Mercer’s Little Alaska Problem?

Leo Kolivakis's picture

Submitted by Leo Kolivakis, publisher of Pension Pulse.

Gretchen Morgenson of the New York Times reports on Mercer’s Little Alaska Problem (hat tip Dan Braniff):

Although it has received little coverage lately, a bombshell of a lawsuit inching its way through the superior court of Alaska has revealed the financial strain visited on state workers there and promises to have ramifications for public pensions across the country.


The Alaska Retirement Management Board, a state agency, filed the suit in 2007 against Mercer, the human resources consulting firm. The lawsuit says that Mercer’s mistakes hindered the ability of Alaska’s retirement system to meet its obligations to former public employees.


Mercer, the agency contends, made multiple errors as the state’s actuarial consultant when it estimated the amounts that two of the state’s retirement plans needed to set aside for health care and pension benefits. The agency seeks damages of $2.8 billion.


Earlier this year, Mercer, a unit of Marsh & McLennan, had asked Patricia A. Collins, the superior court judge overseeing the matter, to dismiss the case. Mercer’s lawyers argued that it did no “compensable harm” or damage to Alaska’s retirement systems.

On Dec. 4, Judge Collins denied the motion and ordered a trial to be held in Juneau next July to determine whether Mercer had harmed the system.


That Mercer erred in its calculations is bad enough — getting such details right, after all, is what the firm advertises as its stock in trade.


But an even bigger grenade dropped earlier this year when the Alaska board, citing depositions of Mercer employees, contended that company executives had known about the actuaries’ errors and covered them up.


If Alaska prevails in court, it could entitle the retirement system to punitive as well as treble damages.


Mercer, with 4,000 employees in 150 offices around the world, concedes that the Alaska case is a threat. In its usual corporate filings, a brief discussion of the case heads a list of risks facing Marsh. It also notes that it has “limited” insurance to cover the costs of an adverse outcome.


And according to Marsh’s most recent quarterly filing, the company has not recorded a liability related to the Alaska case because it cannot determine “that a loss is both probable and reasonably estimable.”


In a statement, Mercer conceded that its error and its failure to disclose it was “a mistake in judgment that Mercer regrets and it is not consistent with the company’s corporate culture.”


Mercer had worked for Alaska since the 1970s. From June 1999 to April 2006, it got $2.5 million for its work on behalf of the Alaska funds. The suit said it billed the plans as much as $430 an hour.


Unlike most public pensions that promise to pay future benefits out of money they hope to earn, the Alaska systems funded health care costs in advance.


As actuary for retirement plans that serve both teachers and other public employees, Mercer had the duty to calculate the plans’ liabilities and determine the employer contribution rates to fund those promises.


But, according to the lawsuit, when Mercer prepared the plans’ 2002 report, it understated their liabilities by as much as $1 billion.


Then, rather than own up to the mistake, Mercer executives covered it up, the documents say. “Following standard Mercer policies designed to prevent clients from discovering Mercer’s errors,” Alaska’s lawyers contend, “Mercer’s actuaries carefully avoided creating a written record of their discussions and calculations, in order, one of them testified, to avoid creating a ‘trace.’ ”


The error that Mercer covered up, according to the lawsuit, occurred in 2002 and involved a “per capita claims cost,” which represented the estimated expenses of providing health care to a retiree. Mercer used one assumption for retirees under age 65 and another, lower estimate for those over 65 because they could tap into Medicare benefits.


But the amount entered into Mercer’s computers for employees of pre-retirement age was $213 less than it should have been. The error understated the amount of liabilities owed by one of the Alaska funds by 10 percent.


A Mercer actuary found the error before the 2002 valuations were to be presented to the Alaska plans and reported it, along with a colleague, to a supervisor. But after several discussions, the lawsuit says, the Mercer executives decided not to tell their client about the error.


One of the Mercer actuaries on the account testified he was “concerned about the ethics of what Mercer was doing by not telling the State of Alaska,” the lawsuit shows. He said that Mercer did not disclose the error because the firm was fearful of being fired. (This happened anyway, in 2006.)


The error was compounded in 2003 because Mercer continued to use an artificially low number for pre-retirement-aged beneficiaries. If the firm had corrected the earlier mistake, an actuary said in a deposition, “It would have been difficult to explain.”


Because of the errors and cover-up, the lawsuit said, Mercer underreported by more than $2.8 billion the contributions required to fund the plans.


Of course, estimating future health care costs is not easy. But the lawsuit details what look like obvious failures by Mercer. For example, Mercer consulted “real-world data” on health care expenses only every five years, a problematic practice given the volatility of these costs.


Mercer also made significant “coding errors” when entering information about the plans into its computer models, the complaint says. It ignored some salary increases for employees as well as survivor benefits, thereby underestimating plans’ liabilities.


The errors emerged in October 2002, when an outside auditor hired by the Alaska funds to examine Mercer’s work delivered a highly critical report on its findings. The lawsuit states that Mercer actuaries attended the meeting where the report was presented and accepted the outside firm’s criticisms.


But a company spokesman said last week that Mercer believed that its error wouldn’t have an impact on contributions to be made by the plans because an Alaska regulation imposed a 5 percent cap on annual contribution rate increases, and Mercer’s recommended rate was already much higher. “Accordingly, Mercer believes that the error had no impact on the plans and that the plans have not, in fact, been damaged,” the spokesman said.


Mercer has had similar problems with other pension clients. Last May, the company paid $45 million to settle a negligence lawsuit filed by Milwaukee’s pension board. Mercer did not acknowledge it was at fault in the matter.


Nevertheless, all eyes are on the Alaska case, because of its size. Indeed, while the suit is pending, actuarial firms are finding it impossible to buy liability insurance against such claims.


“This is the largest case out there in the industry and it could have enormous ramifications if the plaintiff were to succeed,” said Gene Kalwarski, founder of Cheiron Inc., an actuarial consulting firm serving large pension and health insurance funds. “It’s unfortunate that one firm’s behavior, if they are found to be liable, is going to result in other firms being unable to obtain insurance coverage.”


Lewis R. Clayton, a partner at Paul, Weiss, Rifkind, Wharton & Garrison, who represents the Alaska board, said the case illustrates the role an actuarial firm plays in workers’ lives, “and how important it is that actuaries do honest and high-quality work.”


Indeed, about 80,000 workers rely on payments from the retirement systems that have sued Mercer. And the errors made by the firm were a big reason why the Alaska system changed its pension structure, according to people briefed on the discussions.

For all employees hired after 2006, the funds no longer offer a classic pension fund, where retirees receive a specified amount each year. Now those workers receive a defined-contribution plan, similar to a 401(k) account.


Mercer, meanwhile, is learning that age-old lesson: To err is human. To cover up, plain dumb.

To cover up is indeed plain dumb. What in the world were those Mercer executives thinking? That the Alaska Retirement Management Board wouldn't notice their liabilities were off by almost $3 billion? Something tells me Mercer is in big trouble and that actuaries are going to find the cost of liability insurance skyrocketing, if they can get someone to provide it to them.

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Leo Kolivakis's picture

What really worries me is that companies and public pensions might be understating their true liabilities, using high discount rates or unrealistic assumptions on lifespan or whatever. One friend of mine who works at a major bank told me that the figures they calculated on Canadian corporations were shocking, and he said "it's far worse in the US". But he said that they cannot publish these figures because they fear losing corporate clients and making enemies. A month or so ago, I reported about a UK firm that said private pension liabilities are understated to the tune of billions of pounds. Can you imagine the deflationary headwinds that will develop if aggregate pension liabilities are truly massively understated? This will make Japan's lost decade(s?) look like a walk in the park.

Budd Fox's picture

In my country, I am one of the fiercest and outspoken enemy of Mercer. They "helped" the country superannuation fund to set the strategic asset allocation, and being the rigid stolid actuaries they are, they prevented anyone from inserting any revision/timing mechanism for the bear markets. A friend of mine, an advocate of algorithmic timing (long term, nothing HF..) even resigned from the Fund supervisory board for their obstructionism, backed up by the Chairman of that board.

Of course, this caused a disaster in 2008 and harsh moves from the Govt, in the fund's funding program.

Well, recently, the fund concocted a PR campaign based on the market rebound and murky percentage results ( as they remained, of course, staunchly stuck in that SAA on the way down, but on the way up as well..) to save the ass of the management team. Then the supervisory board commissioned a study to judge their who??

Yes you are Mercer!!!!!

I wrote news articles on that, blowing the whistle , and they went undercover...never tried to reply ( i know why...I have clear documental evidence of their stupid mistakes..) but, of course, that put in light the incestuous , conflicted, cronyism ridden relationship these clowns had with the supervisory board boss....playing with the country's retirement plans.

If these clowns go under...i will not only dance on their graves..I'll gleefully pee on them!

Miles Kendig's picture

One more primary example of how private & public pension management is getting moved from an outlying industry closer to the center of finance.  Too much flow that needs to support the squid.  Combined with the regulatory changes of the last 15 years and events like the AON & WWW involvement in the UK pension situation (advised by the squid) the process of demonization, self inflicted as it may well be, is well on its way.

primus's picture

Alaska has a $7.5 billion unfunded liablitity, perhaps more thanks, in part, to the swindlers at Mercer.

'Around 1998, Mercer Human Resource Consulting provided new actuarial figures to the state, in response, some observers have suggested, to political pressure from a Legislature looking for funds. The result: Lawmakers cut the PERS contribution rate from 11.5 percent to 6.5 percent. The savings were spent on other government operational costs at the state and local levels.

About two years ago, Mercer reevaluated their assumptions, Holt said. Suddenly, the rosy scenario offered in the late 1990s was looking like skunkweed.'


Anonymous's picture

Hopefully after the 2010 elections and the investigations get underway. We'll see an avalanche of this kind corruption and fraud drug out into the light of day. This administration and it's merry band of fascists don't have a clue what's fixing to hit them.

Obnoxio's picture

The States are broke so I think they may start to sue\tax everyone.

I guess Mercer failed to predict the future accurately enough. Any damages should be based on the fee $2.5 million. I still think we may see some towns in the future with no employees but only retirees taking all the revenues.

mberry8870's picture


The from the AP today and exactly to your point:

Associated Press

PITTSBURGH--Pittsburgh officials shelved an idea for a first-of-its-kind tax on college tuition after two universities and a nonprofit health insurer agreed Monday to make large contributions to the city.

Mayor Luke Ravenstahl said he hoped the contributions from the University of Pittsburgh, Carnegie Mellon University or Highmark Inc. would serve as a catalyst to get other nonprofits to help the city financially.

Mr. Ravenstahl had called for the 1% tuition tax on the city's 65,000 college students as a way of getting money to help pay for some $15 million a year for the city's pension obligations. Nonprofits are exempt from most taxes, but represent many of Pittsburgh's major employers and hold about one-third of the city's property value.

Neither the mayor nor the three institutions would disclose how much they would give, but Mr. Ravenstahl said he was optimistic the money would help resolve the city's long-standing financial problems.

"This is a leap of faith for all of us. The future of our city and our citizens is riding on it,'' he said.

Nonprofits have given money to the city in the past under an entity called the Pittsburgh Public Service Fund, but the amounts given have been far below what Mr. Ravenstahl said was needed.

Mr. Ravenstahl said the new agreement represented a large contribution, but did not offer specifics. Other nonprofits would be welcome to contribute, and the city was in talks with other groups, he said.

University of Pittsburgh Chancellor Mark Nordenberg said the city was "trapped in a fiscal structure that might have been appropriate in the first half of the 20th century'' but no longer made sense.

He and the mayor said state lawmakers must allow Pittsburgh to find a new way of collecting revenue, noting that municipalities across the state face pension-obligation problems.

The tuition tax drew instant and widespread criticism from students and the city's universities, but it appeared to have enough support in council to pass.

Several other college towns have toyed with the idea of a tuition tax--most recently Providence, R.I.--but have set it aside as politically risky and reached similar voluntary payment arrangements with institutions.


I will not steal from you if you agree to a donation?

saladbarbeef's picture

This is exactly the same as what happened to Milwaukee County (Wisc.) early this decade  Mercer jammed the taxpayers (giving the tax-gorged bureaucrats whatever answer was needed)  and then claimed, "Who me?" when sued. 



Anonymouse's picture

Great article, Leo.  Thanks.  Especially after we disagreed so vehemently on your other recent article.

It sounds to me as if $2.5B is a bit excessive as the state did not lose that much as a result.

Even so, this does show the value of transparency, not just in portfolio composition and trades, but in owning up to an error.

We learned in my business long ago that it is much better to admit a mistake and correct it, quickly and completely.  We did worry about the damage to our reputation.  But what we found out is that we gained more reputational value as honest than we lost from the few mistakes that were made (and there always are some).

Our investors learned they could trust our reporting as well as our marketing story as we earned a reputation as honest managers. When a problem did arise, the investors would feel confident we were telling them the whole story so they could get their hands around the issue without worry of other bombs being dropped.

Too bad others haven't learned that lesson.

curbyourrisk's picture MMC a short here????

exportbank's picture

Mistakes happen but it takes a man to stand up straight and admit it. The problem of course is that there are very, very few real men left. 

Leo - keep the spotlight on pensions - more money has been stolen and wasted by pension plans than by any other group charged with the well being of the citizen. This musical chair chase for the magical "four times inflation" return has to stop. 

Anonymous's picture

" actuarial firms are finding it impossible to buy liability insurance against such claims."
No problem there. Lucrative market for GS to delve into. They can buy part of AIG and get into the insurance business since they have the full faith of the fed behind them.

phaesed's picture

Yes, let's continue to de-regulate.

I mean, it would be HORRIBLE to reduce those insurance company profits.

Anonymous's picture

Sideshow, but fun to watch from the other side of the world. How come you monkeys in the northern hemishere trust any of these highly trained baboons. I wouldn't give Mercers the steam off my shit for an opinion.