Call to Order

Strategic risk – Is the plan sponsor at risk of not being able to meet its business objectives? Are the benefits dollars currently being spent effectively in order to attract and retain employees? Is the cost volatility of a mature defined benefit (DB) plan affecting shareholder value? In the case of a defined contribution (DC) plan, is the plan sponsor contributing enough to ensure an orderly pattern of future retirements?

Financial risk – Are there potential adverse impacts on cash flow, accounting expense, balance sheet strength, return on capital or plan solvency and benefit security? Are plan members at risk of benefit inadequacy?

Compliance risk – Are we following the terms of the plan documents correctly? Are we adhering to all relevant legal requirements? Are we following all relevant accounting requirements?

Fiduciary and governance risk – Are we carrying out all fiduciary roles and responsibilities appropriately? Are there any potential conflicts of interest?

Operational risk – Have we implemented the plan correctly? Is it operating efficiently? Are we appropriately managing and measuring the performance of any outsourced service providers?

Reputational risk – Could there be an adverse impact on how the sponsoring company is perceived by plan members, customers, investors/analysts or government regulators?

Hazard risk – Could there be a sudden change in the landscape? Are we at risk of litigation from plan members? What happens if government policy changes adversely?

Best practice requires the pension committee to understand the specific risks posed by its DB or DC plans—the nature and source of each risk, its likelihood or frequency and its potential severity. The committee must then adopt strategies to monitor and manage these risks, including robust early-warning mechanisms.

Performance Monitoring and Measurement
Monitoring is a key element of a committee’s role in managing risk. It encompasses multiple dimensions, looking at the performance of all parties involved in the operation of the plan—as well as the performance of the plan itself—using plan-specific benchmarks.

The committee should establish clear criteria for hiring, monitoring and replacing all plan fiduciaries and service providers, both internal and external, and should conduct regular and meaningful reviews based on these criteria. The committee should also document guidelines on the service provider fees and costs that will be paid from the plan assets.

Towers Perrin’s research shows that regular performance monitoring is commonly done for investment managers, but the frequency of reviews for other service providers—such as the trustee/custodian, the third-party administrator, the actuary/consultant and the internal pension staff—is significantly lower.

The committee’s monitoring function should include regular checks to ensure legislative and plan compliance, as well as assessments to ensure that all policies relating to plan design effectiveness, funding, accounting, investment, administration, member education and communication, record retention and conflicts of interest are being met. In particular, best practices suggest that the committee should adopt monitoring and measurement approaches that are forward-looking, not just retrospective. Monitoring forward-looking metrics helps the pension committee to anticipate and address risks in advance, rather than dealing with problems in hindsight.

For a DB plan, assessing the investment manager’s performance against pre-established benchmarks is important, but it is retrospective. Forward-looking metrics include stochastic modelling of the plan’s future funded status, stress testing against various economic scenarios and projections of how the workforce is expected to evolve over the next business cycle.

For a DC plan, reviewing the current asset mix of plan members by age group and the distribution of recent investment returns achieved by the plan members, while it provides unique and valuable insights to the committee, is also a retrospective strategy. Forward-looking metrics include assessing the projected level of future retirement income from the plan that is realistically attainable by members, based on current participation rates, contribution rates and asset allocation.

Communication and Reporting Framework
The pension committee should establish a clear reporting framework—including the content, format, timing and recipients—to produce relevant, timely, accurate and actionable information for plan stakeholders, including senior management and the board, plan members and beneficiaries, and regulatory authorities.

The reporting approach should be reviewed periodically in light of changes to the plan structure and plan experience. Reporting should focus on transparency and accountability and must respect applicable privacy legislation.

When communicating and reporting to plan members, the pension committee should take these measures:

• establish a policy for ongoing plan member communication and education, and articulate clear objectives and metrics for measuring success;
• explain the plan’s governance process and complaint resolution process;
• provide interactive decision-making support tools that enable plan members to assess the level of their projected retirement income (and, for DC plan members, to assess the potential range and variability of this income); and
• communicate to DB plan members on the impact of equity market performance, the current funded status of the plan and the company’s funding policy.

Conducting a Review and Implementing Changes
Here are a few important tips when undertaking a review of a pension committee’s mandate, structure and activities.

• Clearly define the scope of the review. What or who is driving it? What are the deliverables, timing and budget for the review?
• Look critically at existing relationships between the board, management, plan administrator, active members, retirees, unions and service providers. Each of these stakeholders will have a perspective on the effectiveness of the pension committee and possible changes.
• Find a champion within the organization who will help steer the process with key stakeholders through to the board level. This is crucial to getting buy-in for any proposed changes to the committee’s governance structure or policies.
• Recognize the potential impact of factors such as corporate changes resulting from acquisitions or mergers, new board members or management, budgetary restrictions and the history of employee or union relations.
• Consider the appropriateness of engaging plan members in the review process—provided that you are prepared to seriously consider their feedback and proposals.
• Include member communications in the process of implementing any changes.

Common action items arising from such reviews include formally documenting the plan’s governance structure and reviewing or documenting the plan’s policies; training committee members; establishing a risk-assessment model; reviewing plan monitoring metrics and processes; and evaluating the committee’s ongoing reporting framework for management, the board and plan members, as well as setting standing agenda items for future pension committee meetings.

As organizations continue to struggle with the legal, operational and financial risks of their pension obligations, pension committees are under increasing pressure to better anticipate and manage those risks. Following best practices will help committees to ensure good plan governance, mitigate potential risks and address these challenges proactively.

Ian Genno and Mark Campbell are principals working in the human capital group of Towers Perrin.
ian.genno@towersperrin.com
mark.campbell@towersperrin.com

> click here for a PDF version of this article

© Copyright 2009 Rogers Publishing Ltd. This article first appeared in the August 2009 edition of BENEFITS CANADA magazine.