Although the relevant statutes and the common law impose certain duties on the plan sponsor or administrator that are relevant to the establishment and implementation of a pension governance policy, the scope and specific requirements of an appropriate pension plan governance process are not comprehensively codified in any statute. However, the following governance principles have a relatively broad general acceptance.
1. Roles, responsibilities and accountabilities of all participants in the governance structure need to be clearly identified and documented.
2. The governing body, in its capacity as plan administrator, and its delegates have fiduciary duties to members and beneficiaries.
3. The governing body and its delegates should collectively have the skills and experience required to fulfill their fiduciary and other responsibilities in plan administration.
4. Members of the governing body should be provided with appropriate training and undertake ongoing education.
5. A code of conduct and a control mechanism for conflicts of interest should be set.
6. An appropriate internal control framework should be maintained.
7. The governing body should have appropriate mechanisms in place to oversee the administration of the plan and to ensure compliance with legislative requirements.
8. Objective performance measures for decision-makers and service providers, and for plan performance, should be established.
9. Governance practices should be reviewed regularly and modified as needed.
Impact of the economic crisis
The response of plan sponsors and administrators to the crisis must be assessed in light of their statutory and fiduciary duties, as well as governance principles. The lessons learned by the financial community regarding investment risk, poorly understood financial products and thinly traded securities should become part of a pension plan’s governance framework. That said, sponsors and administrators must also recognize that pension plan investment is a long-term proposition and decisions that will affect a fund in future years or decades should not hinge on one year’s results. The goal of pension plan governance is to realize the long-term goals of the plan notwithstanding short-term market volatility and investment losses.
The Organisation for Economic Co-operation and Development has proposed several recommendations for best practices in pension plan governance, based on the experiences of sponsors during and after the economic crisis.
1. Improve the governance and risk management of pension funds.
Pension fund risk management should be strengthened to reduce exposure to unduly risky investments, and governance should be improved to avoid exposure to assets that are not fully understood.
2. Improve the design of DC pension plans, including default investment strategies.
Default lifecycle funds can help protect those close to retirement, and flexibility should be allowed in the timing of annuity purchases.
3. Step up disclosure and communication, and improve financial education.
Better disclosure of investment performance and costs is necessary. Furthermore, financial education is needed to help beneficiaries—and, to a certain extent, plan administrators—improve their understanding of investing, risk and return.
In response to the increasing volume of pension fund litigation in the U.S., the committee of the Stanford Institutional Investors’ Forum has published the Clapman Report, which contains recommendations on pension fund governance. Several of these recommendations are particularly applicable to Canadian plan sponsors and administrators in light of the decline in the global financial markets in 2008 and the resulting deterioration of pension plan assets. Specifically, sponsors or administrators may wish to consider incorporating these recommendations into their existing governance structures:
• clearly define and make governance rules available to all members and beneficiaries;
• mandate tough and transparent policies to address conflicts of interest;
• take steps to ensure that officers and directors appointed by the employer to be responsible for the investment of plan assets are competent in financial and accounting matters;
• define the responsibilities to delegate to employees and third-party consultants; and
• establish a clear reporting authority among the officers and directors responsible for the investment of the pension plan, as well as employees and third-party consultants to whom investment duties have been delegated.
Although it is difficult to distinguish between short- and long-term volatility in financial markets, sponsors and administrators must continually evaluate the performance of the investment managers engaged to manage the pension plan assets. The governance mandate on investment management must consider the significance of past performance in relation to the fund’s future commitments. If a manager is terminated for poor performance over a short time frame, the long-term strategy of the pension plan may be compromised. However, if a manager consistently underperforms, the governance structure for the plan should specify the actions that the administrator will take, possibly including termination of the manager. The officers and employees charged with the responsibility of investing the plan assets must also have adequate financial and investment expertise to effectively evaluate investment manager performance and to understand complicated financial products.
The recent economic downturn highlights the need for stronger discipline in the investment process. Decision-making criteria for the investment of a plan’s assets should involve greater clarity of the pension fund’s mission and strategic goals; the appropriate allocation for each element in the investment mandate and the risk associated with each element; consideration of the plan population; and the engagement of specialized managers with predetermined buy-and-sell thresholds. The level of risk associated with each element must be clearly understood and should not be deviated from without prior consideration and written approval.
Certain responses by administrators to the economic decline may be seen as governance best practices.
Intensification – An increase in attention and the mobilization of additional resources to deal with exceptional circumstances.
Priority setting – Using dashboards to signal (in green, yellow and red) the importance of issues and the time that should be devoted to those issues.
Risk management – Quantitative discipline, qualitative overlay and greater independence of risk assessment from the investment management process.
Expansion of belief structure – In cases where more complex market conditions can be understood only with more complex beliefs.
While the response and resulting changes may vary depending on certain factors—such as the size of the fund, the plan’s funded status and population, and the sponsor’s investment or financial expertise—the implications of the financial crisis cannot be ignored by sponsors and administrators when reviewing a plan’s governance structure.
While the behaviour of financial markets is neither rational nor predictable, pension plan sponsors have long-term obligations to members and beneficiaries that must withstand such irrationality and unpredictability. To ensure that the pension fund is adequate to meet these long-term obligations, the fund must be properly governed, meaning that the governance structure is not static. The unprecedented events of 2008—and the dramatic losses that occurred as a result—should be reflected in a plan’s governance structure going forward.
Caroline L. Helbronner is a partner and Jessica A. Bullock is an associate with Blake, Cassels & Graydon LLP.
caroline.helbronner@blakes.com
jessica.bullock@blakes.com
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© Copyright 2009 Rogers Publishing Ltd. This article first appeared in the October 2009 edition of BENEFITS CANADA magazine.