Pension Plan Governance
Good governance is important to public retirement systems because it enables improved performance and management of risk across a system's administrative, investment, operational and member service functions.
NCPERS Guide to Pension Governance & Oversight Best Practices, developed in collaboration with Segal Marco Advisors, provides an overview of governance and risk management practices for pension funds to consider. The guide also features a model risk management framework.
You'll find recommendations in key areas including:
Governance manuals
Board practices & policies
Risk oversight & strategic planning
Key performance & risk measures
Stakeholder communications
Why is good governance important for public retirement systems?
Good governance is important to public retirement systems because it enables improved performance and management of risk across a system's administrative, investment, operational and member service functions. Research has found that effective governance may improve long-term investment returns by 1% or more annually.
Beyond investments, best practices such as board self-evaluations, fiduciary training, and risk assessments drive performance across strategic oversight, administrative, member service and compliance functions.
In addition, retirement systems today face emerging risks, including new risks embedded in alternative investments, operational risks, cybersecurity risk, not to mention reputational risk. Management of these risks requires a comprehensive framework for reducing the probability and severity of loss comprised of policies, risk assessments and key measures, all of which are tools under a well-organized governance and risk management framework.
What are the basic definitions of governance and risk?
Governance and risk are abstract, so it's important to define them first. Governance may be defined as the structures and relationships that drive organizational performance and the system by which organizations are directed and managed. Corporate governance, as distinct from fund governance, is externally focused on public companies, while fund governance is internal.
Risk may be defined as the chance of something happening that will impact an organization's ability to achieve its objectives. By breaking risk into distinct categories - operational, market, credit and asset/liability risk, a fund can more effectively measure and manage risk toward the end of reducing the probability and severity of losses. A board's tolerance for each risk type is typically included in key governance documents such as the investment policy, which sets thresholds for acceptable market risk (among other things).
Reputation risk is the risk that an organization's brand will be diminished. As evidenced by past pay-to-play scandals, compliance failures (a type of operational risk) are the leading cause of reputation risk. All things being equal, a strong reputation will help a fund gain support from stakeholders to address funding challenges and protect benefits.
What are some of the best governance practices for public retirement systems to consider?
NCPERS Best Governance Practices are comprised of recommendations in seven areas including governance manuals, board practices, board policies, risk oversight, strategic planning, key performance and risk measures, and stakeholder communications.
- Governance manual: Whether it is in electronic or paper form, a fund should adopt a governance manual that serves as a central repository for the fund's primary governance documents. A well-designed governance manual facilitates effective management and provides a tool to educate trustees and stakeholders on fund operations.
- Board practices: A retirement system should establish, document, and adhere to a set of practices that have a proven impact on performance and risk oversight. Some of these practices are mandatory (e.g. actuarial valuations), while others may be optional. Key practices include development of a strategic (multi-year) plan, board evaluations, adoption of a fiduciary education program, actuarial valuations, asset-liability modeling (ALM) studies, establishment of a program of audits and assessments, and adoption of a corporate governance and proxy voting approach.
- Board policies: A fund should adopt and adhere to a set of policies designed to guide system operations toward the achievement of stated goals within established risk tolerances. While their form may vary, a board's key policies and procedures should include: standards of conduct for fiduciaries, a communications policy, an investment policy, procurement guidelines, a privacy policy, whistleblower policy, and a risk management policy or equivalent.
- Risk oversight: A fund should adopt a risk management framework and document it in a risk policy or within other policy documents (e.g. investment policy, privacy policy). The board should delegate accountability for management of market, credit, operational, asset / liability, liquidity and other risks through job descriptions, contracts, and charters.
- Strategic planning: A fund should adopt a strategic planning approach either in the form of a multi-year plan or within other documents. Strategic planning is a hallmark of successful organizations. It provides the board with a mechanism to map out long-term goals along with the implementation steps necessary to achieve them.
- Key performance and risk measures: Reports to the board should include a set of key performance and risk measures to help the board assess the fund's progress toward goals across actuarial, administrative, audit, compliance, and investment functions. Given their expansive duties, boards rely on efficient reporting to enable effective oversight.
- Stakeholder communications: A fund should communicate regularly with members and other stakeholders through multiple media including website notifications, publications, letters, and required reports. Communications provide transparency into fund operations and may increase member satisfaction, while strengthening the fund's reputation.
Typically, what does a pension fund's governance structure look like?
A pension fund's governance structure is typically comprised of its board, executive management, functional staff, and contracted service providers. Within this structure and under the fund's statutory framework, the board sets strategy, approves implementation plans and oversees performance, risk, and cost-effectiveness.
The board delegates specialized functions such as actuarial studies, asset management, asset liability modeling, benefits administration and auditing to internal staff and contracted service providers.
The fund functions within a framework that is comprised of statutes, rulings, agreements, policies, and contracts that regulate system operations. Risk oversight is a key responsibility of the board. In the post-financial crisis environment, managing reputation risk is an increasingly important responsibility for public funds.
What should pension funds keep in mind when developing (or updating) a governance policy or other policy?
When updating an investment policy, risk management policy, governance policy or any equivalent document, pension funds should bear in mind any changes that have occurred in accountabilities under the governance structure (e.g. have any roles or responsibilities been added?), changes in the legal and or regulatory environment that governs plan operations (e.g. new statutes), changes in risk exposures and any new goals (e.g. earnings assumption), guidelines (e.g. asset allocation targets) or risk thresholds the board has approved.
Funds should also avoid common pitfalls in developing policies that may include, for example, documenting unrealistic, aspirational goals in a policy (this can create more risk) or developing overly complex policies that staff members and service providers who are responsible for adherence may find difficult understand. In updating a policy, the pension fund, with the assistance of fund counsel, may review whether narrative may be improved in form to avoid excessive content, which can discourage plan professionals from understanding it. Finally, in updating a policy, it is important to ensure that guidelines are not overly rigid to the point of taking discretion from experts who are compensated to exercise it.
What is the difference between corporate governance and public retirement system governance?
Corporate governance differs from retirement system governance in that it refers to the structures and relationships that drive the performance of publicly traded companies. In the corporate world, the board of directors who are elected by shareholders, including public pension funds, is the foremost governance structure. While public pension funds seek to influence the quality of corporate governance through proxy voting and shareholder engagement, corporate governance is external to the retirement system.
Public retirement system governance refers to the structures and relationships that drive public fund performance, so it is internally focused. The foremost governance structure of a public retirement system is typically the board of trustees. This is one reason that board practices and policies are key components of NCPERS Best Governance Practices.
NCPERS extends a sincere thank you to Julian Regan of Segal Marco Advisors for his contributions to the guide, last updated February 2024.