees for their decision.
FIDUCIARY LAWS
. Is Sovereign Immunity Sufficient?
. Section 768.28, Fla.Stat.:
· No officer, employee, or agent of the state or of any
of its subdivisions shall be held personally liable in
tort or named as a party defendant in any action for
any injury or damage suffered as a result of any
act, event, or omission of action in the scope of her
or his employment or function, unless such officer,
employee, or agent acted in bad faith or with
malicious purpose or in a manner exhibiting
wanton and willful disregard of human rights,
safety, or property.
FIDUCIARY INSURANCE
Fiduciary Liability Insurance:
· "The Company shall pay on behalf of the insured all loss and
defense costs that the insured becomes legally obligated to pay
solely because of a claim first made against the insured during
the policy period, for a wrongful act committed or allegedly
committed by the insured or by any person for whom the insured
is legally responsible."
· Wrongful Acts are covered = Any breach of the responsibilities,
obligations, or duties prescribed by ERISA or by the common or
statutory law of the United States, or any State or other jurisdiction
therein which are imposed upon an insured while acting as a
fiduciary of a sponsored plan;
· Exclusions deny coverage for the following: deliberately
dishonest, fraudulent, criminal or willful violations of law.
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FIDUCIARY INSURANCE
Fiduciary Liability Insurance:
. Insurance Company Ratings:
AM Best (A++ to F); Moody's (Aaa to C);
Fitch (AM to D); S&P (AM to CC-)
· Compare deductibles and premiums;
· Defense Costs - avoid wasting policies which deduct
attorney's fees from coverage limits;
· Attorney selection - look for policy that permits trustees
to select own attorney to work with insurance
company's attorney.
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FIDUCIARY INSURANCE
Fiduciary Liability Insurance:
Insured's duties include:
· Notice: As a condition precedent the insured is
required to provide written notice as soon as
practicable of any claim made against any or
all trustees for a covered wrongful act.
· Cooperation: Insured is also required to
reasonably assist the insurance company in
the investigation and defense of the claim.
FIDUCIARY INSURANCE
Fiduciary Liability Insurance:
· Subrogation: In the event that the insurance company pays a
claim, the insurance company is "subrogated" to all of the
insured's rights of recovery against any responsible third party.
The insured is obligated to assist the insurance company and is
prohibited from prejudicing the insurance company's subrogation
rights.
· Waiver of Recourse Coverage: Personal insurance can be
purchased as part of the policy by individual trustees. The
insurance company is agreeing to waive any claims or recourse it
may have against the individual trustee. Premium is usually $25
per trustee and must be paid for by the trustee, as it is for personal
coverage.
INVESTMENT ISSUES
A. DUE DILIGENCE
Th.ere are important factors to take into account in
obtaining investment opportunities for the Plan. It
must be remembered that the Trustees act as the
fiduciary on behalf of the members and beneficiaries
of the Plan. All assets must be used for the exclusive
use and benefit of the members and beneficiaries and
for defraying the reasonable cost of Plan
administration. Prior to entering into any investment
contract it is essential that due diligence be performed
regarding the safety and security of the investment
and its aoorooriateness.
INVESTMENT ISSUES
A. DUE DILIGENCE
The following checklist is recommended:
· 1. The Plan should have a written investment policy
setting forth the nature of permitted investments
(stocks, bonds, real estate, etc.).
· 2. The investment policy should set forth the
percentage of assets which may be placed in anyone
investment category, as well as the quality rating
attributable to those securities (for example,
government securities, investment grade securities,
etc. )
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INVESTMENT ISSUES
A. DUE DILIGENCE
· 3. The investment policy should set forth standards
for performance for the investment managers.
· 4. There should be written contracts between the
Plan and the investment manager setting forth the
expected standard of performance of the investment
managers, liability for failure to perform, fiduciary
responsibility standard of the managers in a dispute
resolution process.
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INVESTMENT ISSUES
A. DUE DILIGENCE
· 5. The Plan should retain the services of an
independent performance monitor to compare the
performance of Plan assets against other
standardized investment indices (for example, S&P
500, Russell 2000, etc.). Investment manager reports
should be received not less than quarterly.
· 6. Performance monitor reports should be received
not less than yearly. If the Plan is a defined benefit
plan, the services of an enrolled actuary are required.
INVESTMENT ISSUES
A. DUE DILIGENCE
· 7. An actuarial valuation should be done at least
every three years.
· 8. An experience study to test the accuracy of the
actuarial assumptions utilized should be performed at
least every five years.
· 9. The Plan should have an annual audit performed
by a certified p,ublic accountant independent of the
Plan sponsor. The accountant should also provide a
management letter setting forth any observations
concerning efficiency and security of Plan operations.
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INVESTMENT ISSUES
A. DUE DILIGENCE
· 10. If the Plan is managed by a board of trustees,
errors and omissions insurance may be secured.
. 11. The Plan should be represented by independent
legal counsel.
· 12. Providers of service to the Plan should have
written contracts setting forth duties, compensation,
fiduciary obligations and a dispute resolution.
· 13. An annual report should be made for members
and the Plan sponsor setting forth the annual
performance.
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INVESTMENT ISSUES
B. PRUDENT INVESTOR RULE
. The prudent investor rule is a general
standard of trust law which requires investors
to exercise a reasonable and prudent
standard of care. It compares the behavior of
a fiduciary to the expected standard of
behavior of other similarly situated persons
responsible for the investment of monies
belonging to others.
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INVESTMENT ISSUES
C. RELIANCE ON REPORTS FROM
FINANCIAL ADVISORS
· It is extremely important that financial reports simply
not be taken at face value without review and
explanation. If the fiduciaries do not understand each
investment opportunity in which the Plan is engaged, it
is likely that it is not prudent to be so invested. Recent
federal decisions held trustees in a private sector plan
personally responsible for plan losses attributable to
their failure to question and understand the
appropriateness of an investment.
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INVESTMENT ISSUES
C. RELIANCE ON REPORTS FROM
FINANCIAL ADVISORS
· Example: the trustees blindly accepted the performance report of
the investment manager when it in fact was a substandard and
inappropriate investment.
· The use of a performance monitor is the best protection against
failing to apply prudent investor standards to the performance of
the plan. In addition, it is advisable to pay an on-site visit to each
prospective investment manager to ensure that their operation in
fact is reflective of their promotional material.
· All promotional material should be retained for comparative
purposes against the actual performance received.
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INVESTMENT ISSUES
D. THE DUTY OF LOYALTY
. ERISA codifies the duty of undivided loyalty to
beneficiaries in several provisions, including the
requirements that a plan fiduciary act "solely in the
interest" of the plan and its participants and
beneficiaries "for the exclusive purpose" of serving
plan related goals.
. If a fiduciary takes action that he or she knows will
harm a plan but will advance corporate or personal
interests, that is a breach of fiduciary duty to act
"solely in the interest" of a plan.
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INVESTMENT ISSUES
D. THE DUTY OF LOYALTY
· On the other hand, the mere fact that a fiduciary also
has a role as a corporate official does not mean that
he or she can never take action for a plan that would
benefit the sponsoring company. Rather, the test
generally applied is whether an action was intended to
benefit a plan regardless of what other incidental
effect it might have on the company.
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INVESTMENT ISSUES
E. THE DUTY OF PRUDENCE
. What the courts refer to as prudence is actually a
composite of separate duties of care, skill, prudence,
and diligence. In general, the courts compare the
conduct of a fiduciary to an objective standard of how
a knowledgeable fiduciary would have acted under
similar circumstances. Judicial decisions heavily
emphasize the diligence component of the standard
by examining whether and how the defendant
considered issues that would be thought significant by
a prudent fiduciary acting in similar circumstances.
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FLORIDA ETHICS STATUTES
Constitutional origins
. Government in the Sunshine
Amendment to the Florida Constitution in
1976 provided for the creation of an
independent commission to address
complaints of conflict of interest by
public officers and employees. Led to
creation of;~the Florida Commission on
Ethics.
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FLORIDA ETHICS STATUTES
Statutory Provisions
. Comprises Chapter 112, Part III, Fla.Stat.
. Prohibits dealing with one's own agency, nepotism,
conflicting employment, employment after end of
public service, voting conflicts by public officials and
board members, financial disclosure and reporting.
Also creates the Commission on Ethics and
empowers it to render opinions advising public
officials and to investigate and enforce potential
violations of state ethics statutes. Commission may
levy financial penalties.
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FLORIDA ETHICS STATUTES
Voting Conflicts
· No Board member may vote y matter that inures
to his or her personal gain. Thus; oes not apply when
the member is part of a gene lass of perso ch
as members of a retirement plan. If a conflict exits, he
member must publicly announce the conflict an . e the
appropriate form provided by the ethics Commission.
Cannot have an interest in a company that does
business with the fund over a specified percentage.
Trustees cannot accept gifts in excess of $100. No one
can accept anything of value in return for a vote.
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FLORIDA ETHICS STATUTES
Voting by Retirees and Union
Officials
· Commission has held that retirees may serve
on Board's but could not vote to determine
specific benefits such as COLA's paid to a
discreet group of retired participants. Union
officials may be elected as Board members
because the legislature requires employee
participants which could include union
officials.
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Writer's e-mail: stu@robertdklausner.com
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September 19, 2007
Margaret L. Simmons, CPA
Finance Director
City of Clearwater
Post Office Box 4748
Clearwater, Florida 33758-4748
Re: City of Clearwater Employees' Pension Plan - Fiduciary Liability Insurance
Our File No. 03-0014
Dear Ms. Simmons:
You have requested our opinion as to whether the City of Clearwater should purchase fiduciary
liability insurance for the Pension Advisory Committee, Pension Board of Trustees, the Pension
Investment Committee members, or the City of Clearwater. This letter will discuss the various
issues involved in reaching a decision as to whether the purchase of fiduciary liability insurance is
necessary.
Not all public pension funds have procured fiduciary liability insurance in the commercial market.
Dissatisfied with escalating premiums and with the terms found in commercial policies, some public
plans have opted to self insure their fiduciaries through budgetary pre-funding or simply paying as
a cost should the event arise. Although self insurance or a pay-as-you-go process offers potential
cost savings to plans and more specific protection to covered individuals, this option cannot
effectively restore losses to a retirement fuud itself. The decision to forego commercial insurance
is a business judgment which balances the cost of procuring coverage, the availability of statutory
rights to defense and indemnity, and other factors against the likelihood of a material claim. A
decision not to procure commercial insurance should be supported by a record demonstrating that
the retirement fund trustees made an informed decision based on expert advice from legal counsel
and other appropriate consultants.
RECEIVED
10059 NORTHWEST 1ST COURT, PLANTATION, FLORIDA 33324
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PHONE: (954) 916-1202 · FAX: (954) 916-1232
www.robertdklausner.com
Finance Department
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September 19,2007
Page 2
Claims against retirement systems and trustees fall into several categories: claims based in tort
involving breach of fiduciary duty, contract claims, and claims alleging that the trustees have been
negligent. Most ofthese claims involve either investment situations, or situations based on benefits
provided by the plan. Claims challenging benefit decisions are not insurable.
Our experience has shown that claims are most likely in matters of dealing with the Internal Revenue
Service or for losses arising from less traditional investments such as private equity or direct
ownership of real estate. One Florida city recently settled a claim with the IRS over the treatment
of accumulated leave for approximately $60,000. A Texas city pension fund, which was involved
in a failed hedge fund, expended a significant amount of money in an action by other shareholders
seeking to recover money which the pension fund had received in an early distribution. Both were
insurable events. Weare currently defending two Minnesota pension plans which have been sued
by the employer over their determination of actuarial costs. Their carrier is providing coverage.
In Florida, trustees and the retirement plan have immunity from certain types of claims. Section
768.28(9)( a), Florida Statutes, prohibits the naming of a public officer or employee as a defendant
unless the individual is accused of willful misconduct. In addition, discretionary decisions by the
trustees, made in good faith, are not subject to liability as long as the decision was based on lawful
authority. Courts have reasoned that to subject officials of the executive branch of government to
liability every time a decision involving the exercise of discretion was made would paralyze the
governmental decision-making process. This is best exemplified by the decision of a government
to place a traffic signal at an intersection. That is a discretionary decision which is immune. If the
traffic light is not properly maintained and an accident occurs, that is operational negligence for
which sovereign immunity is waived to the extent of the statutory cap. In the retirement fund
context, there is no liability for an investment decision which proves to be wrong if prior to the
decision due diligence was done. That is discretionary. If after investing, the trustees neglected to
monitor the progress, that would be operational negligence for which liability might attach.
Sovereign immunity does not extend to claims against trustees for incidents where they act in bad
faith or maliciously or in a manner exhibiting a wanton and willful disregard of human rights, safety
or property. Personal liability may attach in these instances. However, a standard fiduciary liability
insurance policy would not individually protect the trustees in these instances either. The limit of
liability for tort claims against the state or its agencies and subdivisions is limited to the sum of
$100,000.00 per person, and $200,000.00 regarding anyone incident, with certain exceptions.
Section 2.032 of the Code of the City of Clearwater provides:
"(I) Pursuant to this article, the city shall save harmless and protect and defend all
employees in any civil action or proceeding in any state or federal court arising out
of any alleged act or omission which occurred or is alleged in the complaint to have
occurred while the employee was acting within the scope of his public employment
.
<<
September 19, 2007
Page 3
or duties, or which is brought to enforce a provision of Section 1981, 1983 or 1985
of Title II of the United States Code.
(2) Nothing in subsection (1) ofthis section shall authorize the city to
indemnify or save harmless any employee or officer where the
employee or officer has acted in bad faith, with malicious purpose, or
in a manner exhibiting wanton and willful disregard of human rights,
safety, or property."
Based on a pure liability standpoint, the immunity provisions of 768.28, along with the City Code
indemnity provisions, may provide the trustees sufficient protection from personal liability. In effect,
the trustees would not be personally liable for any claims unless they act willfully, wantonly,
maliciously, in reckless disregard of human rights, safety, or property. However, it is the trustees
who must ultimately decide whether the cost of obtaining liability insurance is worth the additional
comfort it provides to the trustees.
You may want to consider the purchase of a fiduciary liability insurance policy solely for the
payment of attorney's fees in connection with any fiduciary liability claims. Attorney's fees alone
may easily outweigh the cost of the premium for the policy. In addition, certain policies would allow
you to select the defense counsel of your choice to defend the City and its fiduciaries in any lawsuits.
The majority of policies issued for public plans are written by AIG, Chubb, Travelers, Hartford and
U.S. Specialty. You should ask your insurance agent to price out the cost of the policy before
making a final decision. Should you decide to obtain commercial insurance, it is recommended that
this office review the fiduciary liability insurance issue with the trustees at the upcoming workshop
so that the Fund may develop a proper record evidencing that the matter was thoroughly discussed
prior to a final decision being reached.
Please contact me should you wish to discuss this matter further.
SAK:ldm
cc: Leslie Dougall-Sides, Esquire
\lIp\030014\Simmons Itr re fiduciary liability insurance
City of Clearwater Pension Fund
Asset Allocation
Paul V. Troup
John P. Willoughby
October 22, 2007
CALLAN "":!, i \ II ~
Knowledge .fo,. !I/I'e\(or\
Asset Allocation -
The Cornerstone of a Pension Program
· Defines the Rate of Return
· Defines the Volatility (Risk)
· Shapes the Investment Policy Statement
CALLAN
Kllow/ell 'e f(JlO /Ill'e\ton 1
Three key policies govern a pension fund
· How will the
assets
supporting the
benefits be
invested?
· What risk and
return
objectives?
· How to
manage cash
flows?
· How will the
benefits be
funded?
Accrued?
· What actua ria I
assumptions?
· How are
unfunded
liabilities
amortized/
recognized?
· What type/kind of benefits?
· What level of benefit?
· When and to whom are they payable?
CALLAN 2
KlIow/ell 'e Of !m'e\!on
Two Ways to Develop an Asset
Allocation Strategy
I. Model Assets and Liabilities
Liability Modeling.
Asset Projections
Define Liability
Assumptions
Define Capital
Market Assumptions
.J
Define
Risk Tolerance
Select Appropriate
Tar et Mix
CALLAN ~ ,
Klloll'led'e lor Illl'e\fon 3
Two Ways to Develop an Asset
Allocation Strategy
II. Model Assets Only
Asset Projections
Define Capital
Market Assumptions
+
Define
Risk Tolerance
+
Select Appropriate
Target Mix
CALLAN
Knowledge for IIlI'e\tof\ 4
When do Most Institutional Investors Conduct
an Asset Allocation or an Asset Liability Study?
Every 3-5 years unless a big event occurs:
· Change in return objective
· Change in risk tolerance
- Change in financial condition of plan sponsor
- Change in funded status of pension plan
· Change in constraints
- Time horizon, liquidity needs, federal and state regulations
· Change in funding policy
· Change in benefit policy
- Benefit improvements
- "Freeze" plan or "close" plan (tier)
· Change in risk/return expectations of asset classes
CALLAN
KI/owlet/"e for IIlI'e\tol'\ 5
· Asset-allocation optimization is used to deploy pension fund
assets most efficiently, given market environment
· Purpose of projections: guide asset-allocation analysis
· Projections should be thought of as a set; i.e., not meant to
peg the actual returns for a given year
· Five-year annualized projections:
- Retu rn
- Risk
- Correlation
· Five-year projections are updated each year, allowing for
changes in markets during time
CALLAN ': ' "
Kllow/cd,c for J/lI'c\for,\ 6
Projected Annual Return Projected Standard
Asset Class Index Nominal Real Deviation (Risk) Projected Yield 2006 Projections
Equities
Broad Domestic Equity Russell 3000 9.00% 6.25% 16.90 2.10 9.00% 16.90
Large Cap S&P 500 8.85% 6.10% 16.40 2.20 8.85% 16.40
SmallIMid Cap Russell 2500 9.85% 7.10% 22.70 1.20 9.85% 22.70
International Equity MSCI EAFE 9.20% 6.45% 20.1 0 2.20 9.20% 20.10
Fixed Income
Domestic Fixed LB Aggregate 5.25% 2.50% 4.50 5.25 5.00% 4.50
Long Duration Bonds LB Long Govt/Credit 5.50% 2.75% 9.30 5.50 5.30% 9.30
Non-US$ Fixed Citi Non-US Gov't 5.15% 2.40% 9.60 5.15 4.90% 9.60
Other
Real Estate Callan Real Estate 7.60% 4.85% 16.50 6.00 7.60% 16.50
Private Equity VE Post Venture Cap 12.00% 9.25% 34.00 0.00 12.00% 34.00
Absolute Return Callan Hedge FoF 6.50% 3.75% 9.70 0.00 6.50% 10.20
Cash Equivalents 90-Day T-BiII 4.00% 1.25% 0.80 4.00 4.00% 0.80
Inflation CPI-U 2.75% 1.40 2.75% 1.40
· Capital Market Projections define uncertainty
· We are not predicting a specific return, but the breadth of
possible returns and the likelihood of their occurrence
· Risk, equal to standard deviation of return, means how wide
the range of returns can be around the expected return
CALLAN
Knowledge for !m'e\fon 7
Asset Class
Equities
Broad Domestic Equity
Large Cap
Small/Mid Cap
International Equity
(A) (B) (A-B) (A+B)
Expected Standard Bottom of Top of
Return Deviation Range Range
9.00% 16.90% -7.90% and 25.90%
8.85% 16.40% -7.55% and 25.25%
9.85% 22.70% -12.85% and 32.55%
9.20% 20.10% -10.90% and 29.30%
Fixed Income
Domestic Fixed
Long Duration Bonds
Non-US Fixed
5.25%
5.50%
5.15%
4.50%
9.30%
9.60%
0.75%
-3.80%
-4.45%
and 9.75%
and 14.80%
and 14.75%
Other
Real Estate
Private Equity
Absolute Return
Cash Equivalents
7.60% 16.50% -8.90% and 24.10%
12.00% 34.00% -22.00% and 46.00%
6.50% 9.70% -3.20% and 16.20%
4.00% 0.80% 3.20% and 4.80%
· Standard deviation is a statistical measure of the range of an asset's performance.
· By definition, approximately 680/0 of the time, the return of any asset class is
expected fall within the range of the expected return plus or minus the standard
deviation.
· Therefore, 680/0 of the time we expect the return for Broad Domestic Equity to fall
between -7.900/0 and 25.900/0.
CALLAN 8
Know/ed'e flJl' /f/I'e\ton
Broad
U.S. Eq - Broad 1.00
U.S. Eq - Large Cap 0.96 1.00
U.S. Eq - Small/Mid Cap 0.92 0.84 1.00
Int'l Equity 0.70 0.70 0.63 1.00
U.S. Fixed 0.20 0.2] 0.]4 0.]5 1.00
Long Duration 0.25 0.26 0.20 0.20 0.92 1.00
Non-US$ Fixed -0.03 -0.0] -0.06 0.21 0.32 0.25 1.00
Real Estate 0.54 0.54 0.47 0.47 0.] 7 0.30 0.03 1.00
Private Equity 0.68 0.68 0.62 0.64 0.15 0.]0 0.10 0.44 1.00
Absolute Return 0.56 0.55 0.52 0.50 0.40 0.05 0.]5 0.40 0.43 1.00
Cash Equivalents -0.]2 -0.1 0 -0.15 -0.25 0.30 0.05 -0.05 -0.06 0.07 0.50 1.00
Inflation -0. ]5 -0.] 5 -0.]3 -0.23 -0.25 -0.30 -0.04 -0.13 -0.13 0.50 0.28 1.00
.
Correlation measures the degree to which pairs of asset classes
move together.
Relationships between asset class assumptions are as important,
or more important, than the individual asset class level of
assumptions.
These relationships will have a strong effect on the generation of
efficient asset mixes under mean-variance optimization.
.
.
CALLAN
Knowledge lo/' IIlI'eHo/'\ 9
"Efficient Frontier"
(5 asset mixes)
Capital Market
Assumptions
Return
Risk
Correlation
Searches for
risk - minimizing
combinations
Mixes which
satisfy the first
criteria
.
A standard quantitative tool that is used to identify a series of
efficient portfolios ranging from conservative to aggressive (the
efficient frontier).
The mixes along this frontier are deemed efficient because they
generate the maximum expected return for their expected level
of risk.
They do this by taking optimal advantage of low correlations
between the performance behavior of the different asset classes
of which they are composed.
.
.
CALLAN
KuolI'lcd"c tor If/l'c\fon 10
Broad U.S. Equity 62% 56% 0% 100% 32% 38% 44% 50% 56%
Non-U.S. Equity 10% 10% 0% 100% 12% 15% 17% 20% 22%
U.S. Fixed Income 27% 30% 0% 100% 50% 40% 30% 20% 10%
Real Estate 1% 4% 0% 100% 6% 7% 9% 10% 12%
Total 100% 100% 100% 100% 100% 100% 100%
Annual Return 7.9% 7.9% 7.1% 7.6% 8.1% 8.6% 9.1%
Standard Deviation 13.0% 12.7% 9.9% 11.5% 13.2% 14.9% 16.6%
Total Equity (%) 72% 70% 50% 60% 70% 80% 90%
Total Bonds (%) 28% 30% 50% 40% 30% 20% 10%
* Not Clearwater data
.
Alternative mixes 1 through 5 form an efficient frontier.
Return Objective of Pension Fund: Investment Return Assumption
= 7. 50/0
.
CALLAN
KI/ow/cdgc for /m'c\/or\ 11
. .
9.5
9.3 -
9.0 -
8.8
-- 8.5
~
<=
'-"
= 8.3
l-<
=
-
Q,) 8.0
~
-
~ 7.8
=
=
=
-< 7.5
7.3 -,
7.0
6.8
6.5
9.0
.
I' 90~1o Equity ~
.
Funding Return Assumption of 7.5%
80% Equity ~
/
,
,
.
.. 1-7()-% Equity I
J
.
1 60% Equity 1-
.
. Efficient Frontier
. Target Mix
. Actual Mix
I 50% E~~ity-~
--~---- I
10.0
11.0
12.0
13.0
14.0
15.0
16.0
17.0
18.0
Standard Deviation (%)
CALLAN "
KllolI'led 'e for Illl'eslor.\ 12
n
-.
~ ~
0
tD ~
w ~ n
0 0 -
~ ::r .... . tD
0- :J -a == C>>
tr -a DI 'Q ..,
tD . C ~
.., -
N ~ < ~
~ -. . C>>
-
- -I ,...
N 0
Q .., * tD
c 0
Q U:2 C ..,
'-I ::r -C tD
-a
cr (it
< tD
~ ::J
(It
-.
c:: 0
.... . ::J
~
."
C
::J
Q.
2,744 Stocks
Number of Stocks
Emerging Markets
Equity
(851 Stocks)
u.S. Equity
(631 Stocks)
Non-U.S. Developed
Countries
(1 ,262 Stocks)
Source: MSCI All Country World Index, as of 12/31/2006
$29.2 trillion
Market Capitalization
Emerging Markets Equity
80/0
Non-U.S. Developed
Countries
470/0
U.S. Equity
450/0
CALLAN
Know/edge for /lIl'e\for,\ 1
Country
Weight
Argentina
Brazil
Chile
China
Columbia
Czech
Egypt
Hungary
India
Indonesia
Israel
Jordan
Malaysia
Mexico
Morocco
Pakistan
Peru
Philippines
Poland
Russia
South Africa
South Korea
Taiwan
Thailand
Tu rkey
0.610/0
11. 920/0
1.370/0
16.240/0
0.270/0
0.740/0
0.790/0
0.880/0
6.910/0
1. 540/0
2 . 180/0
0.100/0
2.380/0
4.920/0
0.330/0
0.200/0
0.680/0
0.520/0
1.650/0
9.020/0
6.840/0
15.500/0
11.380/0
1.350/0
1.670/0
CALLAN
Kl1ow!et!oe fol' !11I'e\1ol'\ 2
Historical DebtjEquity: Historical ROE:
Emerging Markets vs World Emer~ng Markets vs World
2 30
o World. EMF
o World . EMF
25
~1.5 20,54
-m 20 18.15 18.52
---- --.------
.~
= 0.92 0.88 ~
$1 015
--- ---- --- -----.-- --
';i) 0.68 ~
,0 10 --.-----
Q)
00.5 5
0 0
1998 2006 1998 2006
· The majority of emerging market companies have deceased leverage on the back of improving cash
flow generation and lower interest rates
CALLAN \ I I
IwolI'/c{/gc for 1t/l'c.\IOf\ 3
Real GDP Growth
10%
8%
6%
. Emerging
0.. Developed
4%
2%
0%
Pl~ Pl'" Pl~ 0,0,'0 0,0)0, ~\:)\:) ~\:)"\- ~\:)<"v ~\:),., ~\:)'!:)y ~\:)~ ('..~ ~~
~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~
Source: IMF World Economic Outlook, 2006
· Emerging markets have grown faster than the developed world and are expected to continue to
do so
· Reform has been progressing - corporate governance, transparency, and privatization are all
driving forces
CALLAN
Kllowledge /01' 1lll'e\ton 4
Rolling 12 Quarter Correlation Relative To S&P:500
for 10 Years Ended December 31, 2005
1.2
1.0
0.2
I - MSCI:Emer Markets
0.8
=
.s
...
~
e 0.6
a..
o
U
0.4
0.0
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
· Correlation rise is actually just due to a small number of huge global companies
· Biggest 50 stocks are half the market cap of the index; rest of index has lower correlation
· Gazprom (Russia) is the world's largest natural gas producer
· Samsung (Korea) is the world's largest DRAM producer
· Teva Pharmaceutical (Israel) is the world's largest generic drug manufacturer
CALLAN ~, \' ,
5
KI/owledge fo/' JIII'e\lof'\
Returns
for Various Time Periods
Current Quarter Ending June 30, 2007
50.0
45.5
10.0
40.0
30.0
'"
6
;::l
......
Cl)
~
20.0
0.0
Last 2 Quarters Last Year Last 3 Years Last 5 Years Last 1 0 Years
Russell 1000 Index I 7.18 20.43 12.34 11.33 7.55
MSCI:ACWI 10.19 25.83 18.57 15.44 7.64
MSCI:EAFE US$ 10.74 27.00 22.24 17.73 7.66
MSCI:Emer Markets 17.75 45.45 38.67 30.66 9.40
MSCI-ACWI returns are gross owing to historic data limitations
CALLAN 6
KI/owledge lor 11/1'C\tor.\
Returns
for Periods Ended June 30, 2007
Group: CAI Emerging Markets Equity DB
60.0
50.0 - r~~.1 A (68)
40.0 - ~::::.I A (71)
en
~ 30.0 - ~::~:.I A (73)
+->
Q)
~ 20.0 -
~
:: . A (83)
~
10.0 - un . A (90
0.0 I I I I
Last Year Last 3 Years Last 5 Years Last 7 Years Last 10 Years
10th Percentile 53.64 43.64 34.59 21.29 14.83
25th Percentile 51.48 42.13 33.72 19.91 13.67
Median 47.35 40.17 31.96 18.31 12.23
75th Percentile 44.01 38.17 30.62 17.18 11.41
90th Percentile 40.91 36.89 29.27 15.29 9.11
Member Count 112 94 86 82 69
MSCI:Emer Markets eA 45.45 38.67 30.66 16.20 9.40
Excellent returns to active management over long time periods
CALLAN
KI/owledge fo,. hll'e\tot\ 7
City of Clearwater Pension Fund
Real Estate
Paul V. Troup
John P. Willoughby
October 22, 2007
CALLAN "",'" , ' ,
Kl10wledge for JI1I'e\tor.\
Equity
Debt
Privately Traded
Publicly Traded
Direct equity ownership in Real Estate Securities
commercial real estate Vary by structure and include:
Includes: office, industrial, REITs, Real Estate Operating
retail, multifamily and other Companies, Real Estate
specialty property types Development Companies,
among others
Mortgage Loans Mortgage Backed
(Typically held by Securities
insurance companies Include: CMBS, B-Notes,
or in bond portfolios) CDOs, Mezzanine Debt
Diminishing universe with (Typically held in
increased securitization bond portfolios)
All strategies
exist
domestically
and
internationally
CALLAN ',I i , i'
Kl10wledge 1("- /lII'C\tOr\ 1
"Time is Archimedes' lever in investing. Given enough time, investments
that might otherwise seem unattractive may become highly desirable.
Time transforms investments from least attractive to most attractive...and
vice versa." (Charles D. Ellis)
· Real estate has provided competitive returns
· Real estate provides diversification benefits when added to
portfolios of stocks and bonds
· Real estate's returns have relatively low correlations with
the returns of stocks of bonds
· Real estate offers a strong income component
· Inefficiencies lead to opportunities in all market cycles
CALLAN < '" : \ ,<,
Kl1owlcd/.:c for !I/I'c\(or,\ 2
Conceptual Return and Risk
Associated with
Different Investment Strategies
=
-
=
......
~
~
Oppo rtunistic/Internatio nal
Value Added
REITs
Core
Risk
CALLAN "~I ,I , \ ' I ' 3
Knowledge li)r JI/I'e\for.\
· Core
- Most conservative equity real estate approach and most
prevalent in institutional portfolios;
- Existing properties with quality construction and design
features, quality tenants and staggered lease schedules;
- At least 800/0 leased upon purchase;
- Predictable income and cash flows;
- Located in economically diversified metropolitan areas;
- Investment structures using all cash or limited leverage
(less than 400/0);
- Anticipated two-thirds of the total return will be from
Income.
CALLAN' ,
Know/cd'c fo,. /m'c\lof\ 4
· REITs
- Publicly traded real estate companies
- Daily liquidity
- Returns are highly correlated with the returns of small/mid
cap value equities
- Access to property types not attainable in most separate
accounts or commingled funds (e.g., Regional Malls, CBD
Office, and Hotels)
- Enhanced diversification
- Increased volatility
- Lower fees
- Exposure to REITs through equity portfolios (Russell 2000
and S&P 500)
CALLAN "
KIIOJded"e for IfIl'e\tol'\ 5
· Value Added
- Offers a competitive income return with potential for
capital appreciation;
- Acquires properties and incorporates re-Ieasing,
repositioning, and re-development strategies;
- Once value has been created, the property is targeted for
sale;
- Leverage ranges from 400/0 to 750/0;
- Anticipated one half of the total return will be from income
and one half from appreciation.
CALLAN \ \
Knowledge flJl' 11/1'e\1o/'\ 6
· Opportunistic
- Return targets are higher than core and value added;
- Leverage used to enhance returns (650/0+);
- Incorporate various investment strategies;
- Terms and fees similar to those of private equity funds;
- Examples include: Global, International, Distressed Real
Estate Portfolios, Mezzanine Debt, Convertible & Preferred
Equity Investments, Commercial Development
- Anticipated more than two-thirds of the total return will be
derived from capital appreciation.
CALLAN 7
Kl10wledge for /1/\'e\lo/'\
· Infrastructure
- Relatively new investment strategy
- Few investment managers with actual investment experience
- Target returns range from 100/0 to 200/0
- Manager fees are similar in structure and level to private
eq u ity
· Timber
- Competitive returns, diversification, and cash flow
- Limited number of qualified managers with varying
investment strategies and regional experience levels
. Agriculture
- Historically low to moderate return series brought up
significantly by recent performance
- Limited number of qualified managers with varying
investment strategies and regional experience levels
CALLAN' " '
8
Kl10wledge for II1I'e\tor\