Investment misses exacerbate shortfall

As the city of Springfield stares down a $200 million shortfall in its Police and Fire pension fund, a look back at the plan's investments shows a highly conservative strategy - and several years of missed investing goals.

Until 2004, the fund's actuaries based their planning on an anticipated annual return on investment of 8 percent to 8.5 percent, but the city's pension fund met that level only twice in the last 10 years.

Part of the reason for the lackluster returns may have been the city's conservative investment strategy, according to Springfield Business Journal sources and analysis.

Under the average

Andy Stewart, a managing partner at financial advising firm Waddell & Reed Inc. in Springfield, said a basic look at the plan's historical returns is not encouraging.

"Compared to a moderate portfolio, the pension fund has not performed as well. I'm not even talking about an aggressive strategy - I'm talking middle of the road," Stewart said. "For sure, they haven't performed as well as they probably could have or should have."

The fund has hit its stated actuarial goal only twice since 1999: in fiscal 2003, where the fund grew by 8.9 percent, and fiscal 2007, when growth reached 11.2 percent.

Even in 2007, though, the fund was significantly outperformed by both the Standard & Poor's 500, which grew by 18.4 percent, and the Dow Jones Industrial Average, which grew by more than 20 percent.

Additionally, the fund has posted negative returns twice during the same 10-year period.

Deputy City Manager Evelyn Honea, who sits on the 11-member pension fund board, said the city's target asset allocation was 50 percent in equity markets, such as stocks, and 50 percent in fixed-income assets such as securities.

"It's very difficult to make that high of a rate of return with half of your assets invested in fixed income," said Honea, who has been an eyewitness to the pension problems in her 26 years spent mostly in the city manager's office and Finance Department. "I'm not saying we didn't have some double-digit returns in the 1990s, but had we had a less conservative asset allocation, it's very possible the returns would have been even greater."

Springfield City Council, at the recommendation of city staff, changed the asset allocation system in 2006, Honea said. Now, instead of a target percentage for each type of asset, the pension board has ranges to work with: 45 percent to 75 percent of the fund assets are expected to be in equity markets, 25 percent to 40 percent go in fixed-income assets, and up to 15 percent is invested in real estate.

Honea said the range method is much more workable for the pension board and its investment consultants.

"We could move within those ranges, which has really given the board some flexibility in terms of setting the asset allocations," Honea said. "We can make minor changes to or asset allocations without having to go back to council each time."

Ken Homan, senior vice president and senior portfolio manager of Springfield Trust & Investment Co. and one of three citizen representatives on the pension board, pointed out that, while the fund's conservative investment strategy may not have allowed for as much gain as possible, it also lessened the blow of market dips such as the drop in the equity market in 2001 and early 2002.

Too little too late?

Mostly as a response to the fund's investment returns - and the discovery of the shortfall in 2004 due to payouts that would be required for employees' accumulated holiday time - the city made several changes to its investment strategy.

The first step in 2005 was creating a seven-member plan review committee to examine the fund's status and fix the shortfall, which then stood at a now-miniscule $3.5 million.

In 2006, the committee recommended, and council approved, a reduction of the fund's assumed rate of return, to 7.5 percent.

"When we were no longer earning that targeted rate of return after the equity markets disappointed us, I'm sure they realized that ... even if we smoothed (returns) out over several years, we were in jeopardy of not earning the 8.5 percent," Homan said. "That's when the re-evaluation of this started."

With a decreased expectation about rate of return, however, the contribution needed from the city to keep the plan funded at a safe level increased - at a time when the city was already holding back on making its full actuarial contributions.

Around the same time, the city also made a decision to change the makeup of the pension board itself, adding two members. Honea said the decision was an effort to improve communication between city staff, council and the board.

"Some of the things people thought the city manager's office wasn't paying attention to, it was because there wasn't really any involvement with the board. At the time, they were basically managing themselves," Honea said. "As the city was putting more and more money into the plan, there was no one from the city management office in on the governance of the plan - it was all being directed by people who had a vested interest in the plan."

Continued efforts

Despite the city's efforts, the fund's investments have met the expected rate of return only one of three fiscal years since the change, though the pension did outperform both the S&P 500 and the Dow Jones Industrial Average during fiscal 2008, which ended June 30.

Those less-than-stellar returns, along with several other factors such as actuarial recalculations of the fund's total liability, has led to the unfunded amount ballooning to nearly $200 million - two-thirds of the plan's liability total.

City management has taken several steps to slow the growth of liabilities. All employees hired after 2006, are placed in Tier II of the fund, which has slightly fewer benefits. Council also is considering moving those Tier II employees, along with all future hires, into the Local Government Employees Retirement System, or LAGERS, to close the city fund completely to new employees.

Honea said LAGERS offers several advantages, including a larger pool of employees to spread risk and full-time staff to handle investment strategy. The city works with an investment consultant and a group of four investment managers, but the pension board makes the decisions on general investment guidelines.