Difficult times: is your trustee board rising to the challenge?

As the initial sense of being in suddenly challenging economic times is replaced by a deepening awareness of the longer term impact of the difficult conditions, Robin Bew, Editorial Director of the Economic Intelligence Unit, expressed the view at Mercer's 2009 Senior Leaders' Conference that there would be no meaningful recovery until 2010-11. 

Notwithstanding the difficulties presented by the external environment, pension scheme trustee boards and scheme sponsors also have their own internal challenges.  From our consulting conversations and client workshops we have found that, despite a general appreciation of and improvement in "base-level" or regulatory compliance-driven pension scheme governance, there are still some major challenges which many are still struggling to address. 

In this Governance Matters Special, we comment on some of these challenges and what trustee boards can do to respond to them.

Managing the relationship with the sponsor

Many trustee boards report a change in the relationship with the sponsor over the last few years, primarily as a result of the regulatory regime;.the difficult economic conditions add further challenges.  For many there is still some way to go in order to establish and maintain a formal and independently collaborative partnership. Whilst trustees and scheme sponsors will (and should) have different perspectives on pension scheme risk, establishing a framework for intelligent risk taking that joins up sponsor and trustee goals, addresses correlations and allocates responsibilities means that trustee boards and scheme sponsors will be best placed to seize the opportunities inherent in an economic recovery.

A strategic risk management framework

Three years on from the introduction of the statutory requirement for trustee boards to assess their internal controls, many trustee boards are finding that their risk registers have added much volume to the trustee paperwork but little value to decision-making.  A dynamic and strategic risk management framework should be the point of reference for all decision making and activity so that resources can be applied in proportion to the assessed level of risk.  

Management information and other assurances should be designed specifically to make the structure work and should enable swift responses in order to minimise exposure and maximise opportunities; in other words, it’s time to stop using the smoke alarm as the oven timer.  

And with most trustee boards placing a significant degree of reliance on the strength of the sponsor covenant for ultimate funding of benefits, in the current climate it is time to "think the unthinkable".  Scenario planning improves the confidence of trustee boards in dealing with uncertainties such as the impact of a worsening in the sponsor covenant, corporate activity or a further worsening of economic conditions.

Decision-making in a different world

Difficult times can call for some difficult trustee decisions.  Our experience shows that trustee boards are facing challenges such as understanding the impact of volatile market conditions on their investments and their liabilities, grappling with the question of how best to consult and engage with the sponsor and ensuring that their board and support structures are conducive to swift and accurate implementation.  And new and more complex decisions are emerging as the economic situation unravels, causing some trustee boards to return to the debate between taking a long-term view and being willing and able to take advantage of short-term opportunities. 

Two key elements will support trustees in making effective decisions: the first is a shared understanding of strategic priorities and the second is a robust decision-making framework. 

Effective trustee boards

Keith Ambachtsheer, Canadian academic and governance consultant spoke recently of the tension between considerations of representation (of members and the sponsor) and the skills and expertise needed for the job, when considering the composition of the trustee boards.  How can the appropriate mix of skills and expertise be determined and sourced and how can trustee training and development needs best be met?  Trustee boards are beginning to make good use of the flexibility inherent in the MNT regulations and are increasingly also setting out their requirements for employer nominations in order to ensure they have the optimal mix of skills and expertise around the trustee table.

Appointing an independent trustee often addresses some of these issues but if appointing an independent trustee it is vital to determine the skills and competencies required at the outset allowing an objective selection exercise to take place.

Evaluating trustee board performance

There is much talk in the press of the lack of supervision by corporate boards, particularly in relation to executive pay and excessive risk taking.  Lessons can be learned in the trustee board context.  Our most recent survey  showed that most trustee boards evaluate performance only informally, if at all, despite the renewed attention given to this subject by the recent consultation on the Myners' principles.  

An effective board is one which understands its strengths and opportunities for development and acts accordingly. But how can performance evaluation be carried out in order to drive through meaningful change when the job is largely voluntary? (of course trustees who are remunerated ought to have clearly defined role descriptions and performance criteria.) 

Evaluating performance in any event is a response to the simmering media interest in holding trustees to account in relation to the financial demands they are placing on sponsors in these difficult times.  However, there are the potential pitfalls to consider and manage before undertaking an evaluation.

Organisation structure

It is clear from our recent work that few, if any, pension schemes enjoy the luxury of specifically designed management structures.  Most live with structures and resources that have developed over time and in response to specific circumstances.  However at the same time, and in particular in response to the challenging economic conditions, there is a desire for closer scrutiny by both scheme sponsors and trustees of how schemes are run and explicit attention is being given to the pensions delivery model.  We are seeing a desire for increased agility in trustee decision-making in order to maximise opportunities and protect against increasingly complex risks. But to what extent are decisions constrained by implementation issues?  Perhaps it is time to adapt the pensions management structure to the needs of the trustees in order to drive through the implementation of decisions and to make the best of opportunities to protect value or to add value.

Cost-effective operation

The current economic climate has forced many organisations to look even more closely at their fixed cost base, often with a focus on the operating costs associated with the running of the scheme.  Pension functions should of course always ensure they operate efficiently, whilst maintaining a necessary level of quality. An aim to reduce operating costs is a legitimate one, and in many cases, a drive towards improved operational efficiency will not only deliver cost reductions but often improved working practices too.  Factors such as considering the outsourcing of costly or non-core functions or reviewing existing advisers and systems for suitability and value for money can form part of this process.  However, care should be taken; a focus solely on cost reduction without regard for quality of delivery can lead to unintended consequences and associated costs.

Cost benchmarking

Difficult times, difficult measures.  But how can trustee boards take such measures when many don't have a method for assessing overall scheme costs and making market place comparisons?  We are working with trustee boards to benchmark their costs in order that they can begin to make informed decisions on resources and budgeting as they no doubt turn their attention to ensuring they are receiving value for money in all areas of activity.

Personal liability

And finally "whose house is it anyway?".  Worsening sponsor covenants and falling markets tend to go hand in hand with increased nervousness about the personal liability involved in trusteeship.  What protection do trustees have against the risk of future claims brought by disgruntled beneficiaries?  Checking the protection available to them under the scheme's trust deed and rules is a good starting point.  If trustees are successfully sued who will pay up (consider both DB and DC members)?  And, if relying on an indemnity from the fund or employer how good is this now likely to be given the economic conditions?  Is it time to consider or review trustee indemnity insurance?

Conclusion

For some trustee boards the current economic conditions are highlighting shortfalls and tensions in their existing structures and relationships.  As with any organisation, for trustee boards, these challenging times can bring with them a licence to rethink the "business model" to ensure that it has the best chance of coping with the increased demands. 

Back to Robin Bew who asserts "the best ideas come in hard times."  Trustee boards need to respond to the challenges of both the difficult external environment and the key internal issues they face by squaring up to the opportunity for change; challenging times both require and allow different responses.

If you wish to explore any of the issues raised in the Governance Matters Special, please contact your usual Mercer consultant or if you would like to speak to one of our governance consultants, please contact Rachel Brougham or Rachel Croft.

Issued in the United Kingdom by Mercer Limited which is authorised and regulated by the Financial Services Authority. Registered in England No. 984275. Registered Office: 1 Tower Place West, Tower Place, London, EC3R 5BU.