A well structured fund can enjoy a return premium of up to 1%. What governance structures should smaller pension funds aspire to? Gail Moss reports
Committees are a way for pension fund boards to operate more efficiently.
By delegating specific areas of work to smaller groups, the board is free to carry out its overarching role of running the fund.
It is common for pension funds to include an investment committee, for example.
But as the burdens - regulatory and otherwise - increase, the number and type of committees proliferate.
Other areas which may be farmed out include administration, audit (these two are often combined), governance, funding (this could be combined with the investment committee), defined contribution (where a DC scheme has been added to the existing defined benefit scheme) and communications.
In addition to the permanent committees, pension schemes can set up ad hoc working groups to deal with specific issues as they arise.
In the Netherlands, pension schemes are required by law to set up a visitation committee and a pensioners’ committee, whatever other committees they also have.
The visitation committee - in essence, an internal audit committee - evaluates the policy processes and measures within the pension fund. If preferred, the rules allow for a one-tier pension fund board - instead of the extra committee - to carry out this supervisory function.
The pensioners’ committee represents the interests of all pensioners, and the board is legally obliged to ask advice from the committee with respect to policy developments.
“In general, these committees are helpful to make the functioning of the fund more professional and to increase the input from pensioners.” says Patrick Heisen, leader, pension management and organisation, Towers Watson in Amsterdam. “But they only work when their members have a similar minimum level of expertise to look at the functioning of the fund.”
He says a good visitation committee can work within the risk management area at the third level of defence, which represents the audit level.
“In this case, a good visitation committee should be able to add value to the independent auditing function by evaluating the processes and controls within the fund.”
However, pension schemes should not simply draw up a list of possible committees, says Heisen.
“They should first ask themselves what governance structure they need,” he says. “In areas with a higher degree of complexity, for instance investment policy, then you probably need a committee. But committees are not the only solution. To make the governance structure more effective, you need the expertise to monitor all types of risk, and that expertise should exist throughout the organisation, for example, in the support function.”
For example, ultimate responsibility for internal control within the Third Swedish National Pension Fund (AP3) lies with the board. The risk management plan includes frameworks and guidelines set by the board, covering allocation of tasks, risks and limits and procedures for monitoring and control.
The day-to-day internal control of financial and operating risks is overseen by the risk control department. This is independent and organisationally separate from the functions that make investment decisions.
The department reports daily to executive management and stays in close touch with the board via the audit committee. Where necessary, the department also reports directly to the board.
In the Netherlands, a large amount of work is outsourced, for instance to pension administrators or asset managers, and so instead of carrying out specific duties, pension fund committees have more of a monitoring role.
Pension fund boards should have a business plan and schedule, with targets to achieve over the course of, say, a year. But one problem for board members is the tendency to be drawn too far into day-to-day activities.
In large UK schemes, trustee boards are now adopting an executive approach to take some of this burden off trustees, by appointing an individual CEO or trustee pension manager to sit between the board and its various providers, co-ordinating activities, giving a steer to the agendas of the board and committees, and generally supporting board members.
But can you have too many committees?
Yes, if it means the same discussions might be duplicated, says Heisen.
“Integral risk management is a hot topic at present in the Netherlands,” he says. “But pension funds looking at setting up a risk management committee have to decide what is the scope of the existing investment committee, because interest rate risk could end up being discussed on both committees.”
There is also a danger of the opposite problem - that certain issues could fall between the cracks.
“Often, it’s the bigger, long-term issues that get crowded out because of more time-sensitive issues which are seemingly more urgent,” says John O’Connell, director, Dublin-based Trident Consulting.
For instance, in Ireland there is no legal obligation on a sponsoring company to deliver a pension promise.
“Many trustees have been too relaxed about funding,” says O’Connell. “They have never looked at the risk they are facing were the employer to change their level of commitment to the scheme. And this could be a real problem in the light of increased financial pressures, including increased longevity.”
O’Connell suggests that pension boards decide which significant issues are not getting enough airtime, then hive them off for consideration by a dedicated group - say a strategy committee - or convene a special board meeting to focus on those specific issues.
“Too many committees can lead to diminishing returns in terms of efficiency,” says Robert Plumb, governance consultant with Mercer. “There may be a shortage of people with the right skills and personal attributes. That could lead to some individuals being overstretched if they are on several committees. It could also mean - ironically - that the main board is distracted from its own agenda because it has too many reports from committees to deal with.”
But he also warns against concentrating power in too few hands: “You don’t want a small bloc of the same people to be on all the key committees.”
One of the headaches for any pension scheme is to find enough people with the right expertise to sit on the more technical - such as investment - committees. But it is also desirable to have laypeople as well; they can often ask the obvious questions which the professionals sometimes ignore.
A way round this problem is to include those with expertise, for instance, from the sponsoring company, to join the committee as non-voting members. An alternative would be to set up a joint committee between the pension scheme and the company, or to invite the scheme’s investment advisers (say) to attend in a non-voting capacity. However, the cost of their time will clearly be a consideration.
The key to successful delegation is a clear understanding on the part of the pension fund board and each individual committee of the committee’s terms of reference. This can be set out in a charter or a schedule of delegated authority, with details of any powers which are delegated, for instance, whether the investment committee can appoint or dismiss managers, or simply present recommendations to the board.
The board should also make clear other requirements, for instance, how often each committee should report back, and give a deadline for receiving those reports to allow board members enough time to study them before any discussion takes place.
How often is often enough?
The optimum frequency of meetings will depend on the nature of the committee. For aspects such as governance, quarterly meetings may be sufficient, and too many meetings could lead to diminishing returns.
But there are clearly going to be other areas, for instance investment, where events move so quickly that meetings need to be held more often.
A major pitfall with pension fund structures is that boards are often unable to provide adequate oversight of the various committees. Very often, this is because some board members have not been sufficiently trained, and it can be difficult for a lay board member to understand the technicalities contained within committee reports.
“The answer is to give board members sufficient training, but also require committees to write reports in plain English,” says Plumb. “Professional advisers should also be instructed to write advice so that the non-technically-minded can understand it.”
Similarly, he also says that members of both the main boards and committees should be encouraged to use plain speaking at meetings, rather than corporate jargon which not only makes some participants feel excluded, but is often completely incomprehensible.
In the Netherlands, the outsourcing of many operational functions mean that committees are especially dependent on the information they get from their advisers, asset managers, custodians, and so on.
The key to ensuring this information is adequate is a broad, extended service level agreement (SLA), says Heisen.
“The SLA should be specific about what information is supplied, how often and in what format,” he says. “The SLA should also define defensive risk limits, both financial and non-financial, if applicable. The reports based on the SLA should be produced to a certain quality standard.”
Heisen says that in general, a report to the board or a committee is only effective if it contains information on all the agreements or limits (within the SLA) and if the report is in line with the governance structure. “But not every piece of detailed information has to be monitored at board level,” he adds.
In shape for the job
Some countries have distance learning courses for pension board members - the UK has the TPR Trustee toolkit (www.tpr.gov.uk), while Ireland has a similar package (www.pensionsboard.ie).
It is vital for individual members of committees to possess certain personal characteristics.
“You don’t want people who are easily browbeaten and allow the chairman or other forceful individual to dominate meetings,” says Plumb. “You do want someone who is a good team player and can see other people’s point of view.”
Also preferable are analytical skills - not necessarily technical knowledge, but the ability to see things from first principles and not be afraid to ask questions for fear of sounding foolish.
“You also want to include people who have good relations with the company, because there will be times when you will need to engage with the employer,” says Plumb. “Unfortunately, the most capable people can’t always find the time to serve on the board.”
Papers submitted to any committee by outside professionals, and to the board by committees themselves, should be produced to a specific quality standard, with a peer review process in place.
Any committee taking responsibility for a specific area should feel able to call on professional assistance, possibly with a budget to commission support work.
“It’s always worth asking your advisers what is the most effective way of getting a particular task done,” says Plumb. “As a committee, you don’t want to reinvent the wheel. You might spend hours and hours investigating a subject, when there may well be a readily available product or service on the market to perform that same function.”
There should be clear ground rules for the conduct of committee meetings. Boards or committees could seek a review from an independent specialist to sit in on a meeting and make recommendations about the way it is conducted.
Members should aim to participate fully in meetings, keeping any discussion cordial and not making personal criticisms.
“The chairman is vital in achieving this,” says Plumb. “He or she should be doing what they can to encourage members to speak up, while stopping any one person from dominating the discussion. It’s also important to avoid personal bias. I’ve been on boards where the chair has an axe to grind or is highly critical, and that causes tension.”
And he stresses the importance of the overall mood of meetings.
“Committee members give a lot of time to this work, so you need to cultivate the right atmosphere where they think ‘I’m going to enjoy this meeting’ - it makes it worth putting in the effort.”
Communication outside meetings is also crucial. E-mail can be an efficient way of managing discussions, but not at the expense of deluging committee members’ in-boxes. However, collaborative tools such as E-share can provide effective ways of routing comment. Members of the e-mail group get access to their own website which displays information on work in progress, and can also include blogs and message boards, cutting down the need for personal e-mails.