Third-party investigators recently released a highly anticipated report on errant investment return figures used by Pennsylvania’s largest public pension system. Although the report cleared current and former managers of the Pennsylvania Public School Employees’ Retirement System (PSERS), investigators made clear that the plan’s investment consultant, Aon PLC, played a central role in the pension fund’s misreported investment performance. This ongoing story highlights how traditional public pension systems—in response to growing pressures to meet lofty investment return expectations—have evolved into complex global investment funds that often rely on expensive outside consultants to allocate billions of employee and taxpayer contributions.
According to the report, the Pennsylvania Public School Employees’ Retirement System’s (PSERS) 2020 investment returns were low enough that a fraction of a percent difference in a single quarter’s investment revenue dictated whether or not member and state contribution rate hikes would occur. Commissioned to conduct a special investigation into the circumstances surrounding the certification of contribution rates in Dec. 2020, investigators from the law firm Womble Bond Dickinson pored over hundreds of communications between system executives and consultants.
Pinpointing the Error
Ultimately, the third-party investigators found no evidence of crime or self-dealing among PSERS executives or consultants. Investigators did detail how PSERS is increasingly dependent on highly specialized and expensive consultants to meet its fiduciary responsibilities. Investigators found “a series of unfortunate oversights and a lack of transparency from a key consultant led to the Risk Share error.”
Financial services firm Aon PLC was the key consultant investigators were referencing, according to subsequent reporting. In the end, investigators noted that PSERS employees and consultants could not speak to what broke within the system that allowed the error.
Once the investment return was misreported by Aon PLC, the error was repeated quarterly and factored into contribution rate requirements. Despite the fact that millions of dollars of annual contributions were at stake, Aon PLC relied solely on the earlier erroneously entered numbers in their internal system instead of verifying the data when giving their annual report. For its part, Aon PLC described the situation as a data entry issue perpetrated by an unnamed staff member and has continued to serve as the PSERS investment consultant since the error came to light in March of 2021. The PSERS board voted to adopt a new, lower investment return rate assumption in April of 2021, raising contributions requirements on nearly 100,000 education staff members across Pennsylvania.
About Aon PLC
Aon PLC is one of the largest public pension investment consulting and financial service firms in the world, with public pension clients in almost every state. If one considers the funds contributed by taxpayers and members toward pension benefits as public funds, Aon has become one of the largest appropriators of public funds in the country through its role as an investment consultant to state and local public pension plans.
The Chicago-based firm is paid nearly $750,000 annually to work with PSERS staff on investment management and other financial services, according to Spotlight PA. Yet, when approached by investigators, Aon only agreed to supply limited answers to limited questions and refused an interview by Womble Bond Dickinson outright.
Why the Error and Investigation Matter to Other Pension Systems
For decades, traditional public pension systems like PSERS were able to prefund members’ accrued retirement benefits and avoid running up debt by using an investment strategy not too dissimilar from the average American’s. Member and employer contributions, added to the revenue generated by a mix of common public stocks and bonds, were enough to fully fund traditional pensions with little risk of cost overruns before globalization took root.
But, by the early 2000s, the Pennsylvania Public School Employees’ Retirement System and other public pension plans across the country began experiencing lower investment returns, triggering the need for influxes in revenue from other sources—mainly taxpayers by the way of state and local employers. Alternatively, to avoid contribution hikes, some states simply decided to do nothing and allow the pension debt to grow, which it did, expanding rapidly with the 2008 financial crisis.
Facing pressure to achieve overly optimistic investment return assumptions and avoid contribution hikes that would be paid by taxpayers and/or public employees, pension trustees and managers across the country, including at PSERS, have turned to private, alternative investments with greater upside potential. Although investigators in the PSERS case found the error was associated with a public investment, their report highlighted a lack of both transparency and general understanding of the complex financial strategies being executed. Going forward this means the likelihood of another similar error automatically stifling future PSERS revenue remains a very real possibility.
A Quick Fix
Public pension systems like PSERS are trending towards more volatile and opaque investments. This means Aon PLC and firms like it will continue to be increasingly pivotal figures involved with traditional pension plans. However, reversing the trend does not necessarily resign the state and members to a heavier contribution burden.
Many state legislatures across the country are experiencing an increase in general state revenue due, in part, to the COVID-19 pandemic economic recovery. Using this surge in funds to pay off public pension debt would help make up for past shortfalls and shore up a state’s public pension system in preparation for the next economic downturn or market correction.
Furthermore, using supplemental appropriations to maintain contribution rates while investment return rate assumptions are lowered would relieve some of the pressure being applied to public pension investment managers, who may be feeling the need to meet overly optimistic return assumptions. The higher an investment return assumption, the less likely investment earnings will meet expectations, requiring more frequent and less predictable contribution hikes. A lower investment return bar means investment performance is more likely to meet the pension plan’s assumptions, leading to more stable and predictable contributions.
If policymakers and public pension trustees continue walking the investment assumption tightrope, the more pivotal that internal and external analysts, like those at Aon, become to these important pension funds. Active members, retirees, and taxpayers should be wary of this trend and demand public pension system managers not only improve how they report on the overall status of pension plans but also share more about the role and compensation of a system’s consultants.
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