As we continue through these challenging financial times, I get asked some pretty interesting questions. Many of these questions relate to the decline of the financial engineering empire as we know it—the re-engineering of global financial institutions, the disappearance of formerly global brands (e.g., Lehman Brothers and AIG), and government bailouts in staggering dollar amounts. It’s difficult for the average “prudent person” let alone “prudent expert” to make sense of what’s going on. The situation is exacerbated by most economic indicators pointing to an imminent global recession.
In an advisory our firm released in early October, we stressed three important actions pension plan sponsors need to take during these difficult times: first, communicate with plan members; second, review investments; and third, develop and enforce investment policy. Most readers will recognize that these are things that every plan sponsor should always be doing. What is critical now and going forward is that all parties involved with the plan must work together, communicate effectively with each other, and disclose important information with stakeholders.
Communications is where sponsors of defined benefit (DB) plans and/or capital accumulation plans (CAPs) can go on tangents. An analogy to consider is that of a student doing her homework. She does all the easy assignments first and spends time and effort accordingly. She leaves the difficult homework to the end and, if she runs into trouble, she may not have time or know how to ask for help. Pension committees can run into the same issues—they attend to their routine functions in a systematic fashion, but don’t exactly know what to do in ad hoc situations. At the root of this process is often a governance program that focuses on the top-down application of governance principles. This “checklist and work plan” methodology has its merits, but the plan’s governance program should not instill “governance seizure,” leading sponsors to miss identifying serious problems requiring thoughtful solutions, allocation of time and effort, and communication with stakeholders.
For example, do you encourage your investment managers and other third parties who work for your plan to “push” new ideas forward, asking for the time to present and explain their idea’s significance? I can count on the fingers of one hand the number of times that a manager has come forward and asked for a change to a plan’s investment policy, in order to give it more options to mitigate risk and maximize return. In a way, investment managers can be subject to “pooled fund seizure” in running their business and model portfolios, just like pension committees can seize up with an overload of routine governance tasks. Sometimes plan sponsors have to “pull” their managers and ask some tough yet fundamental questions, aimed at ensuring that the manager is attuned to the sponsor’s issues. Then communications can address much more than “where are we now?” and focus on what’s next and who needs to be communicated with—including plan members, executive committees, and the board of directors.
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In the case of CAPs, when first developing our October advisory, we were admittedly worried about whether plan members were qualified to respond to the dramatically changed financial landscape. Even though members without adequate financial literacy should always seek advice from qualified and independent advisors, we know from industry and academic data that this does not always happen. With financial literacy comes the discipline to act systematically in tough times; DB sponsors are simply in a stronger position in this regard.
In the CAP context, plan sponsors have to consider two fundamental factors: first, the financial literacy of plan members needs to be understood; and second, communicating the message to people in their own language. And it’s not enough to say that the message went out; the sponsor needs to verify that the message has been received and understood by members.
In order to understand the financial literacy of plan members, CAP sponsors must engage and communicate directly with their members. This is a relationship between the employer and employee, and should not be delegated to the plan’s service provider. To gain a better understanding of the plan’s membership profile, and test their financial literacy level, sponsors can develop a customized member survey. Surveys like this can reveal members’ general understanding and satisfaction with the plan and workings, the investment options available, and their general understanding of the consequences of their financial decisions.
Results from a top-down checklist will reveal less about a sponsor’s ability to merge investments and communications into a single philosophy than a direct gathering of information. CAP sponsors will subsequently understand the financial literacy spectrum of their members, be in a position to develop targeted education programs, and validate that their messages have been received and understood.
For DB sponsors, communication under the new investing paradigm is about exploring and sharing ideas to real problems and ensuring the message gets to the right stakeholders. While this message is the same for CAP sponsors, the member experience needs to be the focus of a merged philosophy incorporating investments and communications together.
Peter Arnold leads the Canadian Investment Consulting Practice for Buck Consultants, an ACS Company. He is responsible for the development and delivery of all investment and defined contribution consulting services in Canada.
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