Helen Morrissey and Charlotte Moore look at scheme governance practices around the globe and realise while the structures in place are very different the objectives are often the same
Back in the good old days of the 1990s the global pension landscape was very different to how it is today. Many schemes were in surplus and regulators as a result were pretty relaxed. In the UK for instance employers were encouraged to take contribution holidays as the funding levels of their DB schemes were so healthy.Scroll forwards to 2010 and the picture is very different. Many schemes are struggling with funding gaps, regulation has tightened considerably and defined benefit schemes are in slow but steady decline. As the international pension industry faces up to the challenges ahead, there has been an increased focus on scheme governance.
While we may see many different pension scheme structures worldwide, it’s fair to say many of the key issues remain the same. How trustee boards are structured and how they make decisions are all subject to debate. For instance, what proportion of the board should be lay trustees? What kind of experience should they have or how much decision making should be delegated to professional advisers?
The Australian perspective
While Australia may not have the defined benefit legacy of other countries, governance is nevertheless at the heart of the pensions agenda. While scheme members within a defined contribution scheme make their own investment decisions, the range of investments will primarily be chosen by the board who take responsibility for ensuring the fund range chosen meets members’ needs. As a result effective decision making is vital.
The Australian government asked Jeremy Cooper, former deputy chairman of the Australian Securities and Investment Commission to review its pension system. The resulting report issued in July this year said governance practices had not kept pace with change and made many recommendations to strengthen governance. These included recommendations that boards should contain at least one independent director and the development of a Code of Trustee Governance which would set out best practice principles for trustees and trustee directors.
“The evolution of superannuation funds in Australia means we have a legacy of stakeholder representation on boards and an inclusive attitude of including all stakeholders in decision making,” said Russell Investments director – investment consulting Keith Knapman. “This means that often decision making processes are not efficient. It also blurs the role of the trustee board and who is responsible for asset allocation decisions as well as accountability for decisions and the fiduciary role of the board.
“Also superfund boards are not always composed with the appropriate level of skills for the job in the way that is standard in a corporate board. This is a concern since these funds are handling large amounts of the public’s money (compulsory contributions), and should be selecting people who are right for the job, not those who please the various stakeholders.”
As a result it is likely the Cooper Review will lead to increased attention on the decision making process and board composition of many superannuation funds. The Russell Investments July Governance Survey interviewed 40 funds and while the survey showed good governance practices on the whole - decision making processes needed to be improved and care needs to be taken that boards are composed with appropriate levels of capability and independence.
The survey showed that 53% of funds had no independent director and also highlighted shortfalls in terms of experience. In 70% of the funds, between one and four members had a finance or investment background. Only 20% had more than five members with this experience and 5% had no members with this experience. Despite this, asset allocation decisions fell to trustees in 80% of funds and to the subcommittee in 38%. Trustees took portfolio decisions in 60% of funds while subcommittees were responsible in 43% of funds.
Knapman added: “The result shows not only a lack of delegation but a serious overlap in responsibility and potential lack of accountability. The investment committee is polite and inclusive which means it is not operating to the full extent of its power.”
He added: “Many funds need a more corporate way of operating by adopting a skills-based approach to selecting directors and investment committees to ensure they have the appropriate level of experience around the table as opposed to the current focus on stakeholder representation.”
Adopting a more dynamic approach to scheme governance is also an issue facing occupational pension schemes in the UK. If anything, the situation in the UK is even more complex than in Australia as a wholesale swing from DB to DC has left many companies operating both kinds of schemes.
Mercer principal Rachel Brougham said: “The key governance principles involved in running both a DB and DC scheme are very similar. The trustees need to set appropriate strategies, apply rigorous oversight to delegated activity and manage the key risks. But the day-to-day challenges are very different.”
Like the Australian model, trustees of DC schemes need to focus more heavily on education programmes and ensuring that members have access to the right funds. However, again like Australia the UK system uses lay trustees who can struggle taking complicated investment decisions.
In an article published in sister title Professional Pensions in May, trustee life coach Brian Holden highlighted the increasing burdens being placed on trustees of both DB and DC schemes and called for a more professional approach to scheme governance. Key barriers to effective governance according to Holden included an increasingly onerous regulatory regime that has led to increasing demands being placed on trustees to complete more training.
Holden’s views effectively echoed those put forward in his 2008 review of the European pension landscape. In the report he highlighted how the 2003 EU Pensions Directive stated that pension funds should be run “by persons of good repute who must themselves have appropriate professional qualifications and experience or employ advisers with appropriate professional qualifications and experience.” His concern was that the training and knowledge requirements levied on lay trustees since were becoming too onerous and would not automatically improve scheme governance.
“We are at a point where we are effectively training people out of existence,” said Holden. “People want to be involved in the running of their pension scheme but it’s hard to see how they can make an effective contribution with the regulatory barriers we have in place. We are overregulated and this stifles a business-like approach to governance. Just because you have lay trustees in place does not make for better scheme governance overnight.”
Two tier construction
Holden advocated a two tier governance model involving both lay and professional trustees. This should include a fiduciary body, made up of professionally qualified individuals or institutions. They would be appointed and supervised by a board of governors, comprising elected and appointed individuals who are representatives of fund members and the sponsoring employers. A code of professional fund governance should be put in place to provide guidance on standards with an increased emphasis on transparency of communication between trustees, sponsoring employers and scheme members. Looking back at his European research he said the UK could benefit from looking at the more “open minded” approach to governance adopted by countries such as the Netherlands.
“The Netherlands is streets ahead of other countries when it comes to standards of scheme governance,” he said. “We can see an increased tendency to consider change than we do in the UK. In the UK if you want change then you have to change legislation, there is little appetite to get around a table and talk things through.”
The Dutch pension system is different to those of the UK and Australia in that its defined benefit schemes are in much better shape.
SEI Netherlands head of sales Peter in de Rijp explained: “In the Netherlands, companies do not have to start their own defined benefit scheme, they can always join an industry wide scheme. For example companies within the metal working industry, whether they are large or small can join the metal workers’ pension scheme.”
While there are fewer defined benefit schemes in place, the number of members within them provides considerable economies of scale. However, there have been problems for the Dutch schemes. Like other defined benefit schemes worldwide many are nursing pension deficits with a funding level in nominal terms below the minimum required level of 105%.
The industry is dedicated to taking control of the situation and making changes where necessary. The Dutch pension regulator recently investigated ten different pension funds looking at how they handled the recent financial crisis. One of these funds, the industry-wide pension fund for metal workers recently decided to change the way its board is structured.
“Pension board members in the Netherlands are made up of a 50/50 mixture of employers and employees,” said SEI’s de Rijp. “The metal workers’ fund decided to reduce its board from 14 to ten members and to appoint two investment professionals to the board.”
The fund hopes that reducing the number of people on the board will improve efficiency and the addition of two investment professionals to the board will help the others to cope with the increasingly complex financial situation.
Ask the experts
Another area where the Netherlands is leading the way is when it comes to fiduciary management. This is essentially the practice of using financial experts to help apportion assets once the pension board has determined its risk budget. The practice is also gaining traction in the UK where many trustees are not financial experts.
DB schemes in the UK have faced similar problems to those in the Netherlands with the job of trustees proving much tougher now than ever before. As in the Netherlands, many schemes are facing pension deficits and managing the company pension has become a full time job. However, like the Netherlands, many trustees are lay trustees and do not possess high degrees of financial knowledge.
Mercer principal Rachel Brougham said: “Many UK trustees are looking to delegate away some of the activities for which they are responsible. As well as increasing interest in fiduciary management, we are also seeing trustee boards forming investment subcommittees which can meet more regularly to ensure they are not missing out on investment opportunities.”
So it would seem scheme governance is going to remain a hot topic for years to come with many potential solutions being put forward. It is interesting to note that while there may be many different pension models in place the key challenges they face remain the same. Who should be taking the decisions and what level of expertise should they have? How closely should trustees be regulated and how much regulation is too much? There will be many answers to those questions but it is important to realise the objective remains to provide a stable secure level of governance that protects the interests of its members.
Industry Voice: Sponsored by Eaton Vance
Alan Pickering says politicians should have the freedom to redefine what is meant by 'absolute'
This week's top stories included Cardano announcing plans to acquire Now Pensions from a Dutch pension fund later this year.
Royal Bank of Scotland (RBS) faces a £102m impact on liabilities as a result of equalising guaranteed minimum pensions (GMPs), according to its annual results.