Pensions are by their nature long-term and this can often lead to an acceptance of inertia because “this is how we have always done it”. But in today’s world this is no longer good enough. A failure to adapt to changes in the environmental, legislative and economic conditions that can hit a pension scheme will leave those responsible for running the scheme open to charges of negligence.
Implementing good governance will require a plan, but it will also require change, coupled with strong leadership, clear decision making and the right allocation of responsibilities. Unfortunately, there are no magic wands or spells – it takes hard work.
Many schemes would benefit from a review of their governance and the best place to start is to be clear about what they are trying to achieve. Despite the perception of the outside world, it is apparent that pension schemes, like their members, are not all the same. Schemes have different benefit structures, different funding levels and different levels of maturity. The long-term targets of a new defined contribution (DC) scheme will clearly not be the same as those of a mature ‘closed’ defined benefit (DB) scheme. But objectives can still be articulated in a way that can be used as a basis for setting or reviewing specific objectives and to support any decisions taken in delivering these.
As those who run football clubs will tell you, however, simply stating a long-term objective (such as winning the title, reaching the Champions League or not being relegated) does not guarantee achieving it. It is just as important, and arguably more so, to measure progress regularly to determine whether the club is on track, whether buying a new midfielder is likely to make the difference or whether something more radical such as replacing the manager is required.
A pension scheme is no different – a journey plan containing measurable milestones and a means of reporting, scrutinising and monitoring progress is critical. It helps determine whether everything is going well, if a specific area requires attention or indeed if a radical overhaul is urgently required.
The next step in the process is delivery, and I would suggest that one failing of many pension scheme governance structures is a lack of delegation from those who are charged with determining strategy to those charged with implementing it. Returning to the previous analogy, if a football chairman was running his club the way many pension schemes are run, then he would be coaching the team, setting the tactics and picking himself to play up front, as only he could be trusted to score goals.
Accountability, of course, cannot be delegated, but responsibility can. If accountability is taken seriously, then all delegations of responsibility should be clearly defined, clearly structured and regularly revisited. The effort is always worthwhile as the results generated will almost always be better. Ensuring that the day-to-day operation of the scheme is carried out by a trusted executive team and a great set of advisers will ensure that the trustee board or sponsor can focus on owning and evolving the strategy. That is alongside managing and challenging those with day-to-day responsibility.
The importance of your executive team, in whatever form it takes, cannot be overstated. Having an individual or team which is 100% focused on the scheme is of great benefit. Such a team can advise on strategic considerations, manage and co-ordinate other advisers, collate information, provide reports and recommendations on various matters and arrange and run meetings for the scheme – all ingredients of a robust and flexible governance model.
One important area of delegation is a model of delegated investment management. Management of a scheme’s investments is often one of the last things considered for delegation, when in fact the benefits it can deliver mean that it should probably be at the top of the list. Typically, those who have adopted fiduciary management in the past have been small schemes that do not have sufficient resources or expertise to run their own investments. I would contend that many larger schemes overstate their expertise and resources, however, and should be thinking more about implementing a fiduciary management model – even on a limited basis.
Large schemes might feel that they would not benefit from the economies of scale available to smaller schemes that harness the ‘buying power’ of a fiduciary manager with investment capital from many clients. Even if this is the case however, the day-to-day focus of the fiduciary manager and their knowledge of the available investment instruments is unlikely to be matched by an ‘in-house’ team or an investment committee of some description.
In terms of governance, a good fiduciary management model allows the whole of the trustee board to be actively involved in investment and to have a good understanding of what is happening. In my experience, this is more beneficial to the scheme, allowing it to harness input from a wider range of individuals with different experience and perspectives.
Some express concern that a fiduciary manager is conflicted in the choice of investments, but it is perfectly reasonable for an independent entity or scheme reviewer to be appointed to provide challenge in this regard. They can also report back on whether the fiduciary manager is operating within its mandate and whether any potential conflicts are impacting upon their actions.
My own experience is that where the strategy is set and monitored by the trustee and implemented by a fiduciary manager it is possible to save the sponsoring employer or employers of a DB scheme large sums in potential additional deficit contributions. This is because the scheme is well placed to quickly and efficiently adapt to changes and makes decisions based on the agreed long-term goals of the scheme. The model works, delivering quality and performance and strengthening the overall governance.
Good governance is a combination of many factors that come together to ensure that the whole is stronger than the individual parts. It ensures that the scheme can fulfil promises made to beneficiaries, while at the same time understanding the issues being faced by employers who contribute to or underpin the scheme.
The silver thread that should run through and guide all that we do is a governance framework. It does not materialise or work because of any magic, it exists and works by helping us to identify the unique mix required to run a scheme. When successful, this can give the appearance of alchemy to those looking in, but in reality it is the result of hard work, vision and leadership.
Rory Murphy is chairman of the UK Merchant Navy Officers Pension Fund