REPORT DIGEST
ILLINOIS STATE BOARD
COMPLIANCE EXAMINATION For the Year Ended: June 30, 2006 Summary of Findings: Total findings this report 3 Total findings last report 1 Repeated findings 1 Release Date: May 24, 2007
State of Illinois Office of the Auditor General WILLIAM G. HOLLAND AUDITOR GENERAL
To obtain a copy of the
Report contact: Office of the Auditor
General Iles Park Plaza 740 E. Ash Street Springfield, IL 62703 (217) 782-6046 or TTY (888) 261-2887 This Report Digest and Full
Report are also available on the worldwide web at http://www.auditor.illinois.gov |
SYNOPSIS
· The Illinois State Board of Investment (Board) does not have an adequate established accounting and financial reporting process for determining the fair value measurements and disclosures, selecting appropriate valuation methods, and identifying and adequately supporting significant assumptions used for its alternative investments. · The Board identified deposits and investments in their June 30, 2006 financial statements that were exposed to custodial credit risk. In addition, the Board disclosed they did not have a formal policy to address custodial credit risk. {Financial information and activity measures are summarized on the reverse page.}
|
ILLINOIS STATE BOARD OF
INVESTMENT
INFORMATION FROM
COMPLIANCE EXAMINATION
YEAR
ENDED JUNE 30, 2006
SCHEDULE OF OPERATIONS |
FY
2006 |
FY
2005 |
REVENUE: Investment Income - Interest............................ Investment Income - Dividends......................... Investment Income - Securities Lending........... Realized Gain on Investments.......................... Unrealized Gain on Investments...................... Total Investment Income............................. External Support (Investment Expense) ........ Total Revenue (Net Investment Income).... EXPENSES:Operating Expenses....................................... Revenue over Expenses............................ |
$ 183,047,403
123,178,718
4,321,712 775,805,644
116,794,342
$1,203,147,819
(28,556,047)
$1,174,591,772
$ (1,586,585) $1,173,005,187 |
$
142,444,438
119,713,292
3,674,829 505,168,829
260,921,934
$1,031,923,322
(23,025,047) $1,008,898,275 $ (1,457,162)
$1,007,441,113
|
INVESTMENT
PORTFOLIO ANALYSIS – Fair Value |
JUNE 30, 2006
|
JUNE
30, 2005 |
Total Government Obligations.............................................. Total Corporate Obligations................................................ Foreign Obligations............................................................ Fixed Income Options....................................................... U.S. Common Stock & Equities........................................ Preferred Stock ............................................................... Non – U.S. Equity Securities............................................ Real Estate Investments.................................................. Private Equity................................................................. Hedge Funds.................................................................. Money Market Investments........................................... Forward Foreign Currency Contracts.............................. Total Investment Portfolio......................................... |
1,382,574,163 104,455,671 (169,563)
5,369,124,032
1,057,334
1,113,268,102
1,134,025,154
482,264,036
416,462,183
320,641,552
26,145
$11,434,818,360 |
1,645,591,189 88,970,486 (251,151)
5,579,812,196
487,946
986,200,950
778,951,123
466,871,030
0
283,461,008
(497,874) $10,959,676,010 |
INVESTMENT
RETURNS – ACTUAL (bold) & BENCHMARK (unaudited) |
FY
2006 |
FY
2005 |
Total Fund................................................................... Composite benchmark................................................... U.S. Equities..............................................................Wilshire 500 Index...................................................... Non- U.S. Equities....................................................MSCI-EAFE Index...................................................... Fixed Income............................................................
Lehman U.S. Universal Bond Index.......................... Real Estate.........................................................
NCRIEF Real Estate Index..................................... |
11.0% 11.5% 10.7% 10.0% 28.9% 27.1% 0.8% (0.3)% 19.5% 18.7% 21.3% |
10.1% 10.9% 9.3% 8.4% 14.8% 14.1% 6.9% 7.4% 14.8% 15.6% 29.6% |
SUPPLEMENTARY INFORMATION |
FY 2006 |
FY 2005 |
Total Investment Manager Fees.......................................... |
11 $2,777,611 $27,434,504 |
10 $3,316,588 $22,010,299 |
EXECUTIVE DIRECTOR |
||
During Audit Period: William R. Atwood Currently: William R. Atwood |
Inadequate
process for determining fair value for alternative investments Board staff
performed additional procedures to address AICPA guidance and auditor
requests
Reportable
condition Lack of an
established process led to significant delays in completing the Board’s audit
$80,566,513 of Board deposits were not insured or
collateralized for amounts in excess of FDIC coverage
$56,122,313 of Board investments were uninsured or held
by a trust department or agent not in the Board’s name No formal policy to address custodial credit risk The State Officers and Employees Money Disposition Act
notes when deposits are in excess of FDIC coverage other collateral shall be
obtained
Board does not believe State law applies to them Auditors’ comment Funding legislation was changed to reduce the required
employer (State) contributions to participating retirement systems for fiscal
years 2006 and 2007 |
INTRODUCTION
This digest covers our compliance examination of the Illinois State Board of Investment for the year ended June 30, 2006. A financial audit covering the year ending June 30, 2006 was issued separately.
FINDINGS,
CONCLUSIONS, AND RECOMMENDATIONS INADEQUATE PROCESS FOR VALUATION OF ALTERNATIVE
INVESTMENTS The Illinois State Board of Investment (Board) does not have an adequate established accounting and financial reporting process for determining the fair value measurements and disclosures, selecting appropriate valuation methods, and identifying and adequately supporting significant assumptions used for its alternative investments. Alternative investments comprise over 20% of the Board’s total investments and include real estate, private equity, and hedge funds. In connection with the issuance of recent guidance by the American Institute of Certified Public Accountants (AICPA) relating to auditing alternative investments and requests made from the auditors, management did perform extensive additional procedures and evaluation of alternative investment valuations. However, theses procedures were performed primarily to address the current year financial statement audit requirements and were not part of an ongoing comprehensive internal control process related to the valuation of alternative investments. Additionally, there were certain areas within the alternative investments, including hedge funds, of which management had limited available information of the underlying investments. This finding is considered to be a reportable condition. In our judgment, the reportable condition can adversely affect the Board’s ability to record, process, summarize and report financial data consistent with the assertions of management in the financial statements. Failure to establish an adequate accounting and financial reporting process for alternative investments could result in the improper reporting of the fair value of investments and result in a qualification of the audit opinion on the Board’s financial statements. In addition, lack of an established process at the Board resulted in a significant delay in completing the financial statement audit. (Finding 1, pages 9-10) We recommended the Board review its current process for determining the fair value measures and disclosures for alternative investments and develop written procedures related to the determination of fair value measurements, selecting appropriate valuation methods, identifying and adequately supporting assumptions used, and assignment of responsibilities. Further, the Board should evaluate their current staffing to determine whether appropriate resources exist and work with external investment managers to obtain the necessary financial information on a timely basis. Board officials agreed with our recommendation noting they developed a comprehensive plan that contained additional procedures and evaluations of alternative investment valuations for the fiscal year 2006 financial audit process. The Board went on to note the scope and depth of the fiscal 2006 plan has been expanded with the implementation of protocols and procedures contained in that plan as well as with additional staff resources. DEPOSIT AND INVESTMENT
CUSTODIAL CREDIT RISK At June 30, 2006, the
Board had $80,566,513 of deposits held in their investment related bank
account exposed to custodial credit risk.
The deposits were neither insured nor collateralized for amounts in
excess of the federal deposit insurance coverage of $100,000. In addition, the Board also identified
$56,122,313 of investments that were uninsured and unregistered, with the
securities held by the counterparty or by its trust department or agent but
not in the Board’s name. Custodial credit risk is the risk that in the event of a financial institution failure, the Board would not be able to recover the value of the deposits or investments in the possession of an outside party. The Board noted they did not have a formal policy to address custodial credit risk. The State Officers and Employees Money Disposition Act (Act) (30 ILCS 230/2c) provides that whenever funds deposited with a bank or savings and loan association exceed the amount of federal deposit insurance coverage, a bond, pledged securities, or other eligible collateral shall be obtained. Board management indicated this issue is pending from first being identified in the prior year report and they are awaiting an opinion from the Illinois Attorney General. We recommended the Board develop a formal policy to address custodial credit risk as it relates to deposits and investments. (Finding 3 page 13-15) Board officials responded to the recommendation noting their counsel is of the opinion that the Board is not subject to the Act. The Board has requested an opinion from the Illinois Attorney General regarding applicability of the Act to them. The Board went on to respond that once they receive a response from the Illinois Attorney General they will consider adopting a policy regarding custodial credit risk and applicability of the Act. The auditors included a comment to the Board’s response noting they believe the Board is part of the Executive branch of the State government and is subject to the provisions of the Act. OTHER FINDING
The remaining
finding is reportedly being given attention by the Board. We will review the
Board’s progress towards implementation of our recommendation during our next
engagement.
PENSION FUNDING LEGISLATION
In June 2005, Public Act
94-0004 became law. This legislation
modified the funding plan of the State Employees’ Retirement System, Judges’
Retirement System and General Assembly Retirement System. The legislation
included funding reductions of approximately $496.4 million and $429.4
million in fiscal year 2006 and 2007 respectively, for employer contributions
to the State Employees’ Retirement System, Judges’ Retirement System and
General Assembly Retirement System.
This reduction in funding resulted in an increase in member systems’
withdrawals from the Board in fiscal year 2006 of $211.3 million to meet
their respective funding requirements for benefit obligations.
AUDITORS’ OPINION We conducted a compliance attestation examination of the Board for the year ended June 30, 2006 as required by the Illinois State Auditing Act. ____________________________________ WILLIAM G. HOLLAND, Auditor General WGH:RPU:pp SPECIAL ASSISTANT AUDITORS
KPMG, LLP were our special assistant auditors for this
engagement. |