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 The PIAC Governance Model [download a pdf of this document] Click HERE to download the Pension Governance Process Chart Introduction Pension plans are businesses. While they have well defined products and services, they require attention to objectives within long term horizons for both assets and liabilities. Above all, investment returns and profits are uncertain but essential to ensuring that liabilities are met and the pension promise is kept. Pension plans are governed by a series of regulations and there are abundant experts and service providers in the field. As their assets have increased, the importance of pension plans as institutional investors has grown thrusting them into the forefront in the debate on corporate governance in Canada and elsewhere. In exercising their fiduciary duty to their beneficiaries, pension plan managers have participated in the ongoing examination of corporate governance and its effect on shareholder value. At the same time, there has been no universally recommended structure for a pension plan's own governance. The Pension Investment Association of Canada (PIAC) believes the next rational step is to propose a model of best practices for the governance of pension plans. The model we have chosen to follow was developed for the purpose of setting out clearly the responsibility and accountability of those involved in the governance of pension plans. The model closely follows the presentation framework for Effective Corporate Governance developed by Ernst &Young and we are indebted to the firm for their advice and assistance. As with the Ernst & Young model, the PIAC Pension Governance Process model identifies key issues and essential features that will be common for all pension plans, large or small, defined benefit or defined contribution, and sponsored by private or public bodies. We also received advice and encouragement from a number of sources including Dr. John Por of Cortex Applied Research Inc., Keith Ambachtsheer of K. P. Ambachtsheer & Associates, John Ilkiw at Frank Russell Canada, Don Wilkinson of Deloitte & Touche as well as Gordon Wilson, Chair of the Centre for Board and Director Development. We are indebted to them and gratefully acknowledge their assistance. As a committee, we believe there is a cost attributable to a lack of good pension governance. We hope that the principles discussed here and the process model presented will help to remove blockages to excellence and allow pension funds to fulfill the promise of retirement security to their beneficiaries. Robert G. Bertram Chair PIAC Fund Governance Committee February 1997 The Pension Promise The pension promise embedded in the plan provisions is the starting point for providing proper pension plan governance. Proper pension plan governance is a critical feature of delivering on the pension promise. Whether explicit or implicit, the pension promise must address three critical issues: 1) the pension entitlements, 2) the funding policy chosen, and 3) the provisions for management oversight. The pension promise should be clear for all stakeholders to see and understand. It is a promise to provide retirement income in return for current savings as specified in the terms of a plan document. While pension promises vary from fund to fund they are made in all circumstances including defined benefit and defined contribution plans. Regardless of the type of plan involved, the risks and uncertainties must be clearly identified. Who bears any risks must be explicitly defined. Typically a funding scheme is employed to reduce either the risks or costs (or both) of providing retirement income. The pension promise must specifically acknowledge who bears the risks of inadequate investment returns and of maintaining the ability to pay benefits promised. The pension promise should explicitly determine who receives any rewards that might accrue from superior investment returns and favourable actuarial experience. Pension plans are complex businesses created for the benefit of pension plan stakeholders including current members, future pensioners and beneficiaries, and the plan sponsor or its owners. Just as corporate directors must recognize who the stakeholders in a corporation are and what loyalties they owe to each stakeholder, so too must stewards of a pension plan recognize who the stakeholders in the plan are and what loyalties and benefits are owed to each. An effective pension promise is required to establish proper pension governance. Proper pension governance is critical to delivering on the promises made. The Governing Body The pension promise must provide for the means to oversee management of the plan, in other words a scheme for pension governance. Once the terms for a plan have been set, responsibility passes to individuals (or in some cases a corporate trustee) having a fiduciary duty on which the plan member relies. People who accept such stewardship, whether constituted as a Board of Trustees, a Board of Directors or simply as a Pension Committee, will always be subject to the laws of fiduciary duty. Legally they act as owners of the assets, on behalf of the beneficiaries, and must exercise the care, skill and diligence of a prudent person in carrying out their duties. The governance process, for any organization, embodies four discrete features: 1) Board/ Trustee selection and organization, 2) defining how power is shared between the Board/Trustees and management, 3) developing a process to effectively monitor management performance and, 4) providing a means of assessing the overall governance process itself. Pension Trustees are not required to devote their full time and attention to the pension plan's affairs. Pension Trustees are expected to oversee the business and affairs of the plan but are not expected to manage the plan in a day to day sense. Depending on size, ongoing management should be delegated to a senior manager or group of managers who are responsible to and report to the Board on a regular basis for the assets and the liabilities of the total pension plan. Trustees who accept this oversight role must have the qualities necessary to oversee a complex financial business. In many instances, the Trustees may find they deal with work that is broader in scope than their normal duties. Pension Trustees competent in many other management areas sometimes feel, incorrectly, no need to learn about overseeing large amounts of money. While there is no explicit curriculum that needs to be studied as a steward of pension plans, prudence demands that a Trustee should understand financial markets, risk management and actuarial principles. Trustees must also be prepared to study and understand the pension promise and the policies of the pension plan. Trustees must clearly understand what conflicts of interest they have and commit to resolve them in favour of the plan's beneficiaries. They must enunciate and follow an appropriate code of conduct, behave only in an ethical fashion, and clearly understand their fiduciary duties. Governance Principles In 1995, the Toronto Stock Exchange (TSE) published detailed governance guidelines for corporate boards of directors. While a general analogy can be made to the pension plan context, not all the TSE guidelines are readily applicable to most pension plans. In the case of large funds, similar rules could and probably should be followed but, for many smaller funds and for many defined contribution funds, the guidelines do not have the same general applicability. While all of the TSE guidelines should be reviewed in detail, we have grouped them into two general categories for consideration. Stewardship and Oversight: As with corporate boards, the stewards of a pension fund, regardless of size or makeup, have oversight responsibilities to ensure that the fund possesses a strategic plan consistent with delivering the pension promise. The stewards must understand the risks inherent to the specific plan chosen and have plans, policies and procedures to address management controls, risk management, senior staff succession and communications with members and the public. Trustee Independence: A number of the TSE guidelines speak to board independence from management. These include recommendations for an independent chairperson, the number of independent and unrelated directors, appointments to committees for audit, compensation, governance and the nomination of directors, the size of the board and the compensation of directors. Independence from management of the fund, both for a majority of the Trustees and for any committees made up of Trustees, is fundamental to the concepts of fiduciary duty. Further, pension Trustees should be chosen based on their qualifications to truly act in a fiduciary capacity through their knowledge and experience. Management Duties While some large defined benefit plans are constituted as independent entities with management reporting to the Board through a CEO, the management of others, particularly smaller plans, are typically part of larger organizations. The responsibility for the different discrete parts are often managed within existing divisions of the sponsoring organization or are managed by external service providers. Notwithstanding the organizational needs, the delivery of the pension promise requires an integrated management solution. The pension governance process must recognize that all parts of the pension business must be linked and managed as a single business in the case of defined benefit plans. For example, investment risk and liability for pension payments must be managed in the context of the objectives of the overall plan. For defined contribution plans, the incidence of risk changes but the purpose of delivering retirement income to a beneficiary does not. In both cases, Trustees must ensure that there is a focal point where the risks of assets and liabilities are properly considered and managed together. For hybrid plans, both sets of plan business risks must be properly managed. This fact, that a pension plan is really an integrated business entity, should be recognized in the delegation of power to management. If it is not delegated properly then responsibility for asset and liability management should be carefully assigned otherwise co-ordination must be done by the Trustees and the separation between oversight and management will be lost. In many large funds this is effectively accomplished through the appointment of a CEO. In small funds such appointments may be impractical but they will need to find a means to accomplish the same end. The appointment of a responsible management resource (either individual or committee) to manage the total fund will ensure that proper accountability and responsibility is put in place to create value for the stakeholders. Fiduciary Duty The cornerstone of a pension governance process is that it must recognize, reflect and facilitate the discharge of fiduciary duty. A fiduciary has the power and discretion to unilaterally affect the plan beneficiaries' interests. The Trustees have a duty to interpret the plan terms fairly and pay the benefits promised. Clearly the plan member is vulnerable to the fiduciary and this unequal relationship defines the need for duty, care and prudence. The greater the discretionary powers, the greater is the scope of fiduciary duties. The terms of the plan design are frequently set unilaterally by the plan sponsor, but they must be interpreted impartially, fairly, and in good faith when paying the benefit promised. In their role as fiduciary, the Trustees must always act in the best interests of the beneficiary, impartially treating members with loyalty and without personal profit. Fiduciary Obligations Fiduciary obligations normally extend to and include:
The PIAC Pension Governance Process 1- Trustee Selection and Organization With the making of a pension promise, the first step is taken to the creation of a complex business known as a pension plan. Pension plans are created for the benefit of their stakeholders. Stakeholders typically include current and future pensioners and beneficiaries and the owners of the pension plan sponsor (either shareholders or taxpayers). No matter what the basic nature of the pension plan is, governance issues are decided by the overriding fiduciary duty of plan trustees and administrators to the beneficiaries. The nature of the pension promise is a key determinate of the makeup of the governing body (Board of Trustees), the strategies that will be required to fulfill the promise and to whom the Trustees are accountable. Trustees should be selected by the people to whom they are accountable. A pension business should be governed and monitored by stewards who have accepted the responsibility to keep the stakeholders' objective for the business clearly in mind. They are legally the surrogate principals for the assets of the plan from whence stems their fiduciary duty. Trustees should be selected to produce the right mix of independence, duty, experience and education to effectively meet the demands of managing complex pension plans and fiduciary duty. They have an ongoing requirement to educate themselves on the plan and on current pension issues. The principles of pension governance remain unchanged for the type or size of a pension plan. In practice, the process for selecting Trustees and overseeing a plan will vary greatly with the size and type of plan. Large defined benefit plans will typically devote more resources to governance than small plans. Small plans frequently combine the roles of Trustee and manager into a single position often including outside service providers. Each of these approaches presents separate challenges in incorporating the basic principles. Whatever the approach, there must be a governing body that is constituted to fulfill its fiduciary duty in a prudent fashion. 2 - Trustee and Management Power Sharing This section relates to the dynamics between policy and operational personnel-the Policy Makers (referred to herein as the Board of Trustees or the Board) and Management-the allocation of responsibilities between the two, and the criteria for measuring success. The main organizational principle involved is the clear separation of management from governance-operations from oversight. The Board
b. establishes risk parameters; c. monitors compliance; and d. appoints an operating committee or Chief Executive Officer responsible for operations. Succession planning for senior executives should also be established and reviewed regularly. The Investment Policy will clearly state the measures of performance success, both short and long term; the universe of vehicles which can be used to meet these measures; risk tolerance guidelines; and the reporting and compliance structure. The operating management will
b. define a strategy to meet the investment targets; c. define tactics to implement the strategy; d. develop systems to measure the success of the strategy and tactics; and e. report policy compliance and investment performance to the Board. A compensation system linking the economic objectives of the plan and management remuneration will be established, with an operational review carried out regularly. 3 - Trustee Monitoring of Management Performance The Board of Trustees will also ensure that the managerial/actuarial processes to estimate the plan liability and the resulting estimates, are reasonable and prudent in actuarial, accounting and legal terms. Actuarial assumptions and surplus levels will be approved by the Board of Trustees, based on information provided to them by the department Setting acceptable risk parameters is the key to determining rate of return. Therefore, it is essential for Trustees to monitor management's compliance with approved risk parameters. Information systems must measure and report macro information which is relevant, complete, concise, and timely for comparing actual results to benchmark results. Trustees must receive reports in time to allow review and reflection prior to meetings. The Chair must encourage healthy debate prior to reconfirming or revising plans. To resolve conflicts, Trustees must have unencumbered access to senior executives and external advisors through established due process. 4 - Assessing Plan Governance Performance Finally, the Board will assess the performance of those management programmes established to ensure pensioner and other stakeholder satisfaction. The objective of the assessment is to determine the effectiveness of the plan's governance structure and operations in meeting the pension promise and in discharging the Trustees' fiduciary responsibilities. The overall objectives of the plan generally fall into two main categories: financial (investment performance and funded status) and service delivery. Two major topics are examined: performance compared with objectives and methods to achieve the performance. Objectives need to be quantified wherever possible and viewed over appropriately long periods. The amount of progress over time and the costs of attaining the results can be considered. Particular importance may be placed on the response of the organization to under- or over-performance. Methods involve processes and personnel. Processes include items such as the adequacy of information flows, and processes to develop and implement strategies, policies and plans. An important element is whether the best information and understanding available is used, considering the resources of the plan. Personnel topics cover items such as performance evaluation and reward systems; effectiveness of the Chairperson; Trustee commitment; training; and succession planning. The findings of the evaluation and recommendations for change should be directed to the group to which the Trustees are accountable. That group should also receive independent reports from other parties, such as the actuary and auditor. |