The Duties and Responsibilities of Pension Fund Trustees. by Mr. Collin Hendriks, QED Actuaries and Consultants (Pty) Ltd.

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1 The Duties and Responsibilities of Pension Fund Trustees by Mr. Collin Hendriks, QED Actuaries and Consultants (Pty) Ltd., South Africa Overview of the Paper The paper introduces the various types of trustee currently involved with pension funds and looks at the roles that these trustees should play in the pension fund. The paper then looks at the trustees duties, responsibilities and powers and advises how trustees should act and be seen to act in various scenarios. In particular the need for a trustee to act impartially, carefully, reasonably and to act at all times in the interest of the pension fund is looked at in detail. Next the paper looks at the duty of the trustee to seek professional advice. In particular the paper looks at the different types of service and product providers a pension fund may make use of and what the trustees should expect from their service providers. The final part of the paper looks at the important issue of conflicts of interests arising in a service provider s relationship with a pension fund. We discuss why this should be of concern to trustees and give some recommendations as to how trustees can avoid or manage such conflicts of interest. Types of Trustees In most countries, pension funds are set up as trusts that are governed by a board of trustees. The responsibilities of trustees have increased tremendously over the past few years due largely to: the advent of defined contribution funds where investment returns and expenses directly impact on members benefits; the impact of accounting regulations for pension funds where the financial position of the pension fund has a direct and immediate impact on the employer s financial statements; and the advent of consumerism and the shift away from the one job for life scenario. Pension fund stakeholders (members, pensioners and the employer) are holding trustees more accountable for the financial management and the level of benefits and services of their pension fund. Historically, in the defined benefit pension fund environment it was common for the employer to appoint the trustees as the employer was financially responsible for the fund. This has evolved significantly in recent years as the nature of pension funds and legislation has changed. Many countries have introduced legislation to ensure that pension funds have a certain number of the trustees who are elected or nominated by the members. Further, with

2 many defined benefit pension funds converting to defined contribution funds and the financial risks shifting from employers to the members, it was logical that members should be represented by their own trustees (even without legislation requiring this). Many pension funds have also introduced the concept of a pensioner trustee. Often the interests of pensioners may not necessarily coincide with those of active members and therefore it makes sense to give both parties representation. A pensioner trustee could be elected by the pensioners, appointed by the employer or appointed via some other mechanism. Trustees are under increasing pressure to deliver benefits and services and to manage the fund s finances professionally. Most trustees are however only trustees on a parttime basis while they have a full time job elsewhere. Most trustees are also often not experts on pension fund matters. Some pension funds have sought to address these issues using the services of a professional trustee. A professional trustee should be someone with sufficient relevant pension fund experience but there is no formal qualification for such a position. While a professional trustee can certainly add value to a board of trustees I would caution that this does not absolve the other trustees of their duties and responsibilities. Ideally a professional trustee should share his knowledge with the remaining trustees and then be replaced after a period of time (two years say). All trustees must remember that irrespective of whether they are an employer, member, pensioner or professional trustee or whether they were appointed or elected, when acting as a trustee of a pension fund one must act first and foremost as a trustee i.e. a trustee must firstly act in the interest of the fund Duties, Powers and Responsibilities of Trustees Trustees will have duties, powers and responsibilities which can be defined as follows: Duty A task a person is bound to perform for moral or legal reasons Power The authority of do something Responsibility A thing for which a person is accountable. Duties and responsibilities of a trustee The main duties of a trustee can be summarized as follows: To act with reasonable care and in good faith. A trustee should take greater care in dealing with the fund s monies than he would with his own monies. With hindsight it is evident that trustees can and do make wrong decisions. However as long as the trustees ensure that they have all the facts and consider all the facts in making the initial decision, they would not subsequently be guilty of dereliction of their duty. To act in accordance with the pension fund s trust deed and rules and to act within the legislative framework (pension fund, labour laws, tax, constitution etc). My experience is that many trustees neglect the administrative requirements of a fund (e.g. regular trustee meetings, decisions taken and ratified by a quorum of trustees, accurate minute keeping and signing of approved minutes, submission of statutory documents etc.).

3 To act impartially in dealing with the fund s various stakeholders. This is particularly important where the trustees are elected by the various stakeholders. To act jointly. A trustee decision made in terms of the fund s trust deed and rules is a decision of all the trustees. A disagreeing trustee is free to record his views on the decision in the trustee meeting minutes, but he is bound by the decision. To disclose anything that may lead to any discretionary powers being exercised unfairly or being seen to be exercised unfairly. For example, at a given time a trustee may be conflicted in appointing a certain service provider, investing in a specific company or property, may be related to a particular beneficiary etc. I recommend that pension funds require their trustees to disclose such conflicts when they arise and that the remaining trustees be empowered to decide whether the conflict should preclude the particular trustee from taking any part in the related decision To ensure that proper records of the trustees decisions are kept (e.g. minutes). This would also include accounting and administrative records. Not to profit at the expense of the fund. To ensure the pension fund is managed in a financially sound manner. This would include investing the assets in an appropriate manner, ensuring contributions are adequate to cover the cost of benefits, awarding discretionary benefits (e.g. pension increases) within the financial means of the fund etc. Powers of a trustee Trustees may have any of the following powers depending on the funds rules and legislation: To act by majority or as specified in the fund trust deed and rules in making decisions. To appoint or remove a trustee, chairman of the trustees or any other statutory person responsible for the management of the fund. To invest the fund s monies. To augment benefits. To insure benefits. To appoint service providers and advisors. To borrow monies. To amend the trust deed and rules. Trustee liability In most countries, a trustee who fails to carry out their duties can be sued in his personal capacity. In the extreme, a trustee can lose all of their personal assets.

4 Risk management It is evident that trustees have a very onerous responsibility. Given the increasing trend of consumerism and the resulting litigation, trustees must ensure that they do not expose themselves to undue legal risks from a failure to carry out their duties. The following actions can (and should) be taken by trustees in order to minimize this litigation risk: Always act in accordance with the fund s trust deed and rules and any prevailing legislation. Obtain expert advice where necessary (e.g. actuaries, professional trustees etc.). This not only protects the trustees but is also often in the long term best interests of the fund s stakeholders. Act carefully and reasonably and keep records of the decision making process. The trustees should look at obtaining a suitable level of fidelity insurance. Recognise, disclose and manage any conflict of interest situations. Service and Product Providers The majority of trustees do not have the time to actively manage the pension fund on a day-to-day basis and most trustees also lack the necessary skills in managing certain aspects of a pension fund. Trustees may therefore make use of service and product providers to take care of most of the day-to-day running of the pension fund. In assessing a service provider, the trustees must always bear in mind that while they can delegate certain tasks to service providers, they cannot delegate their responsibilities. Trustees should therefore ensure that: Service providers are always acting in the best interests of the pension fund i.e. the service providers and the trustees objectives are the same. The trustees must trust the service providers they have appointed. The fund has a legally binding service level agreement with each service provider, setting out the requirements of the service provider and the fund, the fees payables and any other issues the trustees want to specify. I have set out below the various service providers a fund may want to make use of, what the trustees should expect from them and other issues the trustees need to be aware of. The service providers we look at are administrators, investment managers, risk insurers, auditors, actuaries, lawyers and consultants. Administrators All pension funds need to be administered. Trustees will generally appoint a third party to administer the fund, but larger funds can set up their own internal administration company. In both cases the considerations of the trustees in dealing with the fund s administrator must be identical.

5 The administrator s main functions in respect of a pension fund are: To ensure that contributions are received and benefits are paid in terms of a pension fund s rules and is done so timeously. To ensure that all accounts required by legislation or in terms of a fund s rules are properly maintained (e.g. a revenue account, balance sheet, member accounts in a defined contribution fund, investment accounts etc). To ensure that the fund always has enough cash on hand to pay benefits and expenses and to pay any excess cash to the fund s investment managers timeously. To maintain accurate and reliable member and pensioner data records. To pay any premiums in terms of insurance policies that the fund s trustees may have entered into and to handle any claims with the relevant insurers. To obtain sufficient insurance cover for itself in the event that any of its staffs negligent or criminal actions result in a loss to a pension fund. To perform any other services agreed to in a service level agreement with a pension fund (e.g. secretarial services, providing meeting venues etc). To provide the trustees with regular management report that addresses the above issues. I recommend that management reports are compiled at least half yearly (preferably quarterly) and coincide with a fund s financial year end. In particular a management report should: Cover the period from the previous management report up to the most recent date available (the report period) Contain a statement of all cash inflows and outflows (preferably a trial balance). In particular, the amount of contributions paid and the date that they were paid should be noted. Contain a statement of the fund investments including its bank account balance. Contain a list of all outstanding claims (death, withdrawal, retirement etc.) It is often a difficult and time consuming process to change an administrator. The trustees should therefore thoroughly do their homework before appointing an administrator. In particular, the trustees should look at: The people and systems employed by the administrator. In particular does the administrator have sufficient resources should a few key people resign? Also it is important to establish whether the administrator owns its administration software and if not what the licensing conditions are. References from existing clients of the administrator as well as any feedback from clients who recently terminated the administrator s services. The geographic location of the administrator relative to the location of the fund s members. Fees are important as administration is an easily measurable service and hence any higher fee must be justifiable in terms of improved service. A recent trend is for

6 administrators to charge a lower monthly data storage fee plus a fee per transaction (e.g. claim payment) as opposed to a higher all inclusive fee. This means that funds with less transactions pay less. Investment managers Investment managers are responsible for investing that portion of the pension fund s monies that are not required to pay immediate benefits. The investment manager s main task is to invest a fund s monies, to the best of their ability and in accordance the fund s investment mandate. In particular an investment manager must: Invest in line with the agreed investment guidelines that are either explicitly set by the trustees or implicitly set by the trustees buying into a particular investment portfolio. An example of an explicit investment guideline is where a fund has appointed a specialist investment manager who the trustees mandate to only invest in shares. An example of an implicit mandate is where a fund s trustees elect to invest in an investment manager s balanced fund. Invest in accordance with any legislation. Give accurate regular feedback (preferably at least quarterly) to the trustees on the fund s investment performance. Not take unreasonable risks in their investment decisions. Invest monies timeously and in the correct portfolios. In appointing an investment manager the trustees should consider the following: Past investment performance may give some indication of investment expertise but it is often not a reliable guide to future investment performance. The trustees must understand and be comfortable with the investment manager s investment process. This is important as the trustees are likely to be asked this question by one or all of the fund s stakeholders. Does the investment manager have strict investment control processes i.e. would the investment manager pick up any incorrect investment transactions by its staff? The resources available to the investment manager. Generally, the more resources the investment manager has (i.e. the less dependant it is on one individual), the better. Also, it is important to look at the qualifications the key investment decision makers have within an investment manager. The fees charged by the investment manager. Where possible we would encourage trustees to try and negotiate performance related fees. This helps align the investment manager s interests directly with those of the trustees as better performance means higher fees for the investment manager. The manager must be suitable for the investment mandate. For example only investment managers who have expertise in property investments should be considered for a property only investment mandate.

7 Risk insurers Most pension funds would insure some of their benefits. Typical examples would include death-in-service benefits, funeral benefits and disability benefits. This will be done by means of a policy with a risk insurer. Death and disability insurance is usually provided to a fund by an insurer using a one year renewable term policy. This means that the benefits and premiums are only guaranteed for one year. When the year ends, the policy can be renewed but premiums and benefits may be revised. Trustees must ensure they are getting the best value for money from their risk insurers and should insist that the fund s administrator / consultant shops around the insurance market each year when a policy comes up for renewal for the most competitive premiums. In addition, where disability benefits are concerned, insurers may have different definitions of what constitutes disablement and the trustees need to be sure they understand these definitions. Besides price and definitions of disability, other important things to look at are free cover limits (the amount of cover below which the insurer will not underwrite a member) and good administration and service. Another area where the trustees may want to make use of insurance is in the case of pensions. By purchasing annuities from an insurer, the mortality and investment risk faced by a pension fund is transferred to an insurer. Once again, the trustees must shop around to ensure that they get the best value for money. Auditors Pension funds are usually required by legislation to carry out an annual audit. The auditor will verify the accounts drafted by the administrator on behalf of the trustees. The trustees must clearly appoint a recognized auditing company to perform the audit. In my experience, some auditors have greater pension fund auditing experience and trustees can benefit greatly in terms of advice and audit quality by appointing such auditors. Actuaries In terms of legislation, most pension funds require the services of an actuary. Actuaries have unique skills in combining statistics, probability theory, financial economics and generally common sense in order to solve complex financial problems often related to events that will only occur many years from now. In a pension fund these problems might be: What is the value of a pension of 200 per month currently worth? What is the cost of increasing the retirement benefit accrual rate from 2.0% to 2.5%? At what rate must the employer contribute to the pension fund to cover the cost of future benefits? The main job of the actuary is to determine the financial soundness of the fund and to make recommendations regarding the future financing of the fund. Actuaries are also involved in:

8 Certifying the financial soundness of rules and rule amendments. Making recommendations regarding discretionary benefit increases (e.g. pension increases). Determining transfer values and individual reserve values in cases where members leave or enter a pension fund. Determining values in a conversion from a defined benefit fund to a defined contribution fund Providing the fund with any actuarial factors required in terms of the rules (e.g. commutation factors). In appointing an actuary, the trustees must ensure that the actuary has suitable pension fund experience and that the actuarial company has sufficient actuarial resources to meet the clients demands. Lawyers Most pension funds will require the service of a lawyer from time to time. As with auditors and actuaries, the trustees should ensure that the lawyer has relevant pension fund experience. Consultants Most pension funds use consultants. Consultants are also called account managers, client managers, fund managers etc. We define a consultant as anyone who provides advice to the trustees and who is not one of the parties set out in this above. Consultants typically advise the trustees in any of the following: Investments and investment performance monitoring Risk benefits and rebroking of these benefits Disposal of death benefits Benefits structures New products The trustees need to be particularly careful in appointing consultants as there is no professional qualification required in order to be a consultant (unlike a lawyer, actuary or auditor). Trustees should check what, if any, professional qualifications the consultant has and how much experience they have with pension funds. Service level agreements A pension fund should have a service level agreement with each of its service providers. This service level agreement should specify amongst others: The date and term of the appointment. The services to be provided and the turnaround times. The fee payable to the service provider and a requirement for the service provider to disclose any fees earned that are indirectly related to the fund (e.g. commissions).

9 The need main confidentiality of the fund s information. That the service provider must notify the trustees of any conflicts or potential conflicts of interest (this is covered in more detail later). That the agreement can be terminated by the trustees should any of its conditions be violated. That the service provider has sufficient fidelity and professional indemnity insurance cover. Conflicts of interest Conflicts of interest regularly occur in respect of a service provider s relationship with a pension fund. A conflict of interest occurs where a particular course of action that is beneficial to a service provider is not in the best interest of the pension fund. This is of great concern as trustees are required to act in the best interests of the fund and this requirement is in no way diminished by the appointment of service providers. In fact it is the responsibility of the trustees to ensure that the service providers act in the best interests of the fund. In a pension fund conflicts of interest generally arise in two ways: 1. Where the people advising the trustees (actuaries, auditors, lawyers and consultants) are also product providers (administrators, investment managers and risk insurers). Examples: 1.1. A pension fund has its services (administration, risk insurance, consulting and investments) with a single insurance company. The consultant is approached to rebroke the risk benefits and to recommend an investment manager. Given that the consultant works for the insurer currently providing these services a conflict of interest exists The actuary and administrator work for the same company. The actuary discovers a financially significant administration error as part of the actuarial valuation which if brought to the attention of the trustees may jeopardize the company s administration appointment The trustees decide to appoint a new investment manager. The fund s investment consultant works for a company that provides investment management services so a conflict of interest immediately exists. 2. Where the people advising the trustees (actuaries, auditors, lawyers and consultants) earn different fees depending on the advice given. Examples: 2.1. A particular investment manager is known to give extra incentives (e.g. overseas trips or enhanced commissions) to those investment consultants / actuaries / consultants who place significant business with it The consultant is advising the trustees on whether to insure their pensioner liability or not for which he gets paid a consulting fee. If the pensioner

10 liability is insured, he will receive commission from the insurer in addition to his consulting fee. A conflict of interest exists in that the consultant can make more money if the fund insures the pensioner liability (even if this is not the best course of action to take). Managing conflicts of interest Conflicts of interest are problematic for pension fund trustees but unfortunately they exist. Conflicts of interest therefore need to be removed or at worst appropriately managed. Trustees can deal with this issue as follows: All advisors and service providers must be compelled via their service level agreements to disclose any conflicts or potential conflicts of interest. The trustees avoid conflicts or potential conflicts of interest by ensuring that their advisors are independent of each other i.e. your auditor, actuary, consultant and lawyer are from different companies. The trustees avoid conflicts or potential conflicts of interest by ensuring that your advisors are not service providers as well e.g. your actuary does not work for a company that does risk insurance. This may not always be possible so the trustees should then seek independent advice on those issues where a conflict of interest exists. All advisors and service providers must be compelled via the service level agreement to disclose any additional fees or commissions resulting from their advice or actions concerning the fund and the trustees have the power to decide whether that fee should be paid to the fund instead. Conclusion A trustee of a pension fund has considerable duties and responsibilities. It is imperative that trustees are made aware of these duties and responsibilities and that they then act accordingly. A useful guide to dealing with most situations a trustee may face is to: Act within the fund s rules and any legislation. Ensure that they have all the facts. Obtain expert advice where necessary. Disclose any conflicts of interest or potential conflicts of interest to the other trustees. Apply their minds Take and record the decision in accordance with the fund s rules. Trustees may make use of external service providers. Great care should be taken in ensuring that the service providers act in the best interests of the fund as appointing a service provider does not remove any responsibility from the trustees. In my experience a pro-active, well informed board of trustees is vital in ensuring that all the pension fund s stakeholders have their expectations of the fund met.

11 Understanding their duties and responsibilities is the first step the trustees can take in meeting this goal. About the author Colin Hendriks is a qualified actuary with 8 years of experience in dealing with pension funds including some of the largest public and private sector funds in Africa. Colin is currently a director at QED Actuaries and Consultants and this paper is based on QED s trustee training manual. Colin can be contacted at colinh@qedact.co.za