DB Governance Case Studies
June 2019
Pensions governance is becoming increasingly vital both to clients, who recognise the value which a strong governance framework can provide, and to the Pensions Regulator, who wants schemes to demonstrate their focus on implementing a strong governance process.
bac was very proud to be named the 2018 FT PIPA Governance Adviser of the year, reflecting our strategic approach to governance shown by our work for BAE Systems, Honda, Saint-Gobain and Tesco. In this publication we look at the areas of governance we have been working in over the past year and the solutions we have helped our clients to implement.
Defined Benefit governance
For Defined Benefit (DB) schemes, the definition of governance has been far from precise. Different schemes have interpreted it in their own way, based on their priorities and resources. However, as schemes’ liabilities have matured and become legacy issues to be managed, governance has become the umbrella term for a broad range of risk management tools. And these tools have become a key focus of the Pensions Regulator.
Making IRM work
Integrated risk management (IRM) is increasingly embedded in DB scheme governance but, for many schemes, it is still a tick box process rather than an invaluable tool supporting the risk management of the scheme.
Several of our trustee boards have run highly effective “what if?” scenarios with the help of their IRM framework. Recent examples include:
- a cyber-attack on the sponsor’s IT infrastructure, resulting in the loss of large quantities of personal data with subsequent covenant implications
- a 2008-style credit crunch but with the liquidity crisis extending to personal debt, resulting in both macro-scale investment impacts and pressure on the cash flow of the sponsor
- a fraud perpetrated by an employee of the in-house investment team, leading to large financial losses.
In all cases, the discussion of the scenario led the trustees to strengthen their risk mitigations. One example saw the introduction of independent trustees to reduce the trustee board’s dependence on senior company trustees, who may become conflicted or simply too busy to fulfil their trustee duties in a crisis. In another case there was a fundamental review of the balance between in-house and outsourced resources.
In our experience the most effective IRM frameworks are those where the whole trustee board has a good understanding of how the framework works and what it is trying to achieve. Having a technically perfect framework with a wide spectrum of financial metrics is not much use if the trustees do not understand it well enough for it to lead to effective decision-making. Sometimes less is more.
It is important that the IRM is embedded into trustee meetings, so that it is familiar to the trustees and becomes second nature as a valuable risk management tool.
A large scheme wanted to revamp its approach to IRM to make it easier to use on a day-to-day basis by both trustees and sponsor. The trustees did not want a solution that was too driven by one adviser, but rather something that reflected a balanced view of all the key stakeholders.
bac was appointed to bring together the sponsor, trustees and their advisers to develop and agree a new IRM framework, which included:
- key financial metrics for measuring sponsor covenant and the inter-dependencies with scheme funding and investment
- triggers for when those metrics would result in action/further discussion between sponsor and trustees
- amending and updating the scheme’s risk register and business plans to align with the new IRM framework
- integrating the new IRM into the sponsor’s own corporate risk monitoring framework, so that group treasury could report to the sponsor’s board in an aligned way.
The framework took about six months to agree, at which point bac created an online monitoring and reporting tool which the trustees, sponsor and advisers could all access. The tool also has a training module, so that “what if?” scenarios can be run through the IRM framework in order to support trustee and sponsor training.
Whilst the tool is available at all times, it is used at each trustee meeting, with a much more in-depth session taking place twice a year.
Trustee and adviser effectiveness
An increasing area of focus is to assess the effectiveness of the trustee board in its decision-making and the value of the support provided by advisers in that decision-making process. Traditional tools such as questionnaires or annual interviews with individual trustees do not always provide the necessary evidence. Specific issues that clients have been grappling with include:
- too much reliance on a small subset of the trustee board due to knowledge and experience
- trustees who do not have sufficient understanding of technical aspects to be able to engage in and challenge decisions
- meetings not being well run and meeting papers being late or with the wrong level of detail
- advisers who do not provide the right level of support in meetings.
A number of our clients are now using online technology at the end of meetings to evaluate the trustees’ assessment of the decision-making that took place and a trustee’s personal understanding of the issues.
The quality of the advisory support, including papers prepared in advance, can also be rated. Trustees can provide their comments on an anonymous basis, if this will lead to more open feedback.
The output is available in real time and any significant issues can be discussed at the end of the meeting. Trends in this feedback over time can help identify which topics the trustees find most challenging and inform future training needs.
Business continuity
A very specific but important issue which has come to the fore over the last year is the testing of business continuity plans.
For Defined Benefit (DB) schemes, the definition of governance has been far from precise. Different schemes have interpreted it in their own way, based on their priorities and resources. However, as schemes’ liabilities have matured and become legacy issues to be managed, governance has become the umbrella term for a broad range of risk management tools. And these tools have become a key focus of the Pensions Regulator.
Managing advisers
Even the best adviser relationships can become stale over time. Our view is that changing your adviser is a measure of last resort and most issues can be solved by open and honest dialogue, provided the adviser is willing to listen and respond.
When advisers are first appointed, great care is taken to put in place the right shape of team, so that work can be delivered in the most efficient way possible. Time is also taken to discuss the client’s work needs in detail, i.e. type and detail of advice, frequency of reporting and style of materials, etc. However, over time, team members leave or become more senior and a client’s requirements change. The problem is that neither the client nor the adviser always spots this.
Often bac is brought in by the client because there is concern that the adviser is charging too much for work that does not feel best in class. The paradox is that the adviser in question is normally a leading firm in the industry, so what has gone wrong? Usually it is a combination of reasons – sometimes the client and adviser have not identified their changing circumstances, whilst on other occasions the client can be resistant to new approaches. Linked to the latter, advisers can become nervous of proposing changes if the client might view such suggestions in a negative way.
bac projects tend to start with a detailed review of how the scheme currently operates, how the interaction with advisers works and when/why those processes were put in place. When we start to discuss with the client what is currently not working, the reasons often link back to historic working practices not being appropriate to current circumstances.
Almost without exception, a client starts by telling us that their scheme is uniquely complex and the problem with reviewing their adviser is that it would be too risky to bring in someone new. We have two problems with this:
- it is almost never true – yes, the scheme may be hugely complex but top-end advisers can come up to speed very quickly
- if the incumbent adviser does not believe the relationship is at risk if they don’t deliver, it is unlikely the client will succeed in getting the very best from their adviser.
Of the three most complex schemes where we have led adviser reviews over the last two years, all three have moved to new advisers, in part because the adviser thought their position was secure and did not properly listen to the client’s concerns. And we can vouch for the fact that, in all three cases, the trustees and pensions team are very happy with the new level of advisory support.
bac was appointed by a trustee board because of the convergence of three issues with their scheme actuary team:
- increases in fees year-on-year
- “outdated” reporting and advice, when compared with other firms’ marketed offerings
- a recent investment de-risking opportunity having been missed.
The scheme actuary had been in situ for more than 10 years. The consistent message from the pensions director and the senior trustees was how well the relationship worked and how happy they were with the scheme actuary’s performance. However, on the odd occasion that the actuary did put forward possible changes to service, they were viewed with suspicion and push-back, so eventually the actuary gave up. Conversely, the actuary was not alive to the fact that the support team had changed in experience and the rate-card had increased over time so was no longer the right fit to provide the required work efficiently. This was compounded by a nervousness to propose team changes to the client.
We worked through the history with the client and, once they recognised that they had been a partial barrier to change, we were able to have a mutually open and constructive conversation with the scheme actuary. As a result, a combination of new ideas and service offerings was put forward by the actuary, in conjunction with a revamp of the actuarial team which included an additional senior consultant to provide fresh thinking. Two years later, the relationship is working well and annual fees remain materially lower than before the review.
However, adviser reviews do not always have such a happy outcome for the incumbent. We recently advised on a scheme with a strong lead consultant who was central to the client relationship. This lead consultant was very resistant to change. Despite increasingly frustrated feedback from the client, the adviser held their position and, in the end, lost their appointment.
Final thoughts
Improving your scheme’s governance needs to be done carefully, otherwise at best it will be ineffective and at worst it can actually be harmful. In our experience the following steps are necessary if you want to successfully implement change:
- make sure you are clear on the required resources and that these are put in place before you start
- ensure you have the buy in of all key stakeholders. Changes to governance cannot be forced on people, they need to understand the reasons for change and agree the new approach will help.
bac has developed a tool to help you triage your governance needs and quickly identify areas of weakness, so you can develop an action plan appropriate to your circumstances.Involving key stakeholders in this review process can quickly help build consensus on what needs to change. If you would like to find out more information about any of these case studies or how bac can help you improve your governance, please contact one of our senior team at governance@bathactuarial.com
