When I was invited to speak to you this morning, I was told that I could talk about anything I wanted ... that you were certainly interested in CalPERS Corporate Governance Program, but that you would be polite and listen to me talk about any subject. Well, I'm going to test the parameters of that invitation.

Contrary to popular belief, CalPERS is not "the 800-pound gorilla" ... at least not all of the time. So I'm going to take time this morning to talk about "the softer side" of CalPERS; I'm going to talk about the over 1000 employees at CalPERS who are not involved in corporate governance. I promise I will close with our governance activities for 1997, which you will soon be reading about in the press. But, I have two goals today. First, I'd like to give you an understanding of who and what CalPERS is, so that you can better understand our objectives when you read about our governance activities. But most importantly, I hope to plant in each of your minds a little seed of an idea; to be successful in our future, we will need to develop partnerships with people like you and your companies. I'd like the seed that I leave with you to some day sprout – maybe not this month or this year, but sometime in the next few years – so that we can identify areas where our respective organizations' goals can best be accomplished by working together.

First, what do we do? What is "CalPERS"? Our mission is to protect the health and financial security of our over 1 million participants. We do this in three key ways: by offering innovative programs; by ensuring excellence, both in service to our members and in our financial performance; and by exercising the leadership that will allow us to influence our future. Do these words sound similar to your companies' missions and goals? At CalPERS, corporate governance is just one of our programs that affects all three of these objectives. Let me tell you what else we do...

The Facts

In our retirement program, we serve over 1 million people (this includes both active employees, retirees, and their beneficiaries). Last fiscal year, we paid out over $4.1 billion in benefits; this money was primarily, but certainly not exclusively, paid to citizens within California. This is the reason why we have $107 billion in assets. $107 billion sounds huge, but let me assure you that we do not have one cent more than we need to pay benefits. In fact, for the past several years, we have been paying out more in benefits than we have taken in from contributions from our members and their employers; we have had to rely upon our investment earnings to make up this shortfall, and to help us meet our future needs.

This $4.1 billion per year is really just the tip of the iceberg. Today, we process about 16,000 retirements each year. But, when the first baby-boomers hit age 65 in the year 2011 – just 14 short years away – this number will explode. Unlike the Social Security System, CalPERS is designed to be actuarially sound, funded as a "level percentage of pay" throughout each employee's career (which means that, at the end of each member's career, his or her remaining lifetime benefits will already be fully funded). CalPERS is strongly dedicated to this concept of funding; we believe that it is a question of equity among and between different generations of taxpayers. Today's taxpayers, who – because we are a public system – are essentially our contributing employers, should only pay for the services of today's public servants ... not yesterday's, and not tomorrow's.

But, retirement is only half of what we do. We also have a vigorous health program, which serves as a national model of successful managed care. One million people also participate in this program (although they are not in every respect the same million that participate in our retirement programs). The CalPERS health programs represents the second largest risk pool in the nation, and the largest in California. Last year, we administered over $1.5 billion in premiums. The program provides coverage to these million participants through 14 HMOs, 2 self-funded PPOs, and 4 PPOs provided by employee associations. Again, this program has provided national leadership in the area of cost controls. Now, our challenge is to exercise this same leadership in changing the structure of health care delivery in the state, and most likely in the nation. We have to ensure that affordable managed care doesn't sacrifice the quality of patient care.

We also manage the nation's first (and possibly only) self-funded Long-Term Care Program offered on a not-for-profit basis. As you may have recognized in evaluating your own company's benefit plans, traditional health insurance does not cover long-term care for chronic illness or old age. This program offers financial protection (again, consistent with our mission) against the high costs of extended care that 6 out of 10 Americans over the age of 65 will ultimately need. Our program is somewhat unique in that it covers not only our members, but their parents as well. This feature is important: demographers have identified a new age group – the "oldest old", meaning those people who are over 85 years old. We all know that citizens are living longer, but have we really recognized that seniors (those people who have retired from the workforce) will be, in growing numbers, caring for their elderly parents? And, given smaller family sizes, there are fewer of these senior "children" to share these costs. Have you planned for this cost in your own retirement planning? Will there be enough care givers, or extended nursing facilities, to handle this? These are some of the issues that CalPERS will be facing over the next few – very few – years. Do you see any similar concerns for your companies?

CalPERS speaks a great deal about governance; let me tell you how we are governed. First, we, too, are governed by a Board. My Board consists of 13 members – 6 are elected by the various constituencies that comprise our membership; two serve by virtue of their elected statewide office (the State Treasurer and State Controller); and the remaining 5 serve or are appointed by various political bodies. In corporate America, we generally oppose "constituency" boards, but I strongly believe that it works in public service. And we are a public body. Although we have certain constitutionally-protected independence:

We also administer several smaller retirement and benefit programs that, because of their relative size (it is hard to compete with $107 billion!) are less known: programs for California judges, for certain legislators, and even for volunteer firefighters.

Lastly, let me turn to our investment program. This program serves and only exists because of all of programs I've already discussed. Last year, our assets earned 15.3%. But, it is important to remember that the only reason why we have the $107 billion is to pay for our liabilities. Therefore, our Board is very conscientious in only assuming the amount of investment risk that is appropriate, given our liabilities. CalPERS is, in general, a fairly well funded retirement system. Although known collectively as "CalPERS", we actually administer over 1800 different retirement plans. Most of these plans are between 75 and 100% funded.

With all of this background, I'll now turn to the topic that really brings me to you today – Corporate Governance. The fundamental thesis behind our governance program is simple: we believe that companies that are fun by people who are accountable to someone else will perform better. We all know this is true in the employee/employer dynamics; corporate governance is about instilling this same concept in the officer/director dynamics, AND in the director/shareholder dynamics.

Let's first talk about the officer/director dynamic: how many times does your CEO make a proposal to your board and have it voted down? I have heard that this is a rarity. But, the fact is that – from a shareholders' perspective – this dynamic is very much a mystery. Maybe it always will be. And maybe that's OK -- because if this dynamic is not working, eventually the shareholders are going to know about it through an inability of the company to quickly recover from the inevitable market cycle downturn. We all know that these market cycles are something that every company must fact. CalPERS believes that good governance is one important way to minimize the impact of these inevitable downturns – through effective board oversight of management, performance problems are more quickly identified and corrected. Without good governance, companies are like a huge battleship in a small harbor – unable to quickly turn around and correct course when necessary.

And when this happens, the shareholder/director dynamic comes into play; at that time, it is up to the shareholders to hold directors accountable. As one of my colleagues in the corporate governance movement, Nell Minow, has said: "Directors are like subatomic particles; they react differently when under observation."

What do we expect of directors? First, we at CalPERS are working on Model Board Principles, which we hope to complete within the next 3-4 months. Although these are still in development, I can give you a brief outline of some of expected elements:

• Directors must have the time and energy to full participate as effective board members. If a director also holds a full-time job, I think more than 1-2 board seats is probably too many.
  
  
• Directors' economic interests must be aligned with shareholder interests. This encompasses two elements: stock ownership (both as an item of director compensation, and as a matter of dedication of some portion of a director's personal worth), and avoidance of any economic interest that is potentially in conflict with shareholders (for example, consultation fees).
  

We will be considering some form of director term limits. We think boards, in general, are benefited by new blood and fresh ideas. Tenure, we think, also contributes to a director's willingness to question the status quo.

If there is any single key to the board of the future, it is director independence. Current definitions of that term are, in my personal view, inadequate. Case in point: On Disney's board, the CEO's personal attorney is technically defined to be an "independent" director. This just isn't right. We need to broaden our concepts – we need to seek independent spirits; we need a culture, an attitude, and the will to question. Independence does not mean that we expect disruptive or destructive personalities or cultures; directors obviously need to work together, but collegiality does not require blind and lock-step obedience to the majority.


• Director expertise must vary by company, and by director, but each director should bring some expertise to the table that adds value to the company.
  
  
• Lastly, directors must "just do it". The directors must know the company's strategic direction; hold the CEO accountable to benchmarks developed to support that strategy; and then be willing to similarly hold themselves accountable for their own performance.

What is our Corporate Governance Program today? We will be releasing our list of 10 poor performers next week. And, as I mentioned, we are working on these Model Board Principles for the United States. Internationally, our Board has adopted certain Global Governance Principles, which generally include six concepts that we believe are fundamental to free and fair markets – worldwide. These concepts are: accountability, transparency, equity (such as 1 share/1 vote), voting methods, codes of best practices, and adoption of long-term vision.

In conclusion, why are we involved in corporate governance? Because it is innovative, because it provides us with the opportunity to better influence our future, and – most importantly – because it makes money. We estimate that our program adds over $150 million per year in investment returns, at a cost of less than $500,000.

If you would like to know more about CalPERS in general, or our corporate governance program specifically, you can visit our Web Site at http://www.calpers-governance.org/.

Thank you.