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00600 - [A0751322] (Restricted)

The Investment Decisionmaking Process in Two New York PublicEmployee Retirement Plans. B-164292; HRD-77-41. February 16,1977. 2 pp. + appendices (69 pp.).

Report to Sen. Harrison A. Williams, Jr., Chairman, SenateCommittee on Labor and Public Welfare; Sen. Jacob K. Javits,Ranking Minority Member; by Elmer B. Staats, ComptrollerGeneral.

Issue Area: Income Security Programs: Programs tc ProtectWorkers' Income (1306).

Contact: Human Resources Div.Budget Fuction: Income Security: General Retirement and

Disability Insurance (601).organization Concerned: Department of Labor.Congressional Relevance: Senate Committee on Labor and Public

Welfare.Authority: Administrative Code for the City of New York, title

B. chap. 20. New York Laws of 1920, chap. 741. New YorkState Laws of 1917, chap. 303. Retirement and SocialSecurity Law of New York State* Employee Retirement IncomeSecurity Act of 1974.

Information on the investment decisionmaking process ofthe New York State Employees' Retirement System and theTeachers' Retiresent System of the City of New York was obtainedfrom summary data and interviews with cognizant officials. Theinformation obtained was not verified and the adequacy ofprocedures and practices followed by the plans was notevaluated. Findings/Conclusions: The New York State Employees'Retirement System is the largest of three State-administeredretirement plans for employees of the State and localgovernments. This plan covers about 552,000 active members,compared with the 259,000 members covered by the two otherplans. As of March 31, 1975, this plan had about $6.1 billion inassets, compared with $5.6 billion for the other plans. TheState comptroller is responsible for the management andoperations of the plan, including the investment of plan assets.He draws on a variety of staff resources and outside investmentadvisors to administer the plan and manage the investmentprogram. The Teachers' Retirement System of the City of New Yorkis the second largest of five retirement plans in the city. Asof June 30, 1975, it hal over 83,000 active members and assetstotaling about $3 billion. The other four plans had about257,000 active members and assets of about $5 billion. This planis managed and controlled by a board of trustees. (SC)

°) wRPES'Zl I)trt - F'eb N* r'easejd Ot!tCVa the Oeverr-nAccouitutg Cff· o asis o sqecific a;l z-

) [b~p)Ty tme Office ot 6;u a, eCD REPORT TO UTH '

SENATE COMMITTEE ON, LABOR AND PUBLIC WELFARE

- I BY THE COMPTROLLER GENERALI.,' :' OF THE UNITED STATES

The InvestmentDecisionmaking ProcessIn Two New York PublicEmployee Retirement PlansThis report is the last in a series of sevenstudies requested by the committee.

It contains case studies on the New YorkState Employees' Retirement System and theTeachers' Retirement System of the City ofNew York, giving details of the structure andoperations of the plans.

HRD-77-41

COMPTROLLER GENERAL OF THE UNITED STATESWASHINGTON. D.C. 2046

B-164292

To the Chairman andRanking Minority Member

Committee on Labor andPublic Welfare

United States Senate

In response to your June 14, 1976, letter, we made aseries of case studies of fiduciary standards and conductof public employee pension plans maintained by State and localgovernments in New York, New Jersey, Georgia, Tennessee,Colorado, Michigan, and Virginia.

In New York, we studied the New York State Employees'Retirement System and the Teachers' Retirement System of theCity of New York. Case studies of these plans are includedas appendixes I and II. Case studies for the other six Stateswere previously provided to you.

Based on discussions with your office, we developed aframework for the case studies to provide the informationneeded to help the Committee fulfill its statutory obligationsto study governmental retirement plais. The Employee Retire-ment Income Security Act of 1974 directed the Committee toundertake such studies and provided that the results shouldbe reported to the Senate.

It was agreed with your office that we would obtaininformation on the investment decisionmaking process fromsummary data and interviews with cognizant officials. Wedid not verify the information obtained, and we are not com-menting on the adequacy of procedures and practices followedby the plans.

The New York State Employees' Retirement System is thelargest of three State-administered retirement plans for em-ployees of the State and local governments. This plan coversabout 552,000 active members, compared with the 259,000 mem-bers covered by the two other plans. As of March 31, 1975,this plan had about $6.1 billion in assets, compared with$5.6 billion for the other plans.

The State comptroller is responsible for the managementand operations of the plan, including the investment of planassets. For management and investment purposes, the plan's

B-164292

assets have been combined with assets of the New York StatePolicemen's and Firemen's Retirement System and the Statepublic employees' group life insurance plan. The combinedassets, referred to as the common retirement fund, totaledabout $8.3 billion on March 31, 1976. The comptroller isassisted in managing the common retirement fund by ad-isorycommittees established under State law. He draws on a vari-ety of staff resources and outside investment advisors toadminister the plan and manage the investment program.

The Teachers' Retirement System of the City of New Yorkis the second largest of five retirement plans in the city.As of June 30, 1975, it had over 83,000 active members andassets totaling about $3 billion. The other four plans hadAbout 257,003 active members and assets of about $5 billion.

This plan, established in accordance with State andcity statutes, is managed and controlled by a board oftrustees. The board appointed the Comptroller of tho City ofNew York and hired 10 outside investing firms to help it in-vest plan funds. The board uses employees of a city depart-ment to handle the plan's daily administrative operations.

The investment decisionmaking processes are discussed indetail in the case studies. As directed by your office, wehave prepared this report without waiting for formal writtencomments from plan officials. However, we gave plan officialsan opportunity to comment on the case studies, and we have in-cluded their comments where appropriate. We nave requestedformal written comments, which we will send to you when wereceive them.

Comptroller Generalof the United States

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APPENDIX I

CASE STUDY

ON THE

NEW YORK STATE EMPLOYEES'

RETIREMENT SYSTEM

1

C o n t e n t s

Pae

CHAPTER

1 BACKGROUND 5Membership requirements 5Funding 6Benefits 6

Cost-of-living annuity adjustments 7

2 FRAMEWORK FOR MANAGING INVESTMENTS 8Organizational structure 8

State comptroller 9Investment Advisory Committee 9Mortgage Advisory Committee 9Department of Audit and Control 10Independent advisors 11

Making and implementing investmentpolicy 11

Investment policies 12Implementing investment policy 13

Management and control of pensionplan assets 16

Money management techniques 16Monitoring investmentperformance 17

Disclosure statements 18Audit and disclosure of investment

activities 18Scope of audits 18Reports issued on retirement

plan activities 19

3 INVESTMENT EXPERIENCE 21Annual rate of return 21Pension plan assets 22Funds in non-interest-bearing accounts 22Operating costs 23

Schedule

1 Common Retirement Fund (including theNew York State Employees' RetirementSystem) comparative statement of assetsas of March 31, 1971, 1972, 1973, 1974,1975, and 1976 25

2 Schedule of benefits 26

3

CHAPTER 1

BACKGROUND

The New York State Employees' Retirement System (here-after referred to as the Plan) was established by Chapter 741of the New York Laws of 1920. Under this legislation, onlyState employees were entitled to membership. Amendments toChapter 741, however, authorized extension of Plan coverageto employees of the State's political subdivisions, publicand quasi-public organizations, and certain New York Citylibraries.

As of June 30, 1976, the Plan had about 552,000 activemembers and paid about $26.5 million monthly to its 111,545retirees and beneficiaries. As of March 31, 1975, the Planhad assets valued at about $6.1 billion. The Plan is thelargest retirement system in the State and the largestState retirement system in the country.

The Plan is one of three State-administered retirementplans. The others are the (1) New York State Policemen'sand Firemen's Retirement System and (2) New York State Teach-ers' Retirement System. According to the latest availableinformation, these plans, as of June 30, 1976, had about32,000 and 227,000 active members, respectively, and at theend of the plans' fiscal year ended March 31, 1975, h.i1 as-sets totaling about $900 million and $4.7 billion, respec-tively.

The Plan's management and investment activities arecombined with the (1) New York State Policemen's and Fire-men's Retirement System and (2) New York Saite Public Employ-ees' Group Life Insurance Plan. The assets of the threeplans are combined in an investment pool referred to as theCommon Retirement Fund. A staff of State employees managesthe fund's daily investment activities.

MEMBERSHIP-REQUIREMENTS

Membership in the Plan is mandatory for all personswho entered or reentered the service of the State or partic-ipating political subdivisions on or after July 1, 1948, withcertain exceptions. The exceptions, among otners, include(1) teachers or instructors, policemen, and firemen, who areeligible for membership in other retirement systems, and (2)persons in positions that pay less than $1,500 a year.

Active membership in the Plan ceases upon the member'sdeath or retirement or the member's voluntary withdrawal

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of all or part of his accumulated contributions. Membershipis also terminated when service amoints to less than 5 yearsin any period of 10 consecutive years. However, membershipshall not be terminated if, during the 10-year period, themember had at least 5 years of past service and served asan employee of the Federal Government, the United Nations,or another international organization.

FUNDING

The Pi-,, is primarily funded through contributions fromemployers and income from investments. Originally, both em-ployees and employers had to contribute to the Plan. However,during the past 16 years--to provide increased take-home payto employees--the employers could elect continued membershipparticipation for their employees under a Plan program thatdoes not require any contributions by the employees or underone that permits reduced employee contributions.

During June 1976 about 2,500 of the Plan's 552,0N0 mem-bers were required to contribute to the pension programs.About 10,200 other members were making voluntary contribu-tions. The contribution rates vary from 6.01 to 12.82 per-cent, based on the member's age, sex, and occupation. Forexample, a male enrolling at age 21 contribute, 7.24 percentof his salary, whereas a female of the same age contributes9.09 percent.

New pension legislation was enacted by the State legis-lature during the 1976 session. The chief feature of thelegislation was that a member who joined or rejoined thePlan on or after July 1, 1976, would have to contribute 3 per-cent of gross salary to the Plan. The only exceptions wereemployees under the federally sponsored Comprehensive Employ-ment and Training Act of 1973, as amended (29 U.S.C. 801).

BENEFITS

The Plan provides its members with retirement income andfinancial protection in the event of disability or death.Generally, the benefits available to members depend on whetherthey had joined or rejoined the Plan (1) before July 1, 1973,(2) between July 1, 1973, and June 30, 1976, or (3) afterJune 30, 1976. The enrollment dates differ to comply withthe various provisions of law in effect during these periods.

The Plan offers a broad range of benefit programs. Allprograms provide normal retirement benefits, death and dis-ability benefits, deferred retirement benefits, and optionalmethods of benefit payment. Benefits under the programs

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differ depending on the qualifying age or years of service,the date of membership, and whether the members are contrib-utory or noncontributory. The program available to membersis selected by the employer and is either a contributory,noncontributory, or special program.

Because of the complexity and variety of options offeredto members, we have included excerpts from the Plan's Fifty-Fifth Annual Report, which describes each of the benefitsavailable. This is included as schedule 2 on page 26.

Cost-of-living asnuity adjustments

Legislation enacted in 1976 provides for escalating ordeescalating service retirement, disability, and survivorbenefits annually at a rate equal to the lesser of 3 percent,or the actual increase or decrease in the cost-of-livingindex. Benefits, however, cannot be deescalated below thebenefits initially payable. The law applies only to memberswho joined after June 30, 1976, and has no provisions forcost-of-living adjustments before July 1, 1976.

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ChAPTER 2

FRAMEWORK FO? MANAGING INVESTMENTS

The State comptroller is designated by New York lawas administrator of the Plan and the trustee of the CommonRetirement Fund. The comptroller, as heaJ of the State'sDepartment of Audit and Control, draws on a variety of staffresources, advisory committees, and professional investmentinstitutions to administer the Plan and manage the investmentprogram.

ORGANIZATIONAL STRUCTURE

The following structure is used to manage and controlPlan activities.

,* .. .........COMPtROLLER -- -. -- ,

INVESTMENT MORTGAGEADVISORY ADVISORY

COMMITTEE COMMITTEE

DEPARTMENTOF

AUDIT AND CONTROL

DIVISION OF INDEPENDENT DIVISIONINVESTMENTS AND ADVISORS OF

CASH MANAGEMENT RETIREMENT

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State comrtroller

The State comptroller is administrative head of thePlan, trustee of the Common Retirement Fund, and appointingofficer of the advisory committees. He is authorized bylaw to invest available funds for each retirement systemand hold such investments in his name as trustee. Lrgisla-tion also authorizes him to use any other technical and ad-ministrative assistance he needs.

Two committees--the Investment Advisory Committee andthe Mortgage Advisory Committee--help the comptroller managethe Common Retirement Fund. The comptroller, as head of theDepartment of Audit and Control, exercises administrativecontrol over the Plan and its investment program. He is theState's chief fiscal officer and is elected by the public fora 4-year term.

Investment Advisory Committee

The State law which established the Investrent AdvisoryCommittee provides that the committee shall (1) advise thecomptroller on investment policies relating to the moneysof the Common Retirement Fund and (2) periodically reviewthe fund's investment portfolio and make any recommendationsdeemed necessary.

Each committee member is required by law to be exper-ienced in the field of investments and to have served as asenior officer or member of the board of an insurance com-pany, banking corporation, or other financial or investmentorganization authorized to do business in the State. Thecommittee must consist of at least seven members appointed bythe comptroller for 4-year terms. The committee presentlyhas nine members, who serve without compensation.

Mortgage Advisory Committee

A 1960 State law states that the comptroller shall ap-point a separate Mortgage Advisory Committee, with the adviceand consent of the Investment Advisory Committee, to reviewproposed mortgages and real estate investments by t'le CommonRetirement Fund.

The comptroller has appointed 19 members to the commit-tee; they also serve witnout compensation. The law does notspecify an experience requirement for committee members. APlan official said that the law does not pr3vide for a specificterm of office for committee members a-id that members may bereplaced at the comptroller's discretion.

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Department of Audit and Control

This department is primarily responsible for the Plan'sadministration, including the investment of Plan assets. Thecomptroller, as department head, has delegated this responsi-bility to two divisions within the department, the Divisionof Retirement and the Division of Investments and Cash Manage-ment.

Division of Retirement

The Division of Retirement is responsible for the over-all administration of tiie Plan and the Policemen's and Fire-men's Retirement System and the Public Employees' Group LifeInsurance Plan. Specifically, the division:

--Maintains the accounts for the Common RetirementFund, collects and accounts for the interest incomeard dividends earnc" on investments weld for the fund,a services the mortgages held as investments.

-- Calculates rates of return for various segmentsof the portfolio and determines the long-rangerate of return used in calculating Plan liabilities.

-- Executes transactions related to the acquisitionand disposition of mortgages as investments forthe Common Retirement Fund and manages any realproperty acquired in the fund's name.

The deputy comptroller is in charge of the Division ofRetirement. He is assisted in the administration of thetwo systems by an executive director and in his other dutiesby various bureaus under his direction, such as the AccountingBureau, the Actuarial Bureau, and the Office of Real EstateInvestments. The division employs about 535 people. All em-ployees, except the deputy comptroller, the director of theOffice of Real Estate Investments, and the Counsel, are underthe State's Civil Service System. A Plan official said per-sons holding these positions are appointed by the comptroller.According to the deputy comptroller, there are no specificjob requirements for his position.

Division of Investmentsand Cash Management

The Division of Investments and Cash Management is re-sponsible for administering the investment program for theCommon Retirement Fund, except for mortgage investments.This includes buying and selling securities, determining

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whether certain stock investments are authorized, and safe-guarding securities. The deputy comptroller told us thatthe division director is a civ 4l service employee. A Plan of-ficial estimated that this division employs about 15 people,all of whom are civil service employees.

Independent -advisors

The comptroller has contracted with five professionalinvestment institutions to serve as independent advisors forthe day-to-day common stock transactions of the Common Re-tirement Fund. According to a Plan official, these five in-dependent advisors are banks. Four of them are headquarteredin New York City and one is headquartered in Boston. He alsosaid that one of the local ad-visors also serves as the Plan'sbond advisor.

The deputy comptroller told us that the comptrollerselects these advisors. The latest three advisors selectedwere selected by the comptroller, based on the advice of anactuarial firm, which considered the investment experienceof 15 companies.

MAKING AND IMPLEMENTINGINVESTMENT POLICY

According to Plan officials, the overall investmentpolicy is established by the comptroller and the InvestmentAdvisory Committee. The Director, Division of Investmentsand Cash Management, works closely with them in developingthe policy.

The Plan may make no investment unless it is in accord-ance with the limitations set forth by State legislation.No limitations were established on the amount of funds thatmay be invested in Federal, State, and municipal obligations,including mortgages guaranteed by Federal agencies. Legisla-tion does, however, establish the following limitations forinvestments of the Common Retirement Fund:

-- No more than 30 percent of the fund may be investedin conventional mortgages, no more than 5 percentmay be invested in any conventional mortgage, andno investment of less than $250,000 may be made ina mortgage.

-- No more than 10 percent of the fund may be investedin any conventional mortgage guaranteed by a State bankor trust company.

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-- No more than 6 percent of the fund in any yearor more than 35 percent of the total fund may beinvested in stocks of corporations in which invest-ments are permitted under applicable State laws.

-- No more than 1.5 percent of the fund may be investedin the stock of any corporation, nor may the fundown more than 3 percent of the total outstandingshares o` any corporation.

--No more than 30 percent of the fund may be investedin bonds or other obligations of railroad or utilitycorporations in which investments are permitted underapplicable State laws. Additionally, no more than(1) 5 percent may be invested in equipment trust cer-tificates, (2) 2.5 percent may be invested in obliga-tions of any AAA-rated corporation, (3) 2 percent inany AA corporation, or (4) 1.5 percent in any A cor-poration.

The law specifies that all investments must have arating of A or above assigned by a recognized rating agency,such as Standard and Poor's or Moody's.

Investment policies

The investment objectives of the Common Retirement Fundare consistent with the "prudent man rule"; that is, invest-ment in securities that would be acquired by prudent men ofdiscretion and intelligence in such matters who are seekinga reasonable income and the preservation of their capital.The objectives are to

-- safeguard the principal from any imprudent risk;

-- obtain the maximum yield consistent with thesafety of principal;

--provide for the growth of principal through along-term program of high-grade stock investments;and

-- develop a portfolio which will emphasize quality,flexibility, diversity, and marketability.

According to a Plan official, no specific rate of returnobjectives have been established for investments.

Before 1959, the portfolio consisted entirely of U.S.Government and other governmental obligations, mortgages,

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and tax-exempt bonds. Legislation enacted in 1959 permittedinvestments in corporate obligations, railroad equipmenttrust certificates, and conditional sales notes. FurtheLlegislation in 1960 permitted investments in conventionalmortgages; common stock; and Canadian Government, province,or city obligations. This expansion of investment optionsis reflected in the changing composition of the Plan's port-folio.

The Director, Division of Investments and Cash Manage-ment, said the current investment policy for the Common Re-tirement Fund favors investments in bonds, especially 10-yearshort maturity and tax-exempt bonds and high quality mortgagesthat guarantee 10-percent return. He said the Plan does notmake loans to the State. However, employees may borrow fromthe Plan based on their contributions. Investment policiesare reviewed and revised at quarterly meetings.

Implementing investment policy

The implementation of investment policy for the majorareas of investments--stocks, bonds, mortgages, and short-term investments--is discussed below.

Stocks

According to Plan officials, the five independent ad-visors recommend investments to the comptroller. The comp-troller consults with the director, Division of Investmentsand Cash Management, to determine whether the recommendationsfall within the legislative limitations. Once approved, atransaction is made by an independent advisor through a bro-kerage firm of his choice. Brokerage firms do not deal di-rectly with Plan personnel. The independent advisor submitsconfirmation of purchase or sale to the Division of Invest-ments and Cash Management, which in turn disburses or col-lects funds. According to a Plan official, each of the fiveindependent advisors is given a monthly dollar allocationand assigned part of the stock portfolio to manage.

Bonds

The deputy comptroller said one of the independent ad-visors makes recommendations to the comptroller on bond port-folio investments. Many recommendations involve bond swaps--the trading of low-yielding bonds for bonds with better re-turns. Actual transactions are carried out by the Divisionof Investments and Cash Manaaement.

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Mortgages

The Division of Retirement is responsible for the mort-gage investment program. The deputy comptroller said thatrecommendations for mortgage investments originate withinthe division and are submitted to the comptroller and theMortgage Advisory Committee for review. Unlike the Invest-ment Advisory Committee, which only advises, the MortgageAdvisory Committee actually participates in the decisionmak-ing process. The committee, by law, must approve a proposedmortgage or real estate investment before it can be made.Once a mortgage investment decision is made, the divisionis responsible for executing the transaction, making onsiteproperty inspections, and collecting delinquent payments.The division also collects escrow moneys, pays taxes andinsurance, and identifies delinquent payments.

Short-term irvestments

The Division of Investments and Cash Management issolely responsible for short-term investments. All cash re-ceipts throughout the year are invested in short-term securi-ties, such as Treasury bills and certificates, to produceearnings before the cash is invested in long-term securities.The division director and three division investment officers,who serve as advisors, handle the short-term investments.All decisions regarding these transactions are made by thedirector.

Investments are restricted only by legislation. To carryout the short-term investment program, the division relies ona cash flow projection prepared by the Division of Retirement.This projection and the role it plays will be discussed inthe section beginning on page 16.

Experience of- investmentdecisionmaking staff

Each member of the Investment Advisory Committee is re-quired by law to be experienced in the investment field andto have served as a senior officer or member of the board ofan insurance company, banking corporation, or other financialor investment organization authorized to do business in theState. Although there are no experience requirements statedin the law for members of the Mortgage Advisory Committee,all 19 members are senior officers or board members of banks,insurance companies, or realty corporations.

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The deputy comptroller said that the director, Divisionof Investments and Cash Management, is a civil service em-ployee and that there are no job requirements for this posi-tion. The current incumbent, who has been the divisiondirector since 1946, holds a master's degree in public admin-istration.

Initially, an independent advisor was engaged to managethe bond portfolio. In 1960, when common stocks became partof the Comimolt Retirement Fund, the advisor was also selectedto manage tl.e stock portfolio. As the portfolio grew, anotheradvisor was engaged. Each was allocated part of the portfolioto manage. As the stock portfolio continued to grow, Plan of-ficials felt that more competition among advisors would bene-fit the portfolio.

A consulting firm was engaged to review the investmentperformance of various financial institutions and provide areport to the comptroller on which he could base the selec-tion of additional stock advisors. The firm reviewed theperformance of 15 companies with broad stock investment exper-ience. The report included comparisons of the investment re-sults achieved by the various institutions, along with illus-trations of the general stock market performance based on theStandard and Poor's Composite Stock Index tnd the Dow JonesAverage. The comparisons were based on total investment per-forman-e. The report also included the institutions' feeschedules.

The consulting firm suggested that the following factorsbe considered in selecting advisors:

--Ability of the financial institution to manage largecommon stock investment programs.

--Size of the financial institution, in terms of bothassets managed and depth of staff.

--Expense charges tL be levied by the financial insti-tution.

-- Depth of research and investment policy of the finan-cial institution.

The report highlighted the 15 institutions reviewed andrecommended 6 of them. Three of the institutions were thenchosen as additional independent advisors. According to aPlan official, some of the independent advisors have sincebeen replaced because of poor performance or high fees.

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Selection of brokers

The deputy comptroller said the Plan does not selector deal directly with brokers. The five independent advisorsdo the selecting.

MANAGEMENT AND CONTROLOF PENSION PLAN ASSETS

The Plan has developed an automated investment informa-tion system to provide for complete accounting of investmenttransactions and income. The Accounting Bureau of the Divi-sion of Retirement is responsible for opeiiting this systei.,.The automated system facilitates the collection, editing,and analysis of the large volume of data generated and thetimely and comprehensive review of the investment program byproviding updated reports on all long-term stock and bondtransactions. The reports generated are discussed on page20.

The comptroller, by law, uses the services of a New YorkCity bank as fiscal agent to help the State carry out controlprocedures. The fiscal agent is responsible for transferringand storing all securities. Negotiable securities--mostlyshort-term--are maintained with the fiscal agent. Where prac-tical, securities, which are not readily negotiable, are reg-istered in the name of the comptroller as trustee of the Com-mon Retirement Fund. Physical custody of such securities isthe responsibility of the Division of Investments and CashManagement.

The director of that division told us that no specificcontrols have been established to prevent "soft dollar" ar-rangements--the receipt of research from broker-dealers inexchange for commission business--or loans to other bank cus-tomers or broker-dealers who direct trade to their own firms.He sald the Plan is dealing with reputable firms whose trans-actions are governed by Securities and Exchange Commissionregulations.

Money management techniques

The deputy comptroller said that to make sure that in-coming cash is invested immediately, the director, Divisionof Investments and Cash Management, develops a cash flow planfor anticipated cash receipts. The Division of Retirementis responsible for providing investment income data for cashmanagement purposes. The Division of Retirement prepares acash flow projection report which lists contributions, invest-ment income, benefit payments, and other payments anticipated

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for the coming year as well as the amount available for in-vestment. The director, Division of Investments and CashManagement, said that he is notified by the depository bankof the daily account balance. The forecasted available fundsare invested immediately in short-term investments, mortgages,and stocks.

According to the director Division of Investments andCash Management, adherence to the statutory limitations isthe best way of obtaining optimum return on and security ofinvestments. To upgrade the portfolio wherever possible, asystem of security exchanges has been implemented throughwhich bonds are exchanged for higher yielding obligations.The law spells out the restrictions on this type of transac-tion.

Further, various controls have been set up to obtainoptimum return on and safety of pension assets. For example,an investment may be made only within the limits authorizedby law for the category of securities involved. The director,Division of Investments and Cash Management, said that he hasa staff of investment officers who make sure that stocks andbonds purchased meet the quality restrictions of the law andthat statutory limits are not exceeded.

Monitoring investment performance

The Division of Investments and Cash Management and theActuarial Bureau of the Division of Retirement are jointlyresponsible for evaluating the performance of the independentadvisors. The Plan's actuary said that the evaluation tech-nique used considers many factors when computing rates of re-turn. He said that it provides complete investment results byconsidering not only the income earned from interest or divi-dends, but also changes in market value of assets, which arisefrom both realized and unrealized gains and losses. The tech-nique also includes (1) expression of investment results asannual rates of return, (2) recognition of cash flow--thelength of time that funds were invested, (3) consideration ofsufficiently long periods of time to obtain meaningful re-su'ts, and (4) selection of time periods to illustrate resultsobtained during different periods and under different marketconditions.

According to the actuary, the technique has been com-puterized and reports are prepared monthly. Meetings are heldperiodically with each independent advisor to discuss its per-formance and to compare it with the other four advisors. As aresult, two advisors have been recently discharged because ofpoor performance. The actuary further stated that the bond

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advisor is not monitored because the Plan uses only one, thusno comparison can be made.

Disclosure statem'ents

Plan officials said disclosure statements are not re-quired from the comptroller or anyone else in the Plan. Nodisclosure statements have been filed. The State's PublicOfficers Law cites ethical standards for employees and publicofficials. Beyond the general requirements imposed on allpublic employees, the law places special responsibilitieson Plan employees. The law states that, except as provided,neither the comptroller nor any person employed by the Planshall

-- have any interest in the gains or profits ofany investment of the Plan, or receive anypay or emolument for his services;

--borrow for himself or as an agent or partner ofothers any of its funds or deposits or ir anymanner use the funds except to make current andnecessary payments authorized by the comptroller;or

--become an endorser, surety, or an obliyor inany manner of moneys loaned by or borrowed fromsuch funds.

The deputy comptroller was unaware of procedures fordisclosure statements followed by the banks handling theportfolio. The Plan has received no disclosure statementsfrom the banks.

AUDIT AND DISCLOSURE OFINVESTMENT ACTIVITIES

Investment procedures and controls are subject to bothinternal and external audits. Auditors of the comptroller'soffice, who are independent of the operating divisions respon-sible for the investment program, make internal audits. Stateregulatory agencies and certified public accountants make ex-ternal audits.

Scope of audits

Legislation requires that the Plan be subject to thesupervision of the superintendent of insurance, in accordancewith the provisions of the State insurance law. In this con-nection, the State's Insurance Department audits the Planevery 5 years. Its latest report, which covered the 5-year

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period from April 1966 to March 1971, dealt with the history,management, membership benefits, assets, and financial con-dition of the Plan.

The deputy comptroller, Division of Retirement, saidthere is no legal requirement for an annual audit of thePlan's operations by a certified public accounting firm.However, certified public accountants do take an annualinventory of securities, including an examination of vaultcontrols ant. other custodial and safekeeping procedures re-quired by State law for all State-owned securities.

The latest available report covered the year endedDecember 31, 1974. The accountants inspected or accountedfor securities and other investments owned by the State andheld and administered by the comptroller or the State'sCommissioner of Taxation and Finance, including the CommonRetirement Fund. A Plan official said the accountants re-concile their count with vault records and Division of Re-tirement records.

The comptroller has instituted a regular system of in-ternal audits. A central internal audit staff audits alldivisions of the Department of Audit and Control. Internalaudits of the Division of Investments and Cash Managementinclude review and evaluation of the (1) accounting and se-curity aspects of investment operations, (2) results of oper-ations for selected periods, (3) effectiveness of internalcontrol systems, (4) interim reconciliations of State recordswith a physical count of securities, and (5) performance ofthe fiscal agent. Internal audits also seek to make certainthat the investment function is adequately reviewed and eval-uated.

According to the deputy comptroller the internal auditsare not made on any formal basis at the Division of Retire-ment, nor is there a formal reporting system. No reports ofinternal audits of the Division of Retirement were published.He also said that the audit by the State Insurance Departmentis the only formal, complete audit of the Plan's operation.

Reports issued onretirement plan activities

The comptroller issues an annual report on Plan opera-tions. The report includes a list of the entire investmentportfolio and the actuarial report. It also includes th'amount of assets by type of investment, rates of return hvtype of asset for various years, and rates of return for in-vestments acquired in the current year. The annual report

19

is sent to each public retirement system in the country,each participating employer, public hospitals and libraries,retirement information representatives of the Plan, and theNew York State Exchange Library.

The Division of Retirement's Accounting Bureau preparesan annual financial report. This report, which is sent tothe comptroller, consists of detailed financial statementsof the Plan. The Plan and the Common Retirement Fund are alsorequired by law to report to the State Insurance Department.This department requires detailed schedules showing invest-ments head at yearend and investment transactions that oc-curred during the year.

The Department of Audit and Control publishes a monthlypamphlet of State financial data. The pamphlet includes dataon the Common Retirement Fund and the Plan along with a sum-mary of investments, by type and rate of return of each type,as well as membership and benefit information.

The automated investment information system providesdetailed lists and records covering all phases of investmentactivity concerning long-term bond and stock investments.These records provide a detailed account of purchases, sales,maturities, receipt of interest or dividend payments, andrelated information. The records are usually in the formof printouts and are not published. From these accountingrecords, internal reports are prepared that provide compari-sons, analyses of performance, and historical records of in-vestment activity to be used for investment management.

20

CHAPTER 3

INVESTMENT EXPERIENCE

ANNUAL RATE OF RETURN

The following table shows the annual rate of return forcommon stock and fixed dollar investments (primarily bondsand mortgages) for fitful years 1971-75, as shown in the?lan's annual reports. Except for fiscal year 1971, the an-nual reports did not present an overall rate of return onPlan investments.

Percent returnFiscal Common Fixed dollaryear stock investments

1971 - a/4.851972 10.50 5.231973 8.80 5.301974 .90 5.901975 -1.70 6.30

a/Represents rate of return for all investment assets, includ-ing stocks. At the end of fiscal year 1971, stocks ac-counted for 16.6 percent of total Ilvestments.

The actuary said thet ;he rate of return for commonstock is computed according to the method used for performancemonitoring. This computation includes income from dividends,unrealized gains and losses from appreciation or depreciation,and realized gain; and losses from the sale of assets. Theyield included the changes in market values from November 28,1960, to the end of each fiscal year. The rate of returnfor total fixed dollar investments is obtained by dividingthe income earned during the year by the average asset valuefor the year. Neither realized nor unrealized gains andlosses are considered in -his computation.

According to the Plan's actuary, the rate of return forcommon stock could be computed considering only income andexcluding gains and losses. However, computing the rate ofreturn for fixed dollar investments including realized andunrealized gains and losses would be very time consuming be-cause it would require writing a computer program and accumu-lating raw data which might not be available.

21

PENSION PLAN ASSETS

The values of assets held in the Common Retirement Fund,listed in the annual reports as of March 31 for fiscal years1971-76, were as follows:

Fiscalyear Amount

1971 $4,596,908,2241972 5,376,646,2081973 6,091,833,5191974 6,472,094,2791975 7,139,770,2001976 8,292,245,439

A comparison of the assets by category for the 6-year periodis shown in schedule 1 on page 25. During that period,about 82 to 86 percent of the assets were invested in stocks,bonds, and mortgages.

FUNDS IN -NON-INTEREST-BEARING ACCOUNTS

Four ncn-interest-bearing checking accounts are main-tained for the Plan and the Common Retirement Fund. A regularaccount and an escrow account are maintained for the fund. Apension account for paying benefits and payroll expenses anda revolving fund account for such payments as withdrawals ofcontributions and loans to members are maintained for thePlan. We analyzed the accounts of the Common Retirement Fundand the Plan for the months October 1975 to March 1976. Thefollowing table shows the average daily balances and monthlyexpenditures from the four non-interest-bearing accounts. Theaverage daily balance was computed by totaling the daily bal-ances and dividing the total by the number of days in themonth, excluding weekends and-holidays.

Common Retirement FundRegular account _ Escrow account

gverage Monthly Average Mont-hydaily expendi- daily expendi-

Month balance tures balance tures

October $2,064,299 $559,767,681 $23,440 $6,554,073November 259,313 198,791,151 15,028 2,381,263December 1,596,216 592,400,508 18,237 2,297,771January 1,116,824 178,017,420 26,262 7,374,907February 1,387,445 409,368,358 32,351 1,297,720March 1,186,740 350,303,273 39,776 2,029,104

22

PlanPension payroi l account Revovilng fundAverage Monthly Average Monthlydairy expendi- daily expendi-

Month balance tures balance tures

October -$3,263,066 $27,662,137 -$1,196,521 $10,223,614November -4,272,035 26,627,606 -1,312,467 8,883,046December -2,855,990 26,687,075 -1,290,605 7,841,480January -3,306,029 27,624,098 -1,276,203 6,099,145February -4,228,175 27,449,609 -1,177,843 5,887,429March -3,157,314 28,729,604 -1,254,720 7,684,032

The director of the Accounting Bureau did not believethe balances in the Common Retirement Fund accounts were un-reasonable considering the amount of expenditures.

The director also told us that, for the Plan accounts,a "managed overdraft policy" is followed. Under this policy,frequent deposits are made in amounts sufficient to coverchecks presented to the banks for payment. As a result ofthe policy, the amount of cash recorded in the books of ac-count will frequently be negative--as illustrated in theabove table--while the checking accounts will not show anyoverdrafts.

Our review of the balances recorded in the pension pay-roll account showed that during about the first half of eachmonth a negative cash balance is recorded, but during therest of the month the cash balance generally showed zero oran insignificant amount. Our review of the balances recordedin the revolving fund account showed that the account gener-ally has negative balance, except on the last working day ofthe month, when a positive amount is shown. According tothe director. at the end of the month a deposit is made tobring the book balance up to about $50,000.

OPERATING COSTS

By law, operating costs can be paid only out of theCommon Retirement Fund revolving fund. Disbursements aremade directly from the fund. The director of the AccountingBureau said that charges are prorated aqainst each partici-pating syst-em. A Plan official told us that operating costsincluded salaries, rent, supplies, and utilities. They donot include fees paid to advisors, which are paid outof investment proceeds.

All participating employers are required to make an an-nual contribution to cover the Plan's operating costs. This

23

contribution, which is determined separately from the retire-ment contribution, is computed by dividing the current year'soperating costs by the total current annual payroll of allparticipating employers. The resulting percentage is appliedto each employer's total payroll to arrive at the employer'scontribution.

The following table shows the Plan's operating costsand contributions for fiscal years 1971-76.

Operating costsFiscal Operating as a percentyear costs Contributions of contributions

1971 $5,678,654 $377,692,671 1.501972 6,404,986 508,202,479 1.261973 6,993,963 565,309,199 1.241974 7,117,816 640,384,213 1.111975 8,474,707 701,242,201 1.211976 9,008,122 802,641,410 1.12

24

SCHEDULE 1 SCHEDULE 1

cl 1 IN 1 N N

0% - 0% 0 0% I n Ii - N 0 0% % 1 In 0% 11 0

01 Ino ~ c 0 I0% 0% 0% 0 0 % 0 j

0 'C n % 0 0% In 10 0 %

- rr % - N C

N1 ~ n In 0 r N

ol w ~ ~ ~ i

w ii

lo.8 1~~~0% N0]N

'0 o10 N 1 0% 0% 0 N .

IC - 0 I 0 U In 0% IO 0 N I 0% 0% N 0 I

10 ~ 41 I - N N -. Oo ~ 0% N I IC N %

N In 0

S -0% 0 0 1 0% N, 0% N

IC

.C 1.1 I . - . . . . II£ N 0 0% 0% In N 0% 0% 0 I 0 !0 0% 0% N 0% In - N 0 0 % 0%!

1% 0 N n I 0 N = 0 N 0

* 0% - 0% 0 -, In 0% 0 In NY 0

14 14

0% 4. 0% .1 C

0 0 I

= -a h o IN N N 001010 0. N( g m N0 0%I 0% N - % 0 I I 0

rl ~ ~ S~ 0% -- 0% -

0 N 0 u 1. 0 CIN D NYV C

0% 0 .1 -1 N In N Nj0% C

- . . . ~ 1 1 -1· CI0 0 N In 0

N - N 0%3 InI 01 0% In 0% N j V

01 11. 0 4,n3 0 I ~ ( C( N 0% 0% In 0 - N % 01 0( 41E

0~ I .. . COaa C CJ~/ C0, 0 'I % 0% In 0 N 0111-4 C :F N a 0 o'·

0 II 0 na N a O I l 0% % 0% 0% 0% Nn 0I InI N N 0

- 0· - % O % N 0 01( CN C) 00110 0% .1 N - N N 4- ON 4

0 n N I N N % 1 0 % Ol. -.

0 N *10 N N I CInIL 01 I

SCHEDULE 2 SCHEDULE 2

SCHEDULE OF BENEFITS

[Extracts from the 55th Annual Report, The NewYork State Employees' Retirement System (ERS),The New York State Policemen's and Firemen'sRetirement System (PFRS), and The New York StatePublic Employees' Group Life Insurance Plan,fiscal year ended March 31, 1975.]

Legislation enacted in 1973 substantially revised certainaspects of the Retirement Systems. A new class of members wascreated--those who entered or re-entered the Systems afterJune 30, 1973. Existing benefits were modified, when appli-cable to new members of ERS. In one instance, death benefits,a new formula was mandated for new members of ERS and PFRS.

The normal retirement aqe for Post-July 1, 1973 membersis 62, unless they are in a plan which uses years of serviceas its only criterion. Retirement is permitted members betweenage 55 and 62 but with a reduction in benefits according tothe following formula:

1) One-half of 1% per month for each of the firsttwenty-four full months that retirement predatesage 62.

2) One-quarter of 1% per month for each full month thatretirement predates age 60. In no event is retire-ment allowed before age 55.

Retirement benefits for Post-July 1, 1973 members, exceptany attributable to their own contrib.tions, are subject to alimit. The maximum benefit for ERS m .hers, computed withoutoptional modification, may not exceed 60% of the first $12,000of final average salary and 50% of any final average salary inexcess of $12,000. For policemen and firemen, the maximumbenefit equals the amount payable upon completion of 30 yearsof service.

Other limitations applicable to this group are noted,where appropriate, throughout this summary.

Service Retirement Allowances and Employee Contributions

1. Contributory Plans [See GAO note.]

GAO note: The various retirement options included in thisschedule are referred to as Dlans. Within the casestudy, we zeferred to these plans as programs inorder to minimize confusion with the term "Plan"which we used in referring to the New York StateEmployees' Retirement System.

26

SCHEDULE 2 SCHEDULE 2

If a member's employer has not elected a non-contributoryplan, the employee has a choice between the Age 55 Planand the Age 60 Plan (unless the employee is covered by aspecial plan.)

A. Age 60 Plan

Pre-July 1, 1973 members may retire at or after age60, regardless of length of service, with a pensionof 1/140th of final average salary for each year ofmember service plus 1/70th of final average salaryfor each year of prior service (to a maximum of 35years) plus an annuity purchased by member contribu-tions.

The same benefit formula applies to Post-July 1, 1973members but these members must meet the criteria men-tioned in the introductory paragraphs.

This plan requires member contributions, the rate ofcontribution being based on occupation, sex, and ageat entry into membership. These contributions arelower than those for the other contributory plan.

B. Age 55 Plan

Pre-July 1, 1973 members may retire at or after age55, regardless of length of service, with a pensionof 1/120th of final average salary for each year ofmember service plus 1/60th of final average salaryfor each year of prior service (to a maximum of 35years) plus an annuity purchased by member contribu-tions. The same benefit formula applies to Post-July 1, 1973 members but these members must meet thecriteria mentioned in the introductory paragraphs.The contribution rates for this plan are greater thanthose for the Age 60 Plan.

C. Increased-Take-Home-Pay Provision

For most of the members covered by contributory plans,the required contributions have been reduced by the de-cision of the employer to make contributions to a re-serve for Increased-Take-Home-Pay (ITHP). If an em-ployer makes subn I"HP contributions, they replacepart or all of the riember's own contributions. Tothat extent, a reserve is established which accumu-lates with regular interest and is used to provideadditional income to the member at the time of retire-ment.

27

SCHEDULE 2 SCHEDULE 2

Since April 1, 1960 employers could elect to make ITHPcontributions eaual to 5% of the member's gross sal-ary. Beginning April 1, 1964, employers could electto provide either a 5% or 8% ITHP contribution. As ofApril 1, 1965, employers could elect the 5% or 8% ITHPcontribution, or a fully non-contributory plan. Thefully non-contributory ITHP plan was closed to newelection as of July 1, 1966.

z. Non-Contributory Plan

There are four non-contributory retirement plans: Employ-ees enrolled in any one of these plans are not required tocontribute. Pre-July 1, 1973 members may retre at orafter age 55. Post-July 1, 1973 members must mtet thecriteria mentioned in the introductory paragraphs.

A. Non-Contributory Plan (1/60th Plan)

At retirement, a member will receive a pension equalto 1/60th of final average salary for each year ofmember service rendered after April 1, 1960. plus1/120th of final average salary for each year of mem-ber service rendered before April 1, 1960, plus anannuity from any accumulated contributions left ondeposit with the System. Each year of prior service(up to a maximum of 35 years) will increase the pen-sion by 1/60th of final average salary.

B. Non-Contributory Plan with GuaranteedBenefits (Improved 1/60th Plan)

A member will receive at retirement a pension equal to1/60th of final average salary for each year of serv-ice since April 1, 1960 plus a pension that will pro-duce, when added to the annuity purchasable by re-quired member contributions, a retirement allowance cf1/60th of final average salary for each year of serv-ice between April 1, 1938 and April 1, 1960. All mem-ber contributions since April 1, 1960 and those inexcess of the contributions required under the Age 60Plan for the years between 1938 and 1960 will, if leftin the System, purchase additional annuity. Servicebefore April 1, 1938 is credited in the same manner onthe Improved 1/60th Plan as it is on the 1/60th Plan.Each year of prior service (to a maximum of 35 years)will increase the pension portion of %-c :etirementallowance by 1/60th of final average 6aiary.

28

SCHEDULE 2 SCHEDULE 2

C. Career Plan (25 Years)

A member retiring with at least 25 years of totalservice (member service plus prior service) willreceive a retirement allowance of 1/50th of finalaverage salary for each of the first 25 years ofservice plus 1/60th of final average salary foreach year in excess of 25, provided that requiredcontributions are on deposit. Members retiringwith fewer than 25 years of service will receivethe Improved 1/60th Plan benefit.

D. New Career Plan (20 Years)

A member retiring with 20 or more years of totalservice (member service plus prior service) willreceive a retirement allowance of 1/50th of finalaverage salary for each year of service, providedthat required contributions are on deposit. Formembers who retire with fewer than 20 years oftotal service, the retirement allowance is calcu-lated according to the terms of the Improved1/60th Plan.

3. Special Plans

A. 25 Year Plans

A variety of 25 year plans are offered to policemen,firemen, sheriffs and correction officers. Generally,members may retire with 25 years of service, regard-less of age, or at age 60, with a retirement allowanceof 1/50th of final average salary for each year ofservice (to a maximum of 25 years). Allowances arefunded by employer and member contributions. Membercontributions may be replaced (to the extent of 5% or8% of pay) by ITHP contributions, or the employer mayprovide the plan on a non-contributory basis.

20 Year Plans

These Plans are offered to officers and members ofcertain police and fire departments. A member re-ceives a retirement allowance equal to 1/40th of finalaverage salary for each yeat of service (to a maximumof 20 years). Allowances are funded by employer andmember contributions. Members contributions may bereplaced (to the extent of 5% or 8% of pay) by ITHPcontributions, or the employer may provide the planon a non-contributory basis.

29

SCHEDULE 2 SCHEDULE 2

20 Year Plan for New York State Police

Upon the completion of 20 years of total service, aNew York State Trooper may retire and receive a re-tirement allowance of 1/40th of final average salaryfor each year of service. Troopers retiring withmore than 20 years of service, but not more than 30,will receive an additic.al benefit of 1/60th of finalaverage salary for each year of service in excess of20. With certain exceptions, no credit is allowed forservice beyond 30 years. Most members must retire onDecember 31st of the year in which they attain age 55.

4. Vested Retirement Benefit

The vested retirement benefit is available to a member whois not eligible to retire but leaves service after render-ing 10 years, including a minimum of five years of memberservice. For Post-July 1, 1973 members, the five years ofmember service must follow after July 1, 1973. Memberswho "vest" their retirement allowance must leave any Le-quired contributions on deposit. Upon attaining age 55,60 or 52, depending on the plan by which they were coveredwhen they left service, they must submit applications forretirement. The vested retirement allowance is generallycomputed in accordance with the provisions of the planthey were covered by when last in service.

Disability Retirements

1. Ordinary Disability Retirement

This benefit becomes available after the member has rend-ered 10 years of total service, if he or she is incapaci-tated for the performance of duty. The benefit is meantto be 1/60th of final average salary for each year ofservice. Certain factors, however, may reduce the amount.The minimum allowance, ayain with certaini exceptions, is1/3rd of final average salary.

2. Accidental Disability Retirement

This benefit is available to a member, regardless oflength of service, if he or she is incapacitated forthe performance of duty as the result of an accidentwhich occurred in the performance of duty, and not asthe result of the member's negligence, and if themember applies for the benefit prior to attainingage 60.

30

SCHEDULE 2 SCHEDULE 2

The allowance for Pre-July 1, 1973 members consists

of a pension which is equal to 3/4ths of final aver-age salary, plus an annuity provided out of the mem-ber's accumulated contributions, if any. For Post-July 1, 1973 members, the allowance is eaual to 60%

of the first $12,000, of final average salary and 50%of any final average salary over $12,000, plus an an-

nuity provided out of the member's accumulated contri-butions, if any. The pension is subject to reductionon account of Workmen's Compensation awards.

Supplemental Retirement Allowances

Supplemental payments relate to the first $8,000 of an

eligible member's unmodified allowance and are made to all

service retirees who retired before January 1, 1969 and who

attained age 62 on or before May 31, 1972 and to all disabil-

ity retirees regardless of age. Supplemental allowances are

not payable to benficiaries or designated annuitants.

The supplemental retirement allowances are subject to

renewal by the Legislature each year. The 1975 legislationprovided for continuation of the cost-of-living supplementswhich were already being paid.

Death Benefits

1. Ordinary Death Benefits for Pre-July 1, 1973 Members

This benefit is paid upon the death, before retire-

ment, of a member who meets the eligibility require-ments as set forth in the Law. With some exceptions,the benefit payable on account of a member who, atthe time of death, would have been eligible for a

service retirement benefit is one of the benefits out-lined below or an amount based on the pension reserve

that would have been established had the member re-tired on the date of death, whicheve:r is larger. In

most cases, such reserves are limited so as to excludethe additional benefits contained in retirement plans

enacted since 1967.

The first $50,000 of a member's ordinary death benefit(excluding return of the member's contributions with

interest) is paid in the form of group term life in-surance.

A. Contributorv Plan Benefit

The benefit is equal to one month's salary foreach year of service during the first 12 years

31

SCHEDULE 2 SCHEDULE 2

of service, plus an additional benefit of onemonth's salary for each additional two years ofservice. The maximum ordinary death benefit istwo year's salary. In addition, the member'saccumulated contributions are returned. Both theaccumulated contributions and the ordinary deathbenefit are payable to the beneficiary either ina lump sum or in the form of an annuity.

B. Non-Contributory Plan Benefit

A special death benefit for members under theterms of the non-contributory retirement planprovides for one month's salary for each yearof service up to 36 years.

C. Guaranteed (Minimum) Benefit

New York State employees and members whose em-ployer have elected this benefit are coveredby a "guaranteed" (minimum) ordinary death bene-fit of three times annual salary raised to thenext multiple of $1,000, but not to exceed$20,000. New York State Police and State employ-ees who are members of the Security Services Unitare also covered by a minimum ordinary death bene-fit of three times annual salary raised to thenext multiple of $1,000 but with no limitation.

2. Ordinary Death Benefits for New Members(Post-July 1, 1973)

New members must elect, at the time they first becomta member of the Systems, either of the following bene-fits:

1) An ordinary death benefit of one month's salaryper year of service up to a maximum of threeyears' salary after 36 years of service with analternative formula ("death gamble") applicableto those who die in service after attaining nor-mal retirement age; or

2) A benefit ot one year's salary per year of serviceup to a maximum of three years' salary subject tothe following limitations:

32

SCHEDULE 2 SCHEDULE 2

Age when LastBecame a Member Maximum Benefit

52 2-1/2 x salary53 2 x salary54 1-1/2 x salary

55-64 1 x salary65 & Over $1,000

While in service, the benefit is reduced by 10%yearly after attainment of age 61. Upon retire-ment, the benefit is reduced to 50% the firstyear, 25% the second year and 10% thereafter.In no case is the benefit ever reduced jelow10% of the benefit in force at either age 60 orthe date of retirement if that preceded age 60.

3. Accidental Death Brnefits

This benefit is payable upon the death of a member asthe result of an accident which occurred in the per-formance of duty. This benefit is payable to thewidow until remarriage, or if there is no widow orchild, to a dependent parent.

The accidential death benefit is a pension equal toone-half of final average salary. It is subject toreduction by Wc-kmen's Compensation benefits. In ad-

dition, any acr :,;ulated contributions are paid to thedesignated beneficiary.

If the accidentds death benefit payments, includingpayments made or to be made under the Workmen's Com-pensation Law, are less than the amount which wouldhave been payable as an ordinary death benefit, the

difference is paid to the beneficiary or to the mem-ber's estate.

Options

At the time of retirement, a member may elect to receivethe retirement allowarice in any one of several forms. Eachform is known as an option.

Once payment of the retirement allowance has started, thepensioner may not change the option. Following is a briefdescription of each of the options:

Option 0 (Single Life Allowance):

33

SCHEDULE 2 SCHEDULE 2

The Single Life Allowance is also known as Option Zero.It provides the maximum retirment allc'wance to thepensioner and is payable for life. All payments ceaseat the pensioner's death and no Payments aze madc to anybeneficiary.

Option 1/2 (Cash Refund - Contributions):

Under Option 1/2, pensioners are assured that their ac-cumulated contributions will be returned in full eitherto them or to their beneficiaries. If the pensionershould die before the annuity portion of the retirementallowance has amounted to the pensioner's accumulatedcontributions at the time of retirement, the balancethereof would be paid to the beneficiary in a lump sum.The beneficiary may elect to receive this lump sum in theform of a life annuity or a reduced life annuity. Thepensioner has the privilege of changing the beneficiaryat any time. Because of the assurance provided by thisoption, the annuity portion of the retirement allowanceis less than it would be under Option 0. The pensionportion is the same as it would be under Option 0.

Option 1 (Cash Refund - Annuity Value): (available toPre-July i, 1973 members only)

Under Option 1, pensioners are assured that both theiraccumulated contributions and the reserve established bythe employer will be paid to them or their beneficiaries.If the pensioner should die before the retirement allow-ance has amounted to the pensioner's accumulated contribu-tions plus the reserve established by the employer at thetime of retirement, the balance would be paid to the bene-ficiary in a lump sum. The beneficiary may elect to re-ceive this lump sum in the form of a life annuity or areduced life annuity. The pensioner has the privilege ofchanging the beneficiary at any time. Because of the as-surance provideu by this option, the retirement allowanceis less than it would be under Option 0.

Option 2 (Joint Allowance - Full):

Under Option 2, the pensioner will receive an allowancefor life and if the beneficiary is alive at the time ofthe pensioner's death, the beneficiary will receive thesame retirement allowance for the remainder of his or herlifetime. In this case, the beneficiary cannot be changed.Because two persons are involved instead of one, the re-tirement allowance will be less than it would be under Op-tion 0.

34

SCHHEDULE 2 SCHEDULE 2

Option 3 (Join' Allowance - Half):

Under Option 3, the conditions are exactly the same asunder Option 2, except that the beneficiary will receiveone-half of the retirement allowance which the pensionerhad been receiving.

Additional Options for New Members

Five Year Certain

Under this option, payment is made to a pensioner for lifewith a guarantee that, even in the event of death, pay-ments will continue for five years after retirement.

Ten Year Certain

Payments are made to the pensioner for life with the as-surance that, even in the event of death, payments willcontinue for ten years after retirement.

[GAO note: In interpreting the preceding benefits, the fol-lowing definitions are used.]

Accumulated Contributions - The total contributions madeby a member, with interest.

Annuity - That part of the retirement allowance derivedfrom a member's accumulated contributions.

Beneficiary - A person receiving a payment or paymentsfrom the System by reason of the membership of a spouse orother person.

Designated Annuitant - A beneficary who chooses to re-ceive a benefit as an annuity rather than a lump sum payment.

Employer - The State or other public agency participatingin the System.

Final Average Salary - For pre-July 1, 1973 members, thehighest average annual compensation earned during any threeconsecutive years of member service. For post-July 1, 1973members, the highest average annual compensation earned duringany three consecutive years. Where an employer has so elected,the final average salary may be based on the final year ofmember service.

35

SCHEDULE 2 SCHEDULE 2

Member Service - Service rendered in the employ of theState, or a participating public agency, while eligible formembership.

Non-Contributory - The member is not reauired to makeany contribution.

Option - One of the several forms in which a retirementallowance may be paid.

Pension - That part of the retirement allowance derivedfrom contributions made by the employer.

Pensioner - A member of the System who has been retiredand is receiving a retirement allowance.

Prior Service - Service rendered to a participatingemployer before that employer elected to participate in theSystem.

Retirement Allowance - The monthly payment for life con-sisting of the pension, the annuity, if any and the ITHP pen-sion, if any.

36

APPENDIX II

CASE STUDY

ON

THE TEACHERS' RETIREMENT SYSTEM

OF THE

CITY OF NEW YORK

37

C o n t e n t s

Page

CHAPTER

1 BACKGROUND 41Membership requirements 41Funding 42Benefits 43

Supplemental retirementallowances 43

Cost-of-living annuity adjustments 43

2 FRAMEWORK FOR MANAGING INVESTMENTS 44Organizational. structure 44

Teachers' Retirement Board 45Office of the Executive Director 45Chief accountant 46Comptroller of the City ofNew York 46

Investment Advisory Committee 46Investina agents 46Investment advisor 47

Making and implementing investmentpolicy 47

Investment policy 48Implementing investment policy 51

Management and control of pensionplan assets 53Money management techniques 53Monitoring investment

performance 54Disclosure statements 55

Audit and disclosure ofinvestment activities 55Scope of audit 56Reports issued on pension

plan activities 56

3 INVESTMENT EXPERIENCE 58Annual rate of return 58Pension plan assets 59Funds in non-interest-bearing accounts 59Operating costs 60

39

Schedule Page

1 The Teachers' Retirement System of theCity of New York, comparative statementof assets as of June 30, 1971, 1972,1973, 1974, and 1975 62

2 Schedule of benefits 63

40

CHAPTER 1

BACKGROUND

The Teachers' Retirement System of the City of New York(hereafter referred to as the Plan) was established onAugust 1, 1917, under the authority of Chapter 303 of theNew York State Laws of 1917. The Plan is governed by Title B,Chapter 20, of the Administrative Code for the City of NewYork; the Retirement and Social Security Law of New YorkState; and New York insurance and banking laws.

The Plan is one of five retirement plans for city employ-ees. As of June 30, 1975, the Plan was the second largestcity retirement plan with about 83,000 active members and as-sets totaling about $3 billion. The other four city plans hadabout 257,000 active members and assets of about $5 billion.As of that date, the Plan was paying about $18 million monthlyto its 25,652 retirees and beneficiaries.

Management and investment of the Pi .'s assets are sepa-rated into three programs--a fixed annuity program, a variableannuity program, and a tax-deferred e inuity program. The pur-pose of each of these programs is described in chapter 2, inthe section on investment policy.

The Plan is managed and coi: rolled by a board of trust-ees. To assist it, the board has appointed the comptrollerof the city of New York to mananiE funds of the fixed annuityprogram and has hired 10 outside investing firms to managethe funds of the variable annuity program. The comptrollerand the outside investing firms coinvest the funds of the tax-deferred annuity program.

MEMBERSHIP REQUIREMENTS

Membership requirements are established by the city'sAdministrative Code. Plan members include the following em-ployees of the city's boards of education and higher educationinstitutions:

-- Full-time teachers, instructors, and professors ofpublic schools and colleges.

--Part-time lecturers of municipal colleges.

--Supervisory and administrative teaching personnelof public schools and colleges, such as super-intendents, associate and assistant superintendents,principals, vice principals, and department heads.

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Generally, membership is (1) mandatory for regular am-ployees in a teaching or other related position in the city'spublic schools and colleges and (2) optional for part-timecollege lecturers. Since 1967, public college faculty mem-bers have had the option of jcining the Teachers' Insuranceand Annuity Association, a privately operated nationwideretirement system.

FUNDING

Funds needed to finance the Plan come from earnings oninvestments and contributions by employees and the city'semploying boards of education and higher education institu-tions. The Plan's enabling legislation requires that allemployees contribute through payroll deductions. Members'contributions are based on a percentage of their gross sal-ary. The contribution rate is actuarially determined, basedon the member's age on commencing employment, sex, years ofservice, and the type of pension program selected--eitherthe 20-year pension option or the age-o55-increased-benefitsoption. Under both options, separate rate tables are main-tained for males and females. For example, under the 20-yearpension option, a male at age 25 with 1 year of prior servicecontributes 5.05 percent, whereas a female under the sameonditions contributes 5.45 percent. Moreover, the minimum

rates at age 46 with no prior service are 2.70 percent formales and 3.15 percent for females.

At each member's option, contributions are reduced by(1) the city's contribution for increased take-home pay,described below, and (2) the member's required Federal SocialSecurity contribution.

Since July 1, 1960, the city has contributed a portionof each employee's required contribution, in order to in-crease the member's take-home pay without increasing hisgross salary. The city's portion of the member's requiredcontribution, which has varied between 2.5 to 8 percent from1960 to 1975, is currently 2.5 percent.

In addition, the city contributes annually to the fixedannuity program an actuarially determined amount which pro-vides all benefits that are not included in the annuitiespaid from members' contributions, such as group term lifeinsurance. The city also contributes to the fixed annuityprogram (1) amounts that will amortize various unfunded ac-crued liabilities over periods established by law and (2)an amount which will, over the next 20 years, amortize in-vestment losses in accordance with legislation. The citymakes increased-take-home pay contributiors to the variable

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annuity program. The city makes no contributions to the tax-deferred annuity program but guarantees the benefit paymentsto retired members.

Before July 1, 1971, all the city's contributions to thePlan were paid in the year the liability was incurred. Ef-fective on that date, however, legislation deferred paymentof the city's contributions so that they can be paid 2 yearsafter the liability is incurred.

BENEFITS

The Plan offers a variety of benefits, including normalretirement benefits, disability retirement and death benefits,and deferred retirement benefits. Because of the complexityof the benefits, we have included excerpts from the Plan'sFifty-Seventh Annual Report, which describes each of the bene-fits available. This is included as schedule 2 on page 63.

In addition, the Plan offers supplemental retirement al-lowances and cost-of-living increases.

Supplemental retirement allowances

Teachers who retired before October 1, 1968, with atleast 10 years of credited service are entitled to a supple-mental retirement allowance. This supplement is based onthe year of retirement and the years of service. For example,teachers who retired in 1955 receive a 58.8-percent supplementto their monthly benefits, whereas those who retired in 1967receive a 9.8-percent supplement.

State laws of 1973 liberalized the allowances so thatbenefits are now based on the first $8,000 of annual pensionand the 1969 Consumer Price Index and are payable to thosepensioners who had attained age 62 on or after October 1,1968, and had retired before January 1, 1968. The law re-quires that the computation be developed by the city actuaryand certified to the comptroller. A separate fund, financedby the city and under the control of the comptroller, isused to pay the supplemental allowances.

Cost-of-living annuity adjustments

Under State law, the increase or decrease of normalretirement, disability, and survivor benefits is providedannually at a rate equal to the lesser of 3 percent or theactual increase or decrease in the cost-of-living index.Benefits cannot be decreased below the benefits initiallypaid.

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CHAPTER 2

FRAMEWORK FOR MANAGING INVESTMENTS

The city's Administrative Code places responsibility forthe administration and proper operation of the Plan under thetrusteeship of a Teachers' Retirement Board. To assist it,the board has appointed an executive director to handle theday-to-day administrative activities. The board has also con-tracted with 10 investing agents and appointed the comptrollerof the city of New York to handle Plan investments. An out-side investment consulting firm has also been hired to monitorthe performance of the investing agents.

ORGANIZATIONAL STRUCTURE

The following chart shows the structure established tomanage and control Plan activities.

TEACHERS'RETIREMENT BOARD

COMPTROLLER INVESTING INVESTMENT OFFICE OF THEOF THE CITY AGENTS ADVISOR EXECUTIVE

OF NEW YORK DIRECTOR

iNVESTMENT CHIEFADVISORY ACCOUNTANT

COMMITTEE

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Teachers' Retirement Board

The board is responsible for managing the Plan and isgranted the powers and privileges of a corporation. Boardmembers are trustees of Plan funds, subject to conditionsand limitations imposed by law, as discussed in the sectionbteginning on page 47. The board has the power to hold, pu. -chase, sell, assign, transfer, and dispose of the Plan'ssecurities and investments. City law authorizes the boardto hire investing agents to provide investment advice andmanage portions of the Plan's assets. (Investment activi-ties of the agents are described in the section beginningon p. 48.)

The board consists of seven members, including thecomptroller of the city of New York and the president ofthe city's board of education. The comptroller, electedthrough citywide vote, serves for 4 years. The presidentof the board of education is elected by fellow members,who are in turn appointed by the city's mayor and boroughpresidents. Of the remaining five members, two are ap-pointed by the mayor and three are elected by Plan membersand are themselves Plan members. Of the two appointed boardmembers, one must be a member of the board of education(other than the president). The other need not have anyspecial qualifications. The appointed board members serveuntil a successor is appointed and the elected board mem-bers serve 3-year terms.

Each board member serves without compensation, exceptfor such necessary expenses as travel and printing incurredin serving or the board.

Office of the Executive Director

This office is responsible for the daily administrativeoperations of the Plan. The office prepares operating bud-gets; maintains financial records, including members' con--tribution records; and pays benefits.

An executive director is appointed by the board and isthe board secretary and chief administrator of the Plan. Theexecutive director is authorized, within budgetary limits, tohire necessary staff other than the chief accvlntpnt. Theexecutive director represents the board in meetings withmembers, city departments, and State and Federal authorities.

This office employs about 90 persons. They are city em-ployees selected in accordance with the cicy's civil servicesystem.

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Chief accountant

The chief accountant is in charge of the Plan's generalaccounting work and the members' annuity savings accounts,ana also serves as the budget officer. He is responsible'or preparing and certifying the accuracy of the annual con-solidated financial statements, which show the assets, lia-bilities, and operations of the funds of the fixed, variable,and tax-defeired annuity programs.

The chief accountant, who is appointed by the board,is directly responsible to the executive director for theproper performance of his du ies. His reports are submittedto the board through the executive director. Although thereare no qualifications requirements for the chief accountant,the executive director said that the incumbent is a certifiedpublic accountant.

Comptroller of t? ~city of New York

The comptroller is by law an ex officio member of theboard and custodian of Plan funds. The comptroller isauthorized, subject to the board's approval, to invest thefunds of the fixed annuity program and the fixed portionof the tax-deferred annuity program. (These programs arediscussed in the section beginning on p. 48.)

City legislation permits the Plan to delegate its in-vestment powers to the comptroller. According to a Plan of-ficial, since 1917 the board--through a resolution which hasbeen renewed every 3 months--has authorized the comptrollerto invest the funds of the fixed annuity program and thefixed portion of the tax-deferred annuity program.

Investment Advisory Committee

The comptroller has established an Investment AdvisoryCommittee to advise and assist him in the management of pen-sion funds. The committee is made up of six officials prin-cipally from the banking and insurance fields. This committeemeets about four times a year to review the general economicsituation, including the bond and stock markets, and examinesecurity purchases and sales.

Investing agents

The board has contracted with 10 investing agents tomanage the funds of the variable annuity program and thevariable portion of the tax-deferred annuity program. The

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10 agents consist of 5 local arnks, 3 local and 1 out-of-State broker dealer, and 1 out-,f-State insurance company.These firms adopt their own investment philosophy withinthe guidelines of the law and policies of the board. Theprograms and the investment activities of the 10 investingagents are described in the section beginning on the follow-ing page.

Investment advisor

The board has contracted with a local advisory firm tomonitor the activities of the investing agents and provideinvestment advice. Its responsibilities are described inthe section beginning on page 53.

MAKING AND IMPLEMENTINGINVESTMENT POLICY

The city's Administrative Code gives the board authorityto invest and manage the Plan's assets and responsibility forestablishing and implementing investment policies. However,the investment of Plan funds is subject to the New York StateBanking Law and the Retirement and Social Security Law.

The Administrative Code states that the assets of thevariable fund may be invested in stocks which are permissibleinvestments for domestic life insurance companies or savingsbanks. The investments are subject to the following l'-ita-tions:

-- No more than 5 percent of the Plan's assets shall beinvested in the stocks of any corporation and itssubsidiaries.

-- No more than 2 percent of the total issue and out-standing stocks of any corporation and its subsidiar-ies shall be owned by the Plan.

The Retirement and Social Security law sets the follow-ing limitations on mortgages, stocks, and corporate obliga-t ions.

--No more than 30 percent of the Plan's assets may beinvested in conventional mortgages, no more than5 percent may be invested in any mortgage, and noinvestment of less than $250,000 may be made in amortgage.

-- No more than 10 percent of the Plan's assets may beinvested in any conventional mortgage guaranteed bya State bank or trust company.

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-- No more than 6 percent of the fund in any year ormore than 35 percent of the total fund may be in-vested in stocks of corporations in which invest-ments are permitted under applicable State laws.

-- No more than 1.5 percent of the fixed annuity fundsmay be invested in the stock of any corporation, normay the Plan own more than 3 oercent of the totaloutstanding shares of any corporation.

In addition, the -xecutive director said that the Planmakes loans to members against their contribution accounts.The Plan does not make loans to State or city officials orgovernments. However, with the board's prior approval, bonds,notes, and other obligations of State and city governmentsmay be purchased. Such purchases from funds of the fixed an-nuity program are discussed in the following section.

Investment policy

The board establishes the Plan's investment policy. In-vestment recommendations made by the comptroller and the 10investing agents who manage the three annuity programs mustbe approved by the board before implementation. The boardhas established the following investment guidelines for thefixed, variable, and tax-deferred annuity programs.

Fixed annuity program

The purpose of this program is to provide members with afixed dollar annuity upon retirement. The executive directorsaid that the important investment consideration for the fixedannuity funds is safety of investment--a return of 4 percentis guaranteed by the '.ty. If the Plan's investment portfolioearns less than 4 percent per year, the city makes up the dif-ference. Earnings exceeding 4 percent go to the city. Planearnings have exceeded 4 percent since June 30, 1964. (Seech. 3 for further information on the annual rate of return.)

The comptroller is authorized, subject to prior approvalof the board, to invest the fix-d annuity funds in any in-vestments authorized by law. The comptroller can invest in(1) obligations of the United States, local governments, andCanada, (2) bonds, notes, mortgages, and other indebtedness ofcorporations, (3) public utility obligations, and (4) stocksof corporations. According to a Plan official, there is norequirement that a certain portion of the fixed annuity fund'sassets be invested in local businesses, or State or city ob-liqations.

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The board must approve tax-exempt bonds, such as Stateor local obligations, before the comptroller can buy them.Purchases of long-term bonds are restricted to at least an"A" rating by major rating agencies such as Moody's or Stand-ard and Poor's. Although the comptroller is authorized tobuy corporate stock, subject to the board's approval, theexecutive director said that the comptroller has made ita practice not to purchase any common stock for the fixedannuity plan.

During fiscal year 1976, the investment of fixed annuityprogram funds in New York City obligations increased substan-tially. The increase was reflected primarily in the purchaseof bonds of the State's Municipal Assistance Corporation forthe city of New York and New York City bonds. These pur-chases resulted from a November 26, 1975, agreement signedby the Municipal Assistance Corporation, 11 local commercialbanks, the city's four sinking funds, and the city's fiveretirement systems. The Plan agreed to buy $860 million ofthese obligations, and the other four retirement systemsagreed to buy $1.64 billion over a 3-year period.

Investments in city obligations have increased by $447million--from $165 million on June 30, 1975, to $612 millionon May 31, 1976. As of May 31, 1976, the investment in cityobligations represented about 31 percent of the fixed annuityplan portfolio of about $2 billion.

Variable annuity program

The purpose of the variable annuity program is to protectthe members' retirement income against increases in the costof living by providing a variable retirement benefit basedupon the performance of the portfolio. The investment philo-sophy is to achieve the best rate of return without endanger-ing capital. The combination of earned income and capitalgrowth is expected to increase each member's invested dollarsover a long period.

The board has the authority to invest funds and hasselected outside investing agents .o manage the funds. Theinvesting agents selected have invested in common stock,preferred stock, convertible bonds, and short-term notes.Over 85 percent of the variable annuity program portfoliois in common stocks.

The board established the following conditions forthe investment of variable annuity program funds.

--Securities purchased must be in domestic or compar-able Canadian companies.

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-- Securities purchased--except for securities of banks,trust companies, and insurance companies--must belisted on a national security exchange.

-- Companies in which funds are invested must have earnedat least 4 percent on the par or stated value of theirstock in each of the last 7 fiscal years.

--A company in which funds are invested must have hadaverage earnings--before income taxes--during thelast 5 fiscal years, at least eaual to 1-1/2 timesthe total of the company's fixed costs, maximumcontingent interest, and preferred dividends. Also,the company must have had earnings during one of thelast 2 fiscal years at least equal to 1-1/2 times thetotal of the company's fixed costs, maximum contingentinterest, and preferred dividends.

Investments not meeting the requirements, however, canbe purchased provided that the aggregate cost of the invest-ments does not exceed 10 percent of