inside keystone @ 40% Commonwealth of Pennsylvania State Employees’ Retirement System ® Comprehensive Annual Financial Report For the year ended December 31, 2009 09 A Component Unit of the Commonwealth of Pennsylvania Commonwealth of Pennsylvania State Employees’ Retirement System Comprehensive Annual Financial Report For the year ended December 31, 2009 Prepared by the staff of the Pennsylvania State Employees’ Retirement System Leonard Knepp Executive Director Anthony J. Faiola Chief Financial Officer State Employees’ Retirement System 30 North Third Street, Suite 150 Harrisburg, PA 17101-1716 A Component Unit of the Commonwealth of Pennsylvania inside keystone @ 40% Commonwealth of Pennsylvania State Employees’ Retirement System 30 North Third Street, Suite 150 Harrisburg, Pennsylvania 17101-1716 Telephone: 717-787-9657 www.sers.state.pa.us ® Nicholas J. Maiale Chairman May 28, 2010 Honorable Edward G. Rendell, Governor Commonwealth of Pennsylvania Members, Pennsylvania General Assembly Members, Pennsylvania State Employees’ Retirement System Dear Governor Rendell, Legislators and Members: The Board of the Pennsylvania State Employees’ Retirement System (SERS) is pleased to present our Comprehensive Annual Financial Report (CAFR) on the SERS Fund for calendar year 2009. The CAFR provides us with a vehicle to compile and publicly disclose extensive financial, investment and actuarial reports with introductions from SERS management and the Fund’s consulting actuary. This report reflects a recovery in SERS’ investment performance in 2009. The SERS Fund achieved a 9.1% return for the calendar year. The Fund’s 2009 performance exceeded the assumed rate of return, which is 8%. This marks the 11th time in the last 15 years that SERS has out-performed its assumed rate of return. Over the last 20 years, including two steep economic downturns, the Fund has delivered an annualized compounded return of 8.6%. Still, the investment losses suffered by SERS (along with virtually all other institutional investors) in 2008 continue to weigh on the Fund. Those losses are a major factor in what we anticipate will be a steep increase in employer contribution rates, with the most pronounced rate spike expected in fiscal year 2012-13, to be followed by a sustained period of high rates. The rate, currently 4%, is expected to peak at 29.2% in fiscal year 2013-14. We recognize that increases of the magnitude being projected would impose a great and perhaps unsus- tainable budgetary burden on our member employers. As discussed in the Transmittal Letter, both the Governor and legislative leaders have put forth proposals to phase in the rate increase, and SERS has been working closely with all interested parties to help the Commonwealth address this serious fiscal challenge. On behalf of the 11-member SERS Board and the SERS staff, I assure you we will continue working with the General Assembly and the Administration to explore options for moderating the impact on our participating employers. Unfortunately, however, there is no realistic scenario under which SERS employers will not be facing a sustained period of much higher rates. Board and staff also will continue to pursue prudent long–term investment strategies to assure the solvency of the Fund and the quality of pension–related services to all SERS members. Sincerely, Nicholas J. Maiale SERS Board Chairman This page intentionally left blank Commonwealth of Pennsylvania State Employees’ Retirement System Introductory Section Table of Contents Introductory Section Actuarial Section GFOA Award Certificate i Actuary’s Certification 65 PPCC Public Pension Standards Award Certificate ii Summary of Actuarial Assumptions and Methods 67 Letter of Transmittal iii Schedules of Active Member Valuation Data 68 SERS Board v Schedule of Retirees and Beneficiaries Added to and 70 SERS’ Vision, Mission and Organizational Chart vii Removed from Rolls Solvency Test 71 Analysis of Financial Experience 72 Financial Section History and Projection of Contribution Rates and 73 Independent Auditors’ Report 1 Funding Ratios Management’s Discussion and Analysis 2 Summary of Plan Provisions 74 Financial Statements Statistical Section Statement of Plan Net Assets 8 Statistical Section Narrative 79 Statement of Changes in Plan Net Assets 9 Schedule of Trend Data 80 Notes to Financial Statements 10 Schedule of Additions to Plan Net Assets 81 Schedule of Deductions from Plan Net Assets 82 Required Supplementary Information Schedule of Benefit and Refund Deductions from Plan 83 Net Assets By Type Schedule 1 - Schedule of Funding Progress 23 Schedule of Total Changes in Plan Net Assets 84 Schedule 2 - Schedule of Employer Contributions 23 Schedule of Investment Income 85 Schedule of Active Member Statistics 86 Additional Financial Information Schedule of Retired Members by Type of Benefit 87 Schedule of Administrative Expenses 24 Schedule of Retired Members by Option 88 Summary of Investment Expenses and Consulting Fees 25 Schedule of Average Monthly Benefit Payments 89 Schedule of Average Annual Benefit Payments 90 Investment Section Schedule of SERS Agency Participation 91 Report on Investment Activity 29 Schedule of Additional Participating Employers 92 Investment Policy 31 Investment Objectives 32 Investment Returns 33 Largest Assets Held 34 Schedule of Trading Broker Commissions 35 Investment Summary 36 Commonwealth of Pennsylvania State Employees’ Retirement System Introductory Section i Introductory Section v ii inside keystone @ 40% Commonwealth of Pennsylvania State Employees’ Retirement System 30 North Third Street, Suite 150 Harrisburg, Pennsylvania 17101-1716 Telephone: 717-787-9657 www.sers.state.pa.us ® May 28, 2010 Mr. Chairman and Members of the Board: We are pleased to present you with the Comprehensive Annual Financial Report (CAFR) of the Pennsylvania State Employees’ Retirement System (“System” or “SERS”) for the calendar year ended December 31, 2009. Although SERS is not legally required to produce a CAFR, we do so in the interest of public accountability. Publication of this CAFR also serves to comply with the requirement, contained in the State Employees’ Retirement Code, that SERS’ financial statements be published, after auditing by an independent certified public accountant, on or before July 1 of each year. Financial Information The System’s management is responsible for the preparation, accuracy and objectivity of the information included in this report, and accepts full responsibility for the contents, including not only the audited financial statements but all other information as well. The basic financial statements were prepared by management in accordance with generally accepted accounting principles as promulgated by the Governmental Accounting Standards Board, and have been audited by an independent auditor. Users of the financial statements are encouraged to review the Management’s Discussion and Analysis (“MD&A”), which accompanies the basic financial statements and discusses the market conditions, legislation and changes in operations that affected the financial results and funded status of the System. SERS maintains an effective system of internal controls designed to provide reasonable assurance that assets are properly safeguarded, transactions are properly executed and the financial statements conform to generally accepted accounting principles. It should be recognized, however, that all internal controls have inherent limitations. These limitations exist because of several factors, including cost: The cost of attempting to establish a perfect internal control system would far outweigh the benefits derived. Another limitation is the potential for controls to be overridden by management, either individually or through collusion of two or more staff. To mitigate the risk caused by these inherent limitations, the System’s Audits, Reporting and Compliance division provides a continuing review of the adequacy and effectiveness of the System’s internal control structure. Also, our independent external auditor, Clifton Gunderson LLP, conducts an annual audit of the financial statements in accordance with generally accepted auditing standards. Their audit includes tests and procedures designed to provide reasonable assurance that the financial statements are fairly presented. The external auditors have full and unrestricted access to the SERS Board members to discuss their audit and related findings regarding the integrity of financial reporting and adequacy of the internal control structure. The annual financial audits show that the money entrusted to SERS is being properly managed so that we can continue meeting our obligation to our Active and retired members, and their Beneficiaries. Our members can be reassured that their retirement System is well managed and their benefits are secure. The System also receives independent financial audits on all of its private equity, venture capital, pooled real estate, and absolute return fund–of–funds limited partnerships, as well as audits for its directly held real estate portfolios and collective trust funds. Profile of SERS SERS is a component unit of the Commonwealth of Pennsylvania, and administers a cost-sharing, multiple-employer defined benefit retirement plan. Founded in 1923, SERS is a mature pension plan with the number of Annuitants and Active Members rapidly approaching a 1:1 ratio; as of December 31, 2009 the System had 110,107 Active Members and 109,639 Annuitants and Beneficiaries. The System is administered by an independent 11-member