Status of Retirement Fund’s investments

The ongoing financial turmoil in the global equity and fixed income markets has resulted in the United States’ Department of the Treasury taking unprecedented actions over the past few months. By bailing out some of the world’s leading financial services firms and taking equity stakes in publicly traded companies, the U.S. Treasury Department has rewritten the rule book on federal intervention in its efforts to stave off a global financial meltdown.

The Northern Marianas Islands Retirement Fund has felt the effects of the market turmoil along with other investors in every type of investment including stocks, bonds, mutual funds, money market funds, and the like.

In an effort to provide transparency and reassure the Fund’s beneficiaries about the market impact on the Fund, members of the Fund’s board of trustees felt compelled to write a public letter to disclose facts about the Fund’s recent investment performance and to discuss details of the Fund’s governance that might not be widely known or understood. We also thought this would be a good time to discuss how the Fund can be improved.

Overview

The Fund was established on Oct. 1, 1980, as a defined benefit plan for government employees of the Commonwealth. The Fund is governed by seven board members appointed by the governor with the advice and consent of the Senate. The board members are an eclectic group of citizens who represent the diverse CNMI population and who are entrusted with ensuring the Fund serves its statutorily mandated purpose of providing retirement benefits for all Fund members.

Despite being appointed and approved by the CNMI government, the board is apolitical and fully independent in its actions. Each board member acts as a fiduciary on behalf of Fund members and operates solely with the members’ best interests in mind. This separation of politics from the management of the Fund is a key distinction that we think ought to be strengthened going forward.

Rather than continue the current system of members serving staggered four-year terms, the board would be in favor of extending the staggered terms to a minimum of six years. The staggered six-year terms would enable the Fund to more fully realize its investment in educating board members about pension programs and fiduciary responsibilities. These educational programs are only available off-island and are costly, but they are crucial in understanding pension programs generally, as well a board member’s role and responsibilities with respect to the Fund.

Board members’ responsibilities

The law of the Commonwealth mandates that the board invest all reserve monies, after paying for operational costs. This simple statement underlies two key areas of responsibility for the board: asset management and operations management.

In the area of operations management, the board is responsible for the efficient management of the Fund staff and facilities to ensure that benefit payments are paid when due to the beneficiaries of the Fund. In this regard, over the past year, the board has undertaken a thorough review of all operating expenses, including professional services, to ensure that the Fund is operating on a lean and cost-effective basis.

In the area of asset management, the board and its consultant, Merrill Lynch, have established an Investment Policy Statement, which effectively serves as the “road map” for the management of the Fund’s investment portfolio by a group of qualified, professional investment managers. Each of the Fund’s investment managers must abide by the guidelines and restrictions detailed in the IPS in serving as a fiduciary of the Fund while fulfilling their specific investment management mandate.

The Fund’s consultant

Merrill Lynch, the Fund’s consultant, is responsible for serving as an arm’s length advisor to the board, but Merrill Lynch does not have any decision-making authority, nor does it have discretionary control, over any of the Fund’s investment portfolio. Instead, the firm is responsible for monitoring the Fund’s investment managers and the total pool of assets to ensure compliance with the Fund’s IPS and to confirm the accuracy of the investment managers’ performance reports.

In addition to monitoring the performance of the Fund’s investment portfolio, Merrill Lynch plays a key advisory role to the board by conducting educational investment seminars, helping to screen investment manager candidates, and providing the board with written research reports on a wide range of financial and economic-related topics.

Merrill Lynch has also worked with the Fund’s actuary to provide the board with an estimate of the Fund’s long-term funding status by conducting an asset-liability study that helped identify and quantify the significantly under-funded status of the Fund that, in its current state, will leave the Fund unable to meet all of its benefit obligations to Fund members.

Headline events over the past year that have involved Merrill Lynch, such as the firm’s recent merger with Bank of America, a write-down in the valuation of assets, and a turnover at their chief executive officer’s position, has not had and will not have an impact on Merrill Lynch’s ability to serve as the consultant to the board.

The board has full faith and confidence in Merrill Lynch and, as part of the actions of a responsible fiduciary, the board earlier this year completed a public search for an alternative consultant and, in the end, decided to retain Merrill Lynch as the Fund’s consultant for the foreseeable future.

Current financial crisis

If the CNMI government continues to ignore its legal obligations to the Fund by not paying the actuarially determined and statutorily scheduled employer contributions to the Fund, the government will eventually face limited and unattractive options such as: 1) increasing taxes to pay full pension benefits; 2) reducing the current number of government employees to cut expenditures; or 3) reducing the Fund members’ benefits.

Unfortunately, the CNMI government has been unable to remit the proper actuarially-determined employer contribution, thus contributing significantly to the Fund’s dire financial situation.

Given this reality, it is unfair and incorrect to place the blame for the Fund’s current financial status on the board members and/or its consultant, Merrill Lynch. While the Fund has felt the effects of the recent turmoil in the global investment markets, in terms of performance, the Fund compares quite favorably as compared to other institutional investment funds that hold both stocks and bonds. For the period ending Dec. 31, 2007, the Fund’s annualized investment rates of return are ranked in the following manner:

· Top 6th percentile over the trailing 3 year period;

· Top 1st percentile over the trailing 5 years period;

· Top 10th percentile over the trailing 10 years period.

This type of investment performance has helped the Fund generate above-benchmark returns and investment income to offset the CNMI government’s nonpayment of legally obligated employer contributions over the past few years.

From the calendar year-to-date period ending Oct. 31, 2008, the Fund has experienced a decline in the value of its investment portfolio of approximately 28 percent. Despite suffering a loss of this magnitude, the Fund’s performance has still managed to outperform various countries’ stock markets for the comparable period as demonstrated by the returns of the stock market indices listed below:

· S&P 500 (USA): -33 percent

· MSCI United Kingdom: -43 percent

· MSCI Germany: -47 percent

· MSCI France: -44 percent

· MSCI Japan: -36 percent

· MSCI Hong Kong: -55 percent

· MSCI China: -57 percent

· MSCI India: -64 percent

· MSCI Russia: -65 percent

During the prior periods in which the stock market was registering positive returns, the strong performance of the Fund was able to generate investment income that was necessary to make benefit payments to Fund members in light of the lack of CNMI government contributions. However, now that the stock market has declined globally, the Fund is faced with two negative factors: 1) a decline in the dollar value of the Fund’s investment portfolio; and 2) a continued lack of employer contributions from the CNMI government. These factors have placed the Fund in a fiscal emergency that must be addressed immediately.

The board conducts monthly meetings, which are open to the public, in compliance with the Open Government Act. We allocate time at those meetings to hear from any person and/or group who may wish to address the board. We must work together as a community to address the economic crisis at the Fund because when the Fund is unable to pay retirees’ their pension, it will negatively and greatly impact the CNMI’s economy.