An overhaul of trust-based pension schemes to separate trustee ‘directors’ from professional managers could have prevented a crisis in defined benefit pensions, a new report has claimed.
Fiduciary manager Cardano argued that directors of insurance companies would have been dismissed by shareholders if they had presided over a deterioration in solvency comparable to that seen with DB schemes.
A lack of accountability in the trustee model has hindered use of well-known derisking tools such as liability-driven investment despite adequate levels of trustee competence, the report added.
Once you’ve got a board which is fit for purpose, that board can then decide whether it wants to delegate and who it wants to delegate to
Alan Pickering, Bestrustees
However, fiduciary management has itself been in the spotlight in recent months, attracting criticism in the interim findings of the Financial Conduct Authority’s asset management market study.
Could better governance fix DB?
Stripping out deficit repair contributions from the Pension Protection Fund’s 7800 Index, Cardano identified a £400bn growth in UK aggregate funding deficit over the last decade.
“In the insurance industry, which is more or less paying pensions [...] they would never allow these massive deficits happening because then the insurance company would become insolvent,” said Stefan Lundbergh, head of innovation for Cardano in the Netherlands.
He said the main difference between the insurance sector and trust-based schemes is the governance structure, which has clouded accountability for the scheme's investment outcomes, and has limited uptake of tools such as LDI.
Under the current system, argued Lundbergh, financial officers at the sponsor are unlikely to admit that pressuring trustees to take risk may have widened the deficit. As long as trustees can demonstrate that they have taken expert advice, they are likely to feel justified in their actions.
“If you’ve followed the process and you’ve taken expert advice then you’re off the hook,” he said. “By changing focus on [to] the financial outcomes and saying you’re accountable I think a lot of things can actually change for the better.”
Industry needs shift towards outcomes
Industry figures said an increased focus on outcomes and better governance would be welcome, but disagreed with Cardano’s proposed solution, which would see non-executive trustees appointing fiduciary or internal managers.
“Their argument is simplistic because it sort of points the finger at the employer and the trustee,” said Richard Butcher, managing director at PTL, who was appointed the next chair of the Pensions and Lifetime Savings Association last week.
He said that regulators and legislators were also “too focused on input and process, and not enough on output”.
Butcher said that fiduciary managers were one of the most expensive of a range of tools for making timely investment decisions, and that trustees should be careful to understand what product they are buying before proceeding.
A shift to corporate-style governance would not necessarily solve problems with DB, he argued, as the short tenures of corporate directors could inhibit the long-term strategy so lauded by the pensions industry.
Others argued that constructive dialogue between trustees and sponsors is vital, rather than a framework in which each seeks to secure their own interests.
I don’t accept that the trustee model is bust,” said Alan Pickering, chairman of Bestrustees. “If I want to do something with the employer’s money that the employer finds anathema, he’s going to give me less money.”
Tackle lack of diversity first
While greater delegation might indeed improve pension scheme outcomes, Pickering argued that addressing issues such as groupthink should be prioritised.
“Once you’ve got a board which is fit for purpose, that board can then decide whether it wants to delegate and who it wants to delegate to,” he said.
An Aon Hewitt report into trustee diversity, led by Dr Iain Clacher, associate professor in accounting and finance at Leeds University Business School, found earlier this year that the average trustee is male, 54 years of age, and has a university degree.
Clacher said this made boards susceptible to groupthink, but pointed out that the presence of lay or member-nominated trustees can help disrupt this homogeneity.
“Their voice counts because it’s their pension, and some sort of employee representation is important,” he said. “It’s about getting that mix of backgrounds and perspective.”
Clacher suggested that it was unreasonable to argue that one sole factor could be responsible for the woes of today’s DB employers. While better governance should continue to be a trustee goal, he said that issues such as valuation techniques also merited industry scrutiny.
“I don’t know how much governance gets you to the right outcome,” he said, noting that corporate governance structures had failed to prevent major mismanagement scandals in the past.
