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Cypen & Cypen
JUNE 3, 2004

Stephen H. Cypen, Esq., Editor

Never Forget - September 11, 2001


The June 2004 issue of Governing deals with the current era of uncertainty, in which state and local pension plans are looking to some unusual options. Over the past decade, governments were not attentive in keeping their tax systems tuned up to the changing times. As a result, these systems have been pinched and fractured, lapsing into a stupor when times are slow. Meanwhile, cash management, mired in low interest rates, leaves financial officers few options to capitalize on those sums of money. Both state and local governments have been taking nasty blows to the balance sheets of their pension funds, leading funds either to demand more cash or head toward aggressive (read: “riskier”) investment bets. At another time, rebuilding systems’ balance sheets might have been accomplished by increasing contributions. Today, however, cash-strapped governments are reluctant to raise taxes for that purpose. More likely, governments are entertaining thoughts of “borrowing” from the funds, either directly (both difficult and probably illegal) or indirectly (skipping or reducing contributions). Because public pension benefits are almost always guaranteed, governments are on the hook to pay them anyway, no matter how investments perform. So public employee retirement funds are up to some new tricks. In an effort to improve returns on investments, some systems are forsaking the conventional securities markets and plunging into private equity markets. Variously dubbed “alternative” or “targeted” investments, they range from direct ownership of companies in need of a turnaround to high-stakes real estate transactions or participation in hedge funds. When deals work out, large returns can be reaped, but only because there is lots of investment risk. Another risk is that the private deals can be secretive and entail highly paid consultants and advisers, an environment that often collides with public disclosure and conflict-of-interest laws. And then there is the contrarian view, adopted by the State of Maine, which has formally adopted the “matching approach,” placing about one-third of its pension portfolio into matched investments such as long-term inflation-indexed bonds. The price of such prudence is that it requires more assets to meet future liabilities, as there is little margin for capital gains. Yet, the state is willing to forego big gains and the possibility of reduced contributions in the future in exchange for protection against huge losses and the demand for higher contributions required by a more volatile portfolio. You be the judge.


Reports from Pensions & Investments and the New York Times indicate that the Department of Justice has asked several large actuarial firms for information about the terms of their client agreements, in what appears to be an effort to learn whether certain provisions violate antitrust laws. In a March 25, 2004 letter, DOJ’s Antitrust Division said it is investigating “anticompetitive agreements or understandings relating to contract terms and conditions among providers of actuarial consulting services.” The six largest actuarial consultants confirmed receipt of the letter, all indicating they are cooperating with the request for records and documents. In particular, the letter seeks documents and other information related to the firms’ decisions, a couple of years ago, to ask their pension fund clients to set limits or caps on what they would pay in lawsuits over their work or to exempt the firms from liability in such cases. In these times of increasing legal activities, liability exoneration or liability limits have stirred controversy in the pension industry, raising questions about whether the actuarial firms colluded in setting the limits. Stay tuned for further developments.


Jimmie Smith is a lieutenant in the Salem, Ohio, Fire Department. Biologically and by birth a male, Smith is a transsexual, having been diagnosed with Gender Identity Disorder -- a disjunction between an individual’s sexual organs and sexual identity. The City and several of its officials hatched a plot to terminate Smith. As part of the plot, Smith was suspended based on an alleged infraction of “City and/or Fire Department policy.” After a state court reversed the suspension, Smith filed suit in Federal District Court. The District Court dismissed his claims and granted judgment on the pleadings in favor of defendants. On appeal, the United States Court of Appeals reversed. Smith did state a cause of action for sex stereotyping under Title VII of the Civil Rights Act of 1964, 42 U.S.C. § 2000e et seq. He also stated a claim for adverse employment action under Title VII, even though his suspension was ultimately reversed by the state court. Finally, Smith was entitled to sue for sex discrimination, based on an alleged equal protection violation, pursuant to 42 U.S.C. § 1983. When we learn of the trial court’s ultimate disposition on the merits, we will report it here. Smith v. City of Salem, Ohio, Case No. 03-3399 (U.S. 6th Cir., June 1, 2004).


Wilshire Research has issued its 2004 report on State Retirement Systems’ Funding Levels and Asset Allocation. The following are selected findings from the summary:

  • For the 123 State Retirement Systems covered by the study, pension assets fell 4%, or $77 Billion, from $1.8 Trillion in 2002 to $1.7 Trillion in 2003. On the other hand, liabilities grew 6%, or $109 Billion, from $2.0 Trillion to $2.1 Trillion. Falling asset values combined with continued growth and liabilities caused state pension plans to go from a $180 Billion shortfall in 2002 to a $366 Billion shortfall in 2003.

  • The ratio of pension assets-to-liabilities (funding ratio) for all 123 state pension plans combined declined from 91% in 2002 to 82% in 2003. The median -- 50th percentile -- state pension plan has a funding ratio of 79%.

  • The findings of asset shortfall for state pension plans are similar to corporate pension plans. (Based upon Wilshire’s 2003 corporate funding survey on pensions, Wilshire estimates that as of December 31, 2002 defined benefit pension assets for S&P 500 companies totaled $892 Billion, $177 Billion less than pension liabilities of $1,069 Billion, an aggregate funding ratio for corporate plans of 83%.)

  • The findings of asset shortfall for state pension plans are also similar to city and county retirement systems. (Based on Wilshire’s 2003 Report on City & County Retirement Systems, Wilshire estimates that as of December 31, 2002 City and County pension assets totaled $252.8 Billion, $35.3 Billion less than pension liabilities of $288.1 Billion, an aggregate funding ratio for City and County Retirement Systems of 88%.)

  • Fourteen states maintain pension plans with funding ratios below 70%, with West Virginia the lowest at 40%. Only two states, Florida and North Carolina, have pension plans that continue to have assets exceeding liabilities. In 2002, nine states had pension assets that exceeded liabilities.

  • Because many state pension plans report with a significant time lag, funding ratios in the study do not fully reflect recent bull market performance in stocks. Consequently, it is likely that unfunded liabilities will decrease in future studies. Wilshire forecasts that state funding ratios will increase from the 82% level to approximately 84% in 2004.

  • State pension portfolios have a 65% average allocation to equities (including real estate and private equity) and a 35% allocation to fixed income. Wilshire’s prior study reported 63% allocated to equities.

  • Asset allocation varies widely by state retirement system: 6 of 123 retirement systems have allocations to equity in excess of 75%; 9 systems are below 50%. The 25th and 75th percentile range for equity allocation is 57% to 67%.

  • Wilshire forecasts a long-term return on state pension assets equal to 7.2% per annum, .8% below the average actuarial interest rate assumption of 8%. If correct, this asset performance shortfall will increase total unfunded liabilities for state pension plans by an additional $40 Billion per year.

The entire Wilshire Report is available on line at

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Items in this Newsletter may be excerpts or summaries of original or secondary source material, and may have been reorganized for clarity and brevity. This Newsletter is general in nature and is not intended to provide specific legal or other advice.

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