Lifting the Lid: Alaska case may spur more state pensions to sue

BOSTON Fri Dec 14, 2007 4:34pm EST

BOSTON Dec 14 (Reuters) - Alaska's $1.8 billion lawsuit against Mercer accusing the consulting firm of pension calculation errors sets the stage for a showdown between U.S. government retirement funds and private service providers.

More lawsuits by underfunded pension funds for government workers could be in the cards against consulting and actuarial firms, experts say. They say the legal headaches may also lead to a backlash from the service providers as they reexamine the risk-reward payoffs from the business.

"I think we are going to see more of these suits and they are going to be with even bigger pension plans than Alaska's," said Steven Howard, a partner at law firm Thacher Proffitt & Wood LLP.

"It puts the servicing businesses for pension plans on notice that they have to be very, very careful that the day in which they would never even think of being sued by the pension plans is over," Howard said.

The state of Alaska filed a lawsuit last week in state superior court in Juneau, charging Mercer, a former actuary of two state retirement plans, of mistaken assumptions and methods about future health-care costs and basic mathematical and technical errors in the plans.

The suit, which seeks $1.8 billion in damages, the largest yet in a state case against consultants, said the unit of Marsh & McLennan Cos Inc (MMC.N) also failed to assign competent, experienced personnel to work for the plans.

Mercer said it will defend its case vigorously and said a number of factors, including employees retiring earlier than expected, had caused a shortfall in the funds.

But just the filing of the suit with the huge headline number of alleged damages raised the possibility of similar action by other state entities, analysts said.

"People are going to see that headline. Particularly systems that are looking at surprising and disappointing news," said Nevin Adams, editor-in-chief of PLANSPONSOR magazine, a publication on pensions.

"These systems don't have any other viable source for where they are going to come up with the shortfalls. And they are going to be looking around for deep pockets," Adams said.

The "funding ratio," or the percentage of pension assets versus liabilities, averages 80 to 90 for major U.S. state, city and county retirement plans, according to private sector and government estimates.

But as in the case of the Alaska funds, which had an unfunded liability of about $8.4 billion and total assets of $16 billion as of mid-2006, the funding ratios of several other state funds are also far lower than the average numbers.

These include the Oklahoma Teachers plan, with a ratio of 49.3, and the Missouri DOT and Highway Patrol plan, with 55.5, as of end-June 2006, according to the National Association of State Retirement Administrators.

And the underfunding could worsen if markets sour in the aftermath of the credit market turmoil.

"Bad financial markets, just like bad earnings from Enron, are going to lead to litigation," said John Bogle, founder of money manager Vanguard Group.

Actuaries use mathematics, statistics and financial theory to help pension funds estimate their future liabilities.

CalPERS, the largest U.S. public pension fund with $260 billion in assets, employs 16 professional actuaries in-house but smaller public funds get the work done externally.

Besides Mercer, Milliman Inc and Towers Perrin are among the handful of big firms that provide actuarial services. Like lawyers, actuaries charge fees based on hourly rates, making some question if the risk of getting slammed with a multimillion dollar suit is worth the revenues.

"It's going to come to pass that these public entities, if the big actuarial consulting firms back-off, are going to be left with two actuaries working out of their garage with absolutely no liability cover whatsoever. And that's what you are going to get," said an official from an actuarial firm, who asked not to be identified.

The service providers have been preparing for this scenario. Edward Siedle, founder of pension consultant Benchmark Financial Services, said some actuarial firms have struck deals with clients limiting their liability to the fees they charge.

But some analysts questioned the legal standing of such agreements.

The judiciary is also more receptive to cases involving pension assets, said Howard of Thacher Proffitt.

"Judges now are becoming more and more aware of the vulnerability of pension assets to what they believe are circumstances which harm the pension plan," he said.

Howard also said litigation in the pension industry would mirror the pattern in the $12.4 trillion U.S. mutual fund industry where, culminating in the trading scandals of 2002-2004, suits against service providers were filed for violation of fiduciary responsibilities.

"Service providers were held accountable and now you will see a similar pattern developing in the pension plan business," he said. (Editing by Richard Chang)