The Labour Foundation STAR published its ‘Principles for Pension Fund Governance’ (PFG) in December 2005. The principles are a response to the request by the minister of social affairs and employment to the pension sector, dating from September 2004, to create a system of self-regulation in the field of Pension Fund Governance (PFG).
At the beginning of this year, the minister submitted the report to the House of Representatives of the Dutch Parliament, indicating that the new Pension Act will stipulate that pension funds will have to comply with the principles by 1 January 2008 at the latest. Pension funds therefore have around two years in which to implement the principles.
In 2008, an evaluation will reveal how the pension funds have interpreted the principles in practice. Possibly governance methods which have been shown to be effective in practice will be prescribed as best practice for all funds.
The central themes of the principles are reporting on the policy pursued to all the parties concerned, and the realisation of an adequate and transparent internal supervision. The principles focus on the board, reporting and internal supervision.
Most of the principles affecting the board are already laid down in existing legislation. The new elements are:
q An adequate internal complaints and disputes procedure;
q Provision of insight into the policy and the decision-making procedures;
q An adequate communications policy so that participants,
q Deferred members and pensioners are informed in an understandable manner regarding the pension results, the fund developments and relevant changes;
q A procedure for a periodical evaluation of the performance of both the entire board and the individual members;
q In the event that a board member fails to perform as required, the board has the authority on the basis of the articles of association to ask the party which has appointed the member in question to appoint a different person.
These principles are clear and in our opinion a useful addition to the existing rules.
The principles stipulate that the board has to report on the policy, its implementation and compliance with the principles. Somewhat unusually, these reports must be given to a body (the accountability body) which has been specially set up for that purpose. The fact that the board reports to the parties concerned is no more than should be expected. We believe, however, that creating a separate body does not generate added value for every fund. Reporting is an important principle but prescribing one specific structure is, in our opinion, too rigid an approach. After all, the pension funds profile is diverse.
In concrete terms, the accountability body will issue a judgement on the board’s actions on the basis of the annual report, the annual accounts and the internal supervision findings, and on the policy being pursued. This judgement must be included, together with the board’s response to it, in the fund’s annual report. In addition, the accountability body acquires the right to consult with the board, the scheme auditor and scheme actuary and a general right to information. It may also advise on a range of subjects about which the participants’ council does not yet have a legal right to advise.
The employer, participants and pensioners are represented in the accountability body, with each group holding a third of the seats or the number of votes. This potentially generates a certain degree of tension, since the interests of those involved in the fund do not always run parallel. The employer and participants generally regard an affordable pension scheme to be important, while the interest of pensioners primarily lies with a sound indexation system. It is therefore not beyond the bounds of imagination that the accountability body will issue diverging recommendations.
Within the Labour Foundation, the discussion of the relationship between participation and reporting is still ongoing. The Labour Foundation advises far-reaching cooperation between the participants’ council and the accountability body, on the basis of integration or otherwise. In theory, the following variants are possible:
q A board participation by pensioners and an accountability body;
q A integration of the participants’ council in the accountability body.
This would appear to only be feasible if the accountability body also acquires the statutory authorities of the participants’ council. The rights of participation will, after all, not simply be thrown overboard. Neither should it be forgotten that the board is legally obliged to set up a participants’ council if 5% of the participants request such. Discontinuation of the participants’ council would therefore only seem to be efficient if a survey shows that participants and pensioners support such a move. If this is not the case, the following variants remain:
q A co-operation between the participants’ council and the accountability body;
q A situation in which the participants’ council and accountability body operate independently from each other.
A new aspect is that the board must ensure transparent internal supervision. This means verifying policy and board procedures and processes, the checks and balances and the way in which long-term risks are dealt with. Those involved in internal supervision have a right to information and consultation with the board and the scheme auditor and scheme actuary. The findings of the internal supervision are included in the annual report and discussed by the board and the accountability body. According to the principles, pension funds can set up the internal supervision in four different ways:
q A three-yearly visitation committee; this alternative appears to be the most efficient for small and medium-sized pension funds;
q A separate supervisory body, for example a supervisory committee or board;
q A one tier board; a board with both executive and supervisory members would appear not to be efficient for a lot of funds because double expertise then has to be acquired;
q An audit committee.
The principles are not a one-off exercise in interpretation. The danger is that they are then perceived as 'just more rules' and yet another threat to pension funds. The goal for board members should be not to follow in the wake of developments but to develop an independent vision of PFG. They ought to consider how the available resources - people, time, systems and money – can be used in such a way that the pension fund can best achieve its objectives which are embedded in predetermined principles.
The challenge is to optimise processes in the interest of all stakeholders. But how to tackle this in a structured manner? We recommend that PFG be made a permanent feature of the creative thinking behind pension fund management. Pension funds can improve the governance as a whole, or improve parts, such as the investment process, by using the PFG cycle. The six steps of the PFG cycle are:
q Determine principles;
q Formulate concrete goals;
q Set up structures and processes;
By taking a structured approach, pension funds can apply the principles to their benefit. Implementation does take time and the deadline of 1 January 2008 is fast approaching. Pension funds would be well advised to treat PFG, and particularly the principles, as a top priority.
Stefan Tabak and Paul de Koning are pension lawyers at Watson Wyatt Netherlands