The risk-intelligent public pension trustee.

• Author: Funston, Rick

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Public pension plans have been through many changes. In the late 1990s, the average funded ratio of a public pension plan was approximately 103 percent, but in 2012, after the Great Recession, that number had dropped to 72 percent. (1) Funded ratios are a doubled-edged sword. When economic times were good, a number of plans increased benefits and took contribution holidays. When times are bad, pressures grow to reform the system. Two economic busts, a major recession, and a slow recovery, led to a surge of public pension reforms that continues today

According to the National Association of State Retirement Administrators, nearly every state has substantively changed its pension plan since 2009: Many of these modifications transferred investment risk from employers to employees. There have also been changes in investment policies and styles, shifts from sole fiduciaries to fiduciary boards, decreases in the legal limits imposed on permissible investments, increases in board authority, and other changes in plan design that have decreased benefits and increased contributions. At the same time, higher external management fees have triggered a growing interest in the feasibility of internal management.

As public pension systems grow increasingly complex, trustees face a number of serious challenges. Opinions are often starkly polarized across multiple stakeholders, including the trustees themselves. Many of these controversies and policy decisions have potentially huge effects on beneficiaries and stakeholders. While plan sponsors make benefit promises, plan trustees are charged with keeping those promises.

As a result, many trustees are looking for ways to better prepare their systems to cope with stress and change. These include strategies like defining the powers reserved for the board, continuously educating trustees, prudently delegating authority, increasing the efficiency and efficacy of decision making, building a capable workforce and infrastructure, and instituting periodic evaluations.

CLARIFY AUTHORITIES AND RESPONSIBILITIES

If a pension system is to make risk-intelligent decisions, its governance policies, structures, and decision-making processes need to keep pace with change. Make sure trustees are spending enough time on policy and not just operational issues. Make sure continuing board education is part of the organization's strategic policy agenda, and that risk is factored into every decision. When staff and consultants present policy issues and recommendations for consideration, board members need to review the risks of both action and inaction.

Exhibit 1 shows how strategic choices generally relate to governance, strategy, resource allocation, and oversight. Strategic choices include:

* Determining the strategic policy agenda, reserved board powers, authority delegated to staff, asset allocation, and risk tolerance.

* Defining the investment policy.

* Establishing investment beliefs and policies.

* Approving the strategic plan.

* Ensuring adequate resource allocation.

* Overseeing the implementation of the strategy.

* Obtaining independent confirmation of the reliability of reports from management.

POWERS RESERVED FOR THE BOARD

First, what are the key decisions and who will make them? Governance is about decision-making, setting directions, allocating resources, and overseeing the plan. There are currently four fundamental models of public pension governance in the...