DISCUSSION CALENDAR – AGENDA ITEM NO. 3 BUDGET AND FINANCE COMMITEE MEETING

July 11, 2012 TO: Budget and Finance Committee, Orange County Fire Authority FROM: Lori Zeller, Assistant Chief Business Services Department SUBJECT: Quarterly Status Update - Orange County Employees’ Retirement System Summary: This agenda item is submitted to provide a status update regarding steps taken over the past quarter, covering April–June 2012, to improve the Orange County Employees’ Retirement System’s (OCERS) financial policies, procedures, and practices. Recommended Action: Receive and file the report. Background: In April 2010, OCERS disclosed that it had uncovered an error in how it handled premium pay salary items, which impacted several plan sponsors including the Orange County Fire Authority (OCFA). Premium pay includes salary items such as education bonus, paramedic bonus, bilingual pay, etc. OCERS should have included these items in the salary data it provided to its actuary, but failed to do so resulting in an under-reporting of pensionable compensation. The error occurred going back to 2004, which compounded the problem. The end result was an $82.7 million increase in OCFA’s recognized unfunded liability with OCERS. OCFA immediately requested supporting documentation, and requested an accounting of OCFA’s contributions to OCERS to ensure that OCFA had been given proper credit, since it had always paid retirement contributions on these premium pays. On February 9, 2011, OCFA staff provided a report to the Budget and Finance Committee (B&FC) regarding improvements needed to OCERS’ financial policies, procedures, and practices, as well as an overview of work expected to be performed to correct the amount of retirement contributions attributed to OCFA and other plan sponsors participating in OCERS. The Committee directed OCFA staff to perform additional work, which was completed and reported to the OCFA Board of Directors in April and July 2011. Following the July 2011 report, the B&FC directed staff to continue providing monthly updates until an extended period of time passes with no new findings of errors, and/or until the Committee becomes more confident that OCERS has corrected the underlying systemic weaknesses which allowed these problems to occur. Following the March 2012 report, the B&FC authorized staff to reduce the frequency of status updates from monthly to quarterly.

Discussion Calendar – Agenda Item No. 3 Budget and Finance Committee Meeting July 11, 2012 Page 2 Actions Taken/Financial Policies & Practices – April–June 2012

April 16

OCERS Audit Committee & Board of Retirement: The Audit Committee approved the hiring of the actuarial firm Milliman to conduct an independent audit of OCERS’ current consulting actuary, The Segal Company. This audit is to be scheduled every five years, and is intended to ensure the accuracy and reasonableness of the work being performed by the consulting actuary. The Committee also received a status update regarding the Internal Controls Enhancement Review being performed by the Internal Audit section of OCERS (Attachment 1).

April 18

OCERS Plan Sponsor Financial Workgroup: An update was provided regarding the 2011 actuarial study process. OCERS’ staff indicated that they intended to distribute data to each plan sponsor for the plan sponsors to review for accuracy and reasonableness, in connection with the 2011 actuarial study. Following this meeting, OCERS’ staff provided the sample data, and OCFA has confirmed overall accuracy of this data; however, staff did find minor differences in which staff will continue to research and reconcile with OCERS.

May 21 OCERS Board of Retirement: Items reviewed included a draft of the 2011 Actuarial Study by The Segal Company (Attachment 2) and a report from OCERS’ staff regarding the Evolution of the Unfunded Actuarial Accrued Liability (Attachment 3).

May 23

OCERS Investment Committee: The Board of Retirement met as the Investment Committee, and voted for a new Investment Portfolio Mix, referred to as Option A (Attachment 4). The following report was provided by OCERS’ CEO:

This will allow for the establishment of a significant diversified credit allocation within the existing fixed income allocation, where we are presently constrained in earnings by the historically low yields on Treasuries and TIPS (inflation protected Treasuries). It will also include an increase in the existing emerging market equity allocation, among other changes. In general, however, these changes do not move the portfolio away from the cautious approach the OCERS Investment Committee has always taken with regard to the investment of its capital. With this decision made, OCERS actuary, The Segal Company, will now begin a review of the portfolio’s assumed rate of return (presently at 7.75%).

June 18

OCERS Board of Retirement: The Board received an update regarding the Board Election for a Safety Member and Safety Alternate Member. The Board Election was required to replace outoing safety member Rich White and outgoing safety alternate member Tony Bedolla. The election resulted in Roger Hilton as the winner for the safety member position and Ray Geagan as the winner for the safety alternate member position. The Board also received four new policies for approval from the Governance Committee, including (1) OCERS’ Policy on Administrative Hearings, (2) Actuarial Extract Policy and Process, (3) OCERS’ Education and Travel Policies, and (4) Budget Approval Policy.

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June 18 (continued)

In addition, the Board discussed the 2011 Actuarial Study, and provided approval of the Study, contingent upon the Actuary modifying the footnote displayed on the cover letter regarding the assumed investment rate of return (Attachment 5). The following report was provided by OCERS’ CEO:

In May Paul Angelo of The Segal Company reviewed the initial OCERS actuarial valuation information as of December 31, 2011. Mr. Angelo’s presentation was informational only. As has been OCERS long-standing practice, that first reading of the valuation allows for stakeholders to review the materials in-depth, and offer comment prior to the Board adoption. Mr. Andy Yeung presented the finalized actuarial valuation report to the Board last Monday. The Board approved the valuation, with its related contribution rates which will be effective on July 1, 2013. The Board’s approval did come with a caveat however. In the actuary’s cover letter to the valuation report, it states “in our opinion, the actuarial assumptions¹ are reasonably related to the experience of and the expectations for the Plan.” The footnote that accompanied that statement states “¹ Please refer to the fourth bullet on page ii of Section 1 for a discussion of those assumptions and in particular, the 7.75% investment return assumption prescribed by the Board.” A request was made of Mr. Yeung, that Segal state in the body of the cover letter the acceptability of the Board’s action regarding the 7.75% assumption, rather than leaving it as a footnote. The Board’s subsequent approval of the actuarial valuation was therefore dependent upon Segal making that modification to the text of the reports cover letter. The Board motion was to return this item to the Board of Retirement for further review at its July 2012 meeting should Segal be unable to comply with the request.

Also at this meeting, the Board was introduced to OCERS’ new Director of IT, Jimmy Blanco. With the addition of this newly created, and higher level position, plan sponsors should have high expectations for success with the new pension administration system that is under development and transition.

June 19

OCERS Press Release: Girard Miller named Chief Investment Officer Santa Ana, CA, June 19, 2012 – The Orange County Employees Retirement System (OCERS) announced today the selection of Girard Miller as the system’s new Chief Investment Officer. He is scheduled to assume the position on Monday, July 2, 2012. Prior to assuming his new position, Mr. Miller has served as a senior strategist for retirement finance and public-sector investments at the PFM Group. He is known nationally as an authority on the investment of public funds and retirement plan design and investment strategies. Houston, Texas-based Heidrick & Struggles assisted OCERS with the nationwide search. “We look forward to having Girard Miller lead our investment team. His investment experience and thorough understanding of public pension plans and retirement related issues will be of tremendous value to assist the Board of Retirement in managing OCERS’ increasingly-diversified portfolio,” Steve Delaney, CEO of OCERS said.

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June 19 (continued)

Previously, Mr. Miller was the President of the Janus Mutual Funds and served as Chief Operating Officer of Janus Capital Group, Inc., a global investment company with $170 billion of assets under management. Prior to that, he was the President and Chief Executive Officer of the ICMA Retirement Corporation for 10 years after heading Fidelity Investments’ public funds group.

Mr. Miller’s career began in the public sector. After working for nine years in local governments in New Jersey and Michigan, he joined the professional staff of the Government Finance Officers Association (GFOA) in 1981. He authored 12 publications for GFOA and founded its Public Investor newsletter for investment professionals. Two publications of relevance presently are his textbook Investing Public Funds and a guidebook for pension trustees on Pension Fund Investing.

Mr. Miller earned a B.A. degree from the University of Washington (Seattle). He earned a Master’s degree in Public Administration at the Maxwell School of Public Affairs of Syracuse University, and holds a Master’s degree in Economics from Wayne State University in Detroit. He is a Chartered Financial Analyst (CFA) and a former fellow of the National Academy of Public Administration.

June 20

OCERS Plan Sponsor Financial Workgroup: Items reviewed included the announcement of the new Chief Investment Officer, Girard Miller, and a status update regarding the 2011 Financial Statement audit. OCERS’ staff indicated that the financial statement audit is still in progress, and will be completed subsequent to the June 30 filing deadline. Delays resulted from the late completion of some financial schedules required for the audit, and late submittal of required supplementary information by a plan sponsor (not OCFA) regarding post-employment benefits.

June 27

OCERS Board of Retirement – Annual Education Forum: Topics included Global Economic Outlook, by Patrick Dimick of Bridgewater Associates, Role of Infrastructure and Outlook, by Steven Weddle of J.P. Morgan Asset Management, and Risk Management – What is Risk Management and Discussion on Industry Practices, by Daniel Kelly, NEPC.

Staff will continue to monitor actions taken by OCERS to improve its financial policies and practices, and will report back in October regarding progress made during the next quarter. Impact to Cities/County: Changes in OCFA’s retirement rates have a direct impact on the annual increases in contract charges to OCFA’s cash contract cities, and can impact the amounts available to budget for other important services. Fiscal Impact: The fiscal impacts of items discussed above are not known at this time. Staff will continue to monitor actions taken and provide details as they become available.

Discussion Calendar – Agenda Item No. 3 Budget and Finance Committee Meeting July 11, 2012 Page 5 Staff Contacts for Further Information: Lori Zeller, Assistant Chief/Business Services Department LoriZeller@ocfa.org (714) 573-6020 Tricia Jakubiak, Treasurer TriciaJakubiak@ocfa.org (714) 573-6301 Jim Ruane, Finance Manager/Auditor JimRuane@ocfa.org (714) 573-6304 Attachments: 1. OCERS Agenda Item – Status of the Internal Controls Enhancement Review – April 4, 2012 2. Draft 2011 Actuarial Study by The Segal Company 3. Evolution of the Unfunded Actuarial Accrued Liability 4. Investment Portfolio Mix 5. Final 2011 Actuarial Study by The Segal Company – Cover Letter and Section 1 (entire report

is available upon request to the Clerk of the Authority)