Report of the Treasurer for the Year Ended December 31, 2012 (2013)

Treasurer’s Statement

To the Council of the National Academy of Sciences:

This Report of the Treasurer of the National Academy of Sciences presents the financial position and results of operations as well as a review of the endowment, trust, and other long-term investments portfolio activities of our Academy for the year ended December 31, 2012.

Overview

The income that supports the activities of the Academy comes from two major sources: program revenue received from sponsors to pay for the myriad studies and other activities undertaken each year by the National Research Council (NRC), and a much smaller sum that we obtain from our own endowment under the endowment spending policies adopted by the Council. Regarding the first of these, the 2012 results are not as strong as the 2011 results. Our total program revenue for 2012 ($298 million) experienced a decline of approximately 8% below 2011 revenue. This decline was anticipated based on the ongoing federal budget constraints and we anticipate for 2013 a continuation of this moderate downward trend.

To partially compensate for the downward trend in the NRC program level, the federal government announced toward the end of 2012, two settlements concerning the 2010 Deepwater Horizon disaster, one with BP Exploration and Production, Inc. and one with Transocean Deepwater, Inc. As part of these legal settlements, the NAS has been asked to establish a new $500 million, 30-year program on human health and environmental protection in the Gulf of Mexico. The NAS program will be for studies conducted based on scientific merit and integrity with emphasis on freedom of inquiry and independent, nonpartisan advice and recommendations. Among its activities, the program will fund projects in the public interest and not otherwise supported by private industry or government agencies. Building on existing Academy work and remaining mindful of the tragic loss of life and other human and environmental consequences of the Deepwater Horizon disaster, the NAS is starting a careful plan to guide the work of this long term program.

With respect to the second source of revenue, it has for many years been the formal policy of the Council to limit annual endowment spending to 5% of the average value of endowment for the twelve quarters ending in June of the previous year. When the endowment declined significantly in 2008, the Council made the prudent decision to hold spending to only 4% and to avoid spending whenever possible from endowments with value below the original gift amount, starting in 2009. This 4% draw produced $14.3 million of funding in 2009. These practices will continue for endowment spending in 2013. The return on the endowment in 2012 was positive at approximately 10.2% and roughly in line with the major stock indices.

NAS Highlights

Endowment, Trust, and Other Long-term Investments Portfolio

As the Chairman of the Finance Committee, I am responsible, along with the other committee members, for the prudent management of the endowment, trust, and other long-term investments portfolio (the “Portfolio”). The goal of the endowment is to provide stable support for the Academy’s programs and activities. To achieve this goal, the Council, acting on the recommendation of the Finance Committee, has historically authorized spending from the Portfolio at a rate designed to maintain the purchasing power of the endowment over time. The current spending rule caps annual spending at 5 percent of the trailing 12-quarter average market value of the Portfolio. As I have already noted, the Council has limited spending to 4% since 2009.

During 2012, the portfolio, along with the broader market, began to show positive returns. The market value of the portfolio increased net of withdrawals and new contributions from $352.2 million on January 1, 2012, to $376.0 million at December 31, 2012. The portfolio returned 10.2% for the year which was 4.0% lower than the relevant benchmark return of 14.2%. While absolute

performance results were satisfactory, performance relative to the benchmark was dampened primarily by the uncharacteristically modest gains from the venture capital and multi-strategy hedge funds. On the positive side, investments in small and mid size U.S. stocks and non-U.S. fixed income produced returns exceeding their respective benchmarks.

The actual portfolio allocation and policy guidelines as of December 31, 2012, were as follows:

Market values of the Portfolio, after withdrawals, for the years ended December 31, 2012 and 2011, are displayed in the following chart (in thousands):

It is of some interest to compare our endowment performance with those of similar organizations. A good way of doing this is to review the results of the study of college and university endowments by the National Association of College and University Business Officers which found that as of 6/30/12, the average 1, 5, and 10 year returns for endowments in the $100M - $500M range were -0.7%, +0.7%, +6.0% respectively. The 1, 5, and 10 year returns of our endowment as of June 30, 2012 were -5.4%, 0.0%, and 6.8%, respectively. The 12-months ending June 30, 2012 were quite volatile and the NAS took a defensive posture with the portfolio in September 2011. This reduced returns, as the market reversed quickly and rose at the end of 2011. Short term returns are volatile and that is why it is good to focus on the long-term return, which the NAS endowment is performing quite favorably compared to its peers.

One further comparison may be useful. In gross terms, including both the returns on investments and the gifts received and the withdrawals for Endowment expenditures, the increase in the value of the endowment over December 31, 2011 was 7.6 %, significantly in excess of inflation during the one year period. On the same basis, the endowment has increased by 41.5% over the ten year period preceding December 31, 2012, for an average (compounded) rate of return of 3.5% per annum, again in excess of inflation.

•    See Schedule 2-A for details of investments by asset class.

•    Included in the $376.0 million total market value of the Portfolio as of December 31, 2012, are $6.8 million for the Woods Hole Endowment Funds, $68.4 million for the Institute of Medicine (IOM), and $10.0 million for The National Academies’ Corporation (TNAC). TNAC, which is equally owned by the NAS and the National Academy of Engineering Fund (NAEF), owns and operates the Beckman Center (see note 1 to the financial statements).

•    Withdrawals of $13.8 million were made to fund the President’s Committee, NAS General Fund’s activity, and NAS prizes and awards for the current period. Additional withdrawals of $2.3 million were made to fund Woods Hole, IOM, and TNAC activity.

NAS General Funds

The NAS General Funds provide unrestricted resources to support the activities of the Academy. It receives its funding from the unrestricted portion of the NAS Endowment. As noted above, the Council has limited spending from the endowment, including the unrestricted portion, to 4% since 2009.

For fiscal year 2012, the General Funds revenue totaled $4.6 million and expenditures totaled $4.7 million, resulting in a small deficit of approximately $100,000. Comparable figures for fiscal year 2011 were $4.8 million in revenues, $4.5 million in expenditures, resulting in a surplus of approximately $300,000.

The 2012 NAS General Funds activity is summarized as follows (in thousands):

Any surplus in the General Funds Budget at the end of the year is transferred to the NAS Reserve. Similarly, deficits are funded from the Reserve. The Reserve is invested in the NAS endowment, trust and other long-term investments portfolio. The NAS Reserve had a market value of $5.0 million on December 31, 2012, from which the 2012 deficit will be funded.

The NAS Council has approved a General Funds Budget of $4.9 million for 2013.

Prizes and Awards

Several award funds have existed for more than 100 years, while others were established more recently. The Home Secretary oversees the nomination process that selects award recipients and recommends to the Council (subject to legal and financial review) changes in the award cycle, amounts of the honoraria, and any other administrative changes. The total expenditures for prizes and awards were $640,000 in 2012.

Journal Publications

Financial results of the Proceedings of the National Academy of Sciences are shown below for the years ended December 31, 2012 and 2011 (in thousands):

Facilities

NAS owns the following facilities:

•   Keck Center of the National Academies at 500 Fifth St., NW in Washington, D.C.

•   National Academy of Sciences Building at 2101 Constitution Ave., NW in Washington, D.C.

•   J. Erik Jonsson Center of the National Academies at 314 Quisset Dr. in Woods Hole, Massachusetts.

•   Arnold and Mabel Beckman Center at 100 Academy in Irvine, California (jointly owned with NAEF through TNAC).

As you know, the National Academy of Sciences Building in Washington, D.C. was restored and opened in April 2012 to host the 149th NAS Annual Meeting. Staff moved back into the building following the meeting and the building was opened to the public for weekday visits. The restoration was financed through the issuance of tax exempt fixed rate bonds totaling $59.6 million, which will be repaid principally from the revenue received from sponsors of NRC studies and other activities that take place in the building, with some part provided by gifts to the NAS.

During 2012, NAS terminated several office leases and moved staff back into the NAS building and the Keck Center in Washington D.C. Starting in 2013, all staff members in Washington D.C. are located at either the NAS building or the Keck Center. This consolidation and better use of space have helped to cut costs as NRC program level has declined.

In 2013, NAS will continue to lease the National Academies Data Center at 8619 Westwood Center Drive in Vienna, Virginia.

Development Office Programs

The generous support of members, friends, and philanthropic organizations assists the National Academy of Sciences (NAS) in taking a leadership role in addressing the issues and challenges facing our nation. In 2012, the fund-raising efforts continued to focus on building endowment and expendable unrestricted funds for the NAS, including the Institute of Medicine (IOM).

In 2012, the NAS and IOM received approximately $1.1 million in unrestricted expendable support. This includes strong support of the annual funds. NAS members contributed $315,665, nearly an 11% increase over 2011 totals, while the IOM received $352,013, an increase of more than 13% from 2011. The IOM’s first fund-raising challenge involved newly elected members and resulted in a 59% participation rate among the IOM’s class of 2011.

Many gifts and grants were received to establish named endowments and to fund the numerous projects and activities of the NAS and IOM. The selected gifts described below highlight the scope of philanthropic support received during 2012:

•   A $3.5 million gift made by Richard C. Atkinson (NAS/IOM) was received to establish the NAS Prize in Psychological and Cognitive Sciences. The endowed prize will recognize and support scientists in improving our understanding of how the mind works.

•   The IOM received a $1,050,000 grant from the Kresge Foundation to support its roundtables on environmental health sciences, research and medicine; promotion of health equity and elimination of health disparities; and population health improvement. The roundtables provide neutral venues for government and industry leaders, researchers, health care practitioners, nongovernmental organizations, and consumers to explore complex health topics through discussion of scientific information and best practices.

•   Over $1 million was received to support the core operations of the NAS’s Science and Entertainment Exchange, a program that connects entertainment industry professionals with top scientists and engineers to create a synergy between accurate science and engineering storylines in film and television. Support for the Exchange included a grant of $480,000 from the Gordon and Betty Moore Foundation, as well as grants from the California Endowment, Howard Hughes Medical Institute, and Alfred P. Sloan Foundation.

•   Gilbert S. Omenn (IOM) and Martha Darling made a $750,000 gift to endow a two-year biomedical science and public policy or population-based medicine fellowship at the IOM. The Gilbert S. Omenn Anniversary Fellow will provide early-career health science scholars with the opportunity to participate in evidence-based health care or public policy studies that improve the nation’s health.

•   The NAS received several deferred gifts. A $100,000 bequest was received from the estate of Paul Doty (NAS) to support the Committee on International Security and Arms Control, and the NAS General Endowment. The estate of Avram Goldstein (NAS/IOM) gave $80,000 to support the Committee on Human Rights. A $50,000 gift from Frederic Hoch established a fellowship fund in honor of his late wife Martha Ludwig Hoch (NAS/IOM).

•   The Committee on Human Rights of the NAS, IOM and National Academy of Engineering (NAE) received $164,959 in gifts including support from 204 members of the NAS, IOM, and NAE.

Overall, gifts to the NAS permanent endowment in 2012 totaled $3.3 million as compared to $2.4 million in 2011.

These gifts are representative of the generous support received from many members, friends, and organizations that support the NAS in 2012. This support is essential to the Academy’s ability to fulfill its mission as scientific adviser to the nation.

NRC Highlights

Revenues

The two main sources of revenue for the NRC are the U.S. government and private / nonfederal entities. The total contract and grant revenue from both of these sources totaled $298.2 million in 2012 and $323.0 million in 2011.

U.S. Government Contracts and Grants

NRC activities, conducted in response to requests from a broad range of U.S. government agencies, are funded through cost-reimbursable non-fee contracts and grants.

The total amount reimbursed by the U.S. government agencies in the year ended December 31, 2012, was $251.6 million (see following chart, in thousands, and the Statements of Activities) and in the year ended December 31, 2011, was $277.1 million.

Private/Nonfederal Contracts and Grants

Private sponsors supplemented government projects and provided for new initiatives by funding awards in the amount of $46.6 million in 2012, compared with $45.9 million in 2011. The private and nonfederal revenues were comprised of contracts and grants ($40.7 million) and other contributions ($5.9 million). (See Statements of Activities.)

•   Other contributions revenue increased from $5.6 million in 2011 to $5.9 million in 2012.

Expenses

Almost all government and private contracts and grants are cost-reimbursable agreements. Therefore, even if the revenues and expenses are not equal in any one given year, the revenues and expenses will be the same over the life of the award.

As in many universities and nonprofit institutions, allowing adequate indirect cost expenditures for necessary support services, while keeping these costs in reasonable proportion to program expenditures is a continual challenge. Historically, NRC management has successfully maintained a relatively constant relationship between program and support costs, i.e., the growth rate of indirect costs has been approximately equal to the growth rate of direct costs. In 2012, total indirect expenses were $79.6 million compared to an approved

budget of $82.3 million and NAS recovered $4.3 million less from sponsors than was spent. The NAS Council has approved a 2013 indirect expense budget of $81.6 million.

Related Entities

Many financial transactions take place between the member organizations of the National Academies. The NRC serves as the clearinghouse for these transactions. However, it is important to note that only the financial activity and results of the NAS, NAE, IOM, and NRC are included in these financial statements. The financial activity and results of the National Academy of Engineering Fund (NAEF) and The National Academies’ Corporation (TNAC) are audited and reported separately. Financial information for the NAEF is available on request from the NAE Finance Office; information for TNAC is available from the NAS Controller’s Office.

Overall Financial Condition

While program revenues declined this past year due to federal budget constraints, the endowment experienced a strong year with a 10.2% return. The earnings in the portfolio have been the primary reason for the increase in net assets noted below (in millions).

Net assets, or assets minus liabilities, can be a measurement of a not-for-profit organization’s ability to reinvest net income toward their mission while also maintaining reserves and helping protect against inflation. The NAS 2012 results of operations are further described in the financial statements starting on page 45.

Conclusion

I would like to thank the members of the Council, the Committee on Budget and Internal Affairs, the Finance Committee, and the NRC leadership for their continued support. Also, special thanks are extended to the Office of the Chief Financial Officer, led by Mary “Didi” Salmon, our CFO, for help in managing the Endowment and Trust Pool, providing steady oversight of the Academy’s various budgets, and paying careful attention to the Academy’s financials systems, records, and reports.

Jeremiah P. Ostriker
Treasurer