The Prudence Standard and the Roles of the Plan Sponsor and Plan Administrator in Pension Plan Funding and Investment
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1 The Prudence Standard and the Roles of the Plan Sponsor and Plan Administrator in Pension Plan Funding and Investment A Response by the Bell Pensioners' Group to The CAPSA Consultation Paper 10 February 2010
2 The Bell Pensioners' Group (BPG) is pleased to comment on the Consultation paper The Prudence Standard and the Roles of the Plan Sponsor and Plan Administrator in Pension Plan Funding and Investment produced by the Canadian Association of Pension Supervisory Authorities (CAPSA). The BPG represents the interests of the approximately thirty thousand beneficiaries of Bell Canada's defined benefit pension plan. Our comments are offered in the context of defined benefit pension plans. Because pensioners' pensions are typically their single most important asset, the security of their pensions directly impacts the lifestyle that pensioners can enjoy in their retirement years. Pensioners have already lived their lives of employment. Consequently, any reduction in the pensions that have been promised to them necessarily results in a lessening of the lifestyle that they had every right to expect. For this reason, BPG has on a number of previous occasions made representations to federal and provincial governments on measures that should be employed to safeguard the security of the pension promise. In this submission, BPG assesses the Consultation paper in this same light, that is, in terms of the extent to which it puts forward measures that can be expected to strengthen the security of the pension promise. Though the Consultation paper ostensibly addresses only one aspect of pension plan administration, specifically the interpretation of the prudence standard, it is a very important determinant of pension security. The measures required to ensure sound governance practices are at the heart of the discussions found in the Consultation paper regarding the prudence standard. Adherence to strong and effective governance practices would be in the interests of pensioners, and in the interests of pension sponsors. The BPG concludes that the Consultation paper makes a valuable contribution to the security of the pension promise, and commends CAPSA for its thorough and thoughtful approach. In some instances, however, it is necessary to build on the framework found in the Consultation paper. These instances are discussed below, and recommendations for strengthening the framework are made. In almost all instances, the BPG recommendations are directed towards ensuring that the sound framework presented in the Consultation paper is actually put into practice by plan sponsors and administrators. Specifically, BPG recommends that the Pension Benefit Standards Regulations be amended to require that plan administrators and plan sponsors document the processes that they have put in place to effect the governance measures presented in the Consultation process; plan administrators and sponsors file this documentation with the pension regulator; the pension regulator review the documentation and assure itself that the processes can be expected to achieve the governance objectives contemplated in the Consultation paper; and the documentation of processes be made available to plan members, and their agents, upon request. Finally, BPG addresses the six questions posed in the Consultation paper. The responses to these questions flow from, and must be read in the context of, the points made in this submission.
3 The Role of Pension Stakeholders in Plan Governance Each of government legislators government pension regulator pension plan sponsor pension plan administrator, and pension plan members has a role to play in the governance of a pension plan. The BPG understands from the Consultation paper that CAPSA takes as an underlying premise that sound plan governance is a necessary element of a successful pension plan, and that the standard of prudence is a key component of plan governance. In this context, among the attributes of success would be the plan's ability to meet its pension obligations. The BPG strongly agrees. Government Legislators Government legislators are accountable for pension legislation which imposes the minimum obligations that a pension sponsor and pension administrator bear. Legislation also articulates that the pension plan must by managed in such a manner as to ensure that the pension plan is capable of meeting its obligations, even in the case that the plan sponsor should cease to operate. Legislation imposes, in broad terms, a duty on the plan sponsor and the plan administrator to exercise prudent behaviour in the execution of their responsibilities. For instance, the Consultation paper correctly observes that the Pension Benefits Standards Act, at sections 6, 7, and 8 imposes a standard of care whose detailed elements are not specified. In the case of federally regulated pension plans, Finance Canada is responsible for writing regulations enabled by the PBSA, and which inform plan sponsors and plan administrators of their obligations. Government Pension Regulator The pension regulator, an arm of the government, is responsible for administering the regulations and monitoring compliance with pension legislation. If the regulator deems that compliance is wanting on the part of some plan sponsors or administrators, then it is expected to take steps that would bring the actions of those parties into compliance. Regarding the issue of the standard of prudence, it is appropriate that the regulator provide clarity to pension plan sponsors, administrators, and plan members on this concept. Without clarity, compliance with legislation can be expected to be haphazard. The Consultation paper is thorough in its approach on this issue, in that it lays out the expectations of regulators in this regard, and discusses the processes that should be put into place to meet those expectations. In its discussion of the regulator's expectations, the Consultation paper describes processes that should be followed, that administrators are advised to adopt, or that are described as guidelines. This language is weak, and may well result in equally weak adherence to sound practices. If adherence to sound practices is weak, then plan governance can be expected to be weak as well. And weak governance risks achievement of the pension promise.
4 The Consultation paper makes a strong contribution to the security of the pension promise by detailing the processes that generally constitute best practices in regard to the standard of prudence. But this contribution is undermined if there is no requirement to put the processes into place. BPG recommends that best practices with regard to the meaning of the standard of prudence should be treated in the same way as best practices are treated in the realm of traffic regulations. Best traffic practice is to stop at a red light. That means when the driver is presented with a red light, he must stop. The red light is not a suggestion that stopping may be advisable, leaving open the option that the driver might take his chances in the intersection anyway. The risk to the driver, and others, is obvious. Perhaps less obvious, but certainly no less real, is the risk to the pension promise if the plan sponsor and administrator are free to ignore those practices that ensure the standard of prudence is met. It should be made clear in regulations that if a sponsor or administrator is not able to demonstrate that the processes discussed in the paper have been put into place, then they would be found by the pension regulator to be non-compliant with the legislation that imposes a duty of prudence. For instance, the statement each pension plan should have documented processes and standards to comply with plan documents and legislative requirements, such as the prudent person rule (page 6) should be understood as a requirement to institute and maintain documented processes and standards, and not as a suggestion to do so at the discretion of the plan administrator. In the exercise of its duties to ensure compliance with legislation, the regulator should require plan administrators and sponsors to document the governance processes on which they rely to manage their pension plans, and to review these processes to assure itself that they can be expected to effect sound governance of the plans. Indeed, pages 25 and 26 of the Consultation paper list the considerations that should be undertaken by a regulator in its examination and review of funding and investment processes. The regulator would not be in a position to conduct an effective examination in the absence of the documentation of the plan's governance processes. If the regulator is not given sufficient resources to monitor compliance with the standard of prudence requirements, then the regulatory framework would be undermined in as much as adherence to the sound principles which the framework encompasses would be left solely to the good will of the plan administrators and plan sponsors. Though this approach might prove satisfactory to some pension plans, others could be put in jeopardy. BPG strongly urges governments to make resources available to their pension regulators that would be sufficient to ensure compliance with requirements. For example, selective audits of governance processes by the regulator could allow it to gauge the general level of compliance, and give it insight into further steps that it may conclude are necessary. The duty to document processes and to make such documentation available to the regulator, and on a wider basis, is discussed in the following subsection regarding the roles of the plan sponsor and the plan administrator. If, notwithstanding the plea of plan members that plan sponsors and administrators should be required to follow best practices regarding the standard of prudence, regulations continue to fall short of imposing these requirements, then other steps will be necessary to assure those members that their interests are being protected in the plan governance processes. For example, representatives of plan members could be made part of the decision making process regarding investment strategy. As another example, the pension regulator could establish an office of the pension ombudsman who would be
5 empowered to address, and remedy as required, disputes between the plan sponsor/administrator and plan members arising from a perceived deficiency in plan governance. To be clear, BPG does not regard these alternative approaches as preferable to, or even equivalent to, a requirement that sponsors and administrators should follow the governance practices presented in the Consultation process. Plan Sponsor and Plan Administrator The responsibilities of the plan sponsor and the plan administrator are well described in the Consultation paper. In particular, the paper rightly points out that the plan sponsor owes a responsibility to the firm and to its pension plan members, but that the plan administrator must act solely in the best interests of the plan members. In the case of a single-employer pension plan where the sponsor is the administrator, it is very important to put into place, and document, administrative processes that would alleviate the potential that an administrator might face a conflict of interest. BPG supports Principles 3 through 11, which set out the framework for the role of the plan administrator, as useful tools to effectively manage the pension plan. The measures would be enhanced if the plan administrator were required to make the documentation available to the pension regulator at the time of the pension plan's valuation filing. These documents should also be made available, on request, to pension plan members or an agent operating on behalf of a pension plan member, as would appear to be contemplated in Principle 9. With respect to principle 6, the plan administrator should document the pertinent information to be accessed, and the time frame contemplated for such access. The pertinent information is likely to be particular to the specific investment vehicles utilized by the administrator, and should be updated at the same time as is the Investment Strategy. With regard to Principle 7 (Risk Management), the administrator should document the manner in which the investment strategy would change with any change in plan member demographics, and make the documentation available to plan members. For instance, a mature plan for which the proportion of plan members is increasingly of retired members would likely require a more conservative investment strategy than would a plan with a growing membership base. With respect to Principle 8, BPG agrees that the mechanisms should be put in place, and further suggests that the mechanisms be documented by the plan administrator, and made available to plan members. Principle 11 calls on the plan administrator to conduct regular reviews of its plan governance. This is a valuable exercise, and would be enhanced if the administrator were required to document the objectives against which the governance practices would be judged, the mechanisms used to ascertain the degree to which the objectives were being met, and the manner in which the governance practices would be changed to facilitate, going forward, achievement of the objectives. Under the discussion of the prudent person rule, the Consultation paper observes [s]ince the prudent person rule emphasizes processes, it places a premium on the governance structure, deliberate decision making and appropriate documentation. BPG endorses this approach, and believes that the suggestions noted above would enhance reasoned decision making and process documentation, and thereby would enhance governance. In the same vein, the discussion under Elements of Procedural Prudence is helpful, and there should be a requirement on the plan administrator to document the processes in place to effect each of these elements. For example,
6 how does the administrator assure itself that the appropriate skills are made available and that care is exercised in the use of these skills; what expertise is brought to bear in the decision making process; what methods are employed and how frequently to manage the risks of the pension plan; what are the mechanisms that would verify compliance with the code of conduct, and identify and manage conflicts of interest. The Consultation paper notes the advantages of establishing and documenting a funding policy, and identifies the elements that should be addressed in a funding policy. BPG agrees that the documentation of a funding policy, as described in the paper with the two exceptions noted immediately below, would protect the interests of pension plan members. (1) Under Actuarial Methods and Assumptions, the Consultation paper contemplates that the plan sponsor can provide guidance to the plan actuary in selecting actuarial assumptions and methods that are appropriate for the plan sponsor's risk management approach. However, it is the plan administrator, not the plan sponsor, that is responsible for seeing that the pension fund is capable of covering its liabilities. In this role, the administrator in its fiduciary responsibility to plan members can provide advice to the actuary of the sort discussed in this section. In this way, the administrator can meet its obligation to ensure an accurate picture of the plan's liabilities. If the plan sponsor is permitted to provide this advice, then there could be a conflict between the sponsor's business incentive to keep funding obligations as low as possible with the obligation to make sure that the plan fund can cover its liabilities. The discussion of actuarial methods and assumptions should be between the actuary and the plan administrator, not the plan sponsor. Of course, the plan sponsor must inform the plan administrator of its risk tolerance so that the plan administrator can fashion the plan's investment strategy with that risk tolerance in mind. The paper correctly points out that many plan sponsors value predictability of contribution requirements, and this may lead the plan administrator to adopt lower-risk investment vehicles. Though a higher-risk strategy may promise high returns and consequent low contribution requirements, it also risks poor investment performance and consequent high contribution requirements. The sponsor's tolerance for volatility has to be accommodated in the investment strategy. That is the mechanism that should be used to accommodate the plan sponsor's risk management approach, rather than a mechanism that would allow the sponsor to influence the actuarial valuation of the pension plan. (2) In the exercise of its duty to ensure an accurate measure of the plan's liabilities and assets at any time, it is the plan administrator, not the plan sponsor, that should be setting the frequency of valuations, subject to minimum requirements set by legislation and regulation. The Consultation paper provides many useful elements of an effective investment policy (pages 20 through 25). BPG agrees with the Consultation paper that the focus should be on process rather than on performance. However, a caveat to this general approach should be added. Sustained poor performance may well be an indication of inadequate governance processes, and may in themselves alert the regulator and plan members to the need for a closer look at the processes. The administrator should be required to document the processes that are designed to put into effect the steps suggested in the Consultation paper, and make that documentation of the processes available to the regulator, and on request to plan members. For example, the administrator should document how it determines whether the investment strategy is appropriate in light of, for example, the changing demographics of the pension plan members.
7 Pension Plan Members Pension plan members, as the current and future beneficiaries of the pension plan, have a very real and personal stake in the ability of the pension plan to meet its obligations. As noted above, if the pension plan falls short, that is, if the pension plan is wound-up when it is not fully funded, then it is the members of the pension plan who will feel the ultimate impact of this shortfall. In the past year, the media has reported numerous examples of pension plan failures. One common characteristic of these examples is that the plan members have found themselves in a position where they must rearrange their lives to fit within pension payments lower than those that were promised, and therefore expected. It is likely the case that pensioners today have a keener awareness of the fact that their pensions cannot be taken for granted. It is perhaps more broadly understood now, compared to past years, that as long as pension plans invest in other than risk-free investment vehicles, there is a risk to their pensions. This realization is positive in that it allows pensioners to make informed choices, and to hedge against this risk to the extent that opportunities are open to them. The extent of the risk can never be precisely known, but when pensioners are informed of the processes undertaken by the plan administrator and the plan sponsor to manage the pension plan, they can make their own assessments of the risks that they face. Further, if pensioners are unsatisfied with the measures that the plan sponsor and plan administrator employ to manage the risks that ultimately fall to the plan membership, then they can militate for process amendments that they feel would lessen the risks that they face. This dynamic would allow for more robust governance of the pension plan. It is for these reasons that the documentation pertaining to the processes of plan governance should be made available to pension plan members. Recognizing that not all pension plan members would wish to involve themselves in this process, it is reasonable that the plan sponsor and plan administrator be required to make the documentation available only upon request. BPG's responses to the Six Questions BPG's responses to the six questions flow from the discussion above. 1.What role should the plan administrator play regarding the funding policy? The plan administrator is responsible for making sure that the funding policy conforms to legislated minimum funding requirements. The plan administrator is responsible for providing accurate and timely reports of the pension fund's assets and liabilities. Consequently, it is the administrator not the sponsor who should work with the plan's actuary to evaluate the pension plan. The funding policy, working in concert with the investment strategy, has to be capable of generating assets sufficient to meet the plan's liabilities. The plan administrator has to be cognizant of the funding policy, set by the sponsor, so that the investment strategy is consistent with the funding policy. For instance, if the sponsor places a premium on predictability of funding obligations, then the investment policy should support that
8 preference with investment vehicles that do not collectively exhibit marked volatility. On the other hand, if the sponsor has a tolerance for unpredictable results, then the investment policy can be less conservative. The plan administrator must inform the plan sponsor of the pension plan contributions that must be made according to the actuarial valuation of the plan and legislative requirements. If those contributions are not made in a timely manner, then the administrator should take steps to ensure the sponsor is aware of its obligations, and to inform the pension regulator that the plan sponsor is remiss in its funding obligations. The administrator does not set the funding policy, and is not accountable for it. 2. Has this paper sufficiently set out the elements for the funding policy? If not, are there any additional elements that you would recommend? The processes in place for putting the funding policy into effect should be documented, and that documentation should be provided to the regulator and updated as it changes, and be made available to plan members on request. 3. What role should the plan sponsor play regarding the SIP&P? The sponsor should inform the administrator of its funding policy, and of its tolerance for volatility as discussed above. The plan administrator is responsible for ensuring that the investments must be made in such a way as to fulfill the plan's duties to its members. The plan administrator should be required to document the processes it designs to fulfill its governance obligations, and to provide that documentation to the pension regulator. It is the administrator not the sponsor who holds a duty exclusively to the membership of the plan. The sponsor, by contrast, is expected to act also in the interests of its shareholders/owners, which may conflict. 4. Under what circumstances should the plan administrator be encouraged to have an investment policy covered by more than one document? There should be an investment policy associated with a pension plan. The investment policy can, and likely should, have a number of elements associated with it, being mindful of the sponsor's funding policy and the demographics of the plan membership. The elements of the investment policy have been well described in the Consultation paper. The documented investment policy should be provided to the pension regulator, and be made available to plan members on request. Spreading the investment policy over more than one document would appear to be unnecessarily cumbersome, and may be the cause of confusion for those wishing to review the documented investment policy, such as the regulator and plan members. 5.Does this paper adequately address what additional elements could be incorporated into the SIP&P? The Consultation paper makes a strong contribution in this regard. 6. Are the items listed in the section Regulator Examinations and Review of Funding and Investment Processes sufficient? If not, what additional elements do you recommend?
9 The list is comprehensive, and the steps it outlines should allow the regulator to determine whether the governance processes are capable of protecting the interests of pensioners. It should be made clear in regulations that the language such as should, guideline, and expectation that appear in the Consultation paper are to be read as requirements. And the regulator should, in the course of its examinations, regard the prescriptions found in the paper as requirements on the plan sponsor and plan administrator. In other words, if the sponsor or administrator is found to be deficient in its processes, deficiency measured in terms of compliance with the prescriptions found in the Consultation paper, then they would be found to be noncompliant with the legislation that imposes a duty of prudence. Compliance will be enhanced if the sponsor and administrator are required as a matter of course to document the processes that are designed to ensure that the expectations laid out in this document are achieved. The documentation should be part of the annual filing process. Though the production of documentation may require a little more work initially and it is just a matter of documenting what is in place each subsequent filing would be much less resource intensive, since updates need only incorporate changes that have been initiated in the processes. This documentation should be made available on request to members.
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