The opdu Report - Issue 14, May 2003

Bulletin Board
Risk Management for Trustees
Brian Holden MBE

In Issue 13 of the opdu Report (November 2002), I expressed a hope that, in the context of occupational pensions, the Government's proposals would enable us to look at trusteeship as a united whole, and not in the piecemeal approach adopted by Myners and Pickering. Why did I make this comment? Because in an increasingly risk focused environment, radical changes are needed to reform the overcomplicated regime that currently provides a straightjacket for employers and trustees. If employers are given more flexibility in how they run their schemes, members should be able to rely on trustees to protect their interests and strike a fair balance between the interests of different groups of beneficiaries.

The pensions Green Paper Simplicity, security and choice: Working and saving for retirement published in December 2002 highlights many of the issues to be addressed in bridging the pensions gap and removing the barriers to adequate saving for retirement. The Green Paper spans many areas of private pension provision in the UK and seeks to consider a series of measures to make it easier for employers to set up and run good pension schemes by reducing the complexities in pensions legislation and regulation. Unless effectively managed, however, greater simplicity for employers can result in more complexity for trustees.

But the Green Paper makes remarkably few references to trustees, yet public policy demands high standards of pension scheme management. Also, present Government policy supports the trustee structure of governance and requires some trustees to come from the scheme's membership. This could require the appointment of more 'lay' trustees (the general description given to all those trustees - from the sponsoring employer and scheme membership - who are not paid professional trustees) but individuals could be deterred unless a structured and workable system of guidance and support is identified. It is essential to ensure that no further disincentives are introduced into
what has become an increasingly difficult environment for pension schemes to flourish.

I have always promulgated the need for comprehensive education and guidance for pension scheme trustees. I believe that this is a far more constructive route for the Government to take, rather than increasing the burdens on trustees. These burdens are already onerous enough.

The reviews that preceded the Green Paper made differing, yet challenging, references to trustees. For example:

"Trustees are at the heart of the system. Our legal structures put them firmly centre-stage" (Myners)

"Guidance should be made available to the trustees of insured pension schemes" (Sandler)

"Making the office of trustee more attractive to a wider range of good quality people is in the interests of good governance and member security" (Pickering)

"Trustees are the initial defence in the sound operation of occupational pension schemes" (National Audit Office report on Opra)

The report by the National Audit Office "Opra: Tackling the risks to pension scheme members" (November 2002) drew attention to the governance-related risks to pension scheme members and identified the necessity for a regulator to identify the pension scheme risks which should receive priority.
The Report of the Quinquennial Review of Opra (December 2002) continued this issue and recommended that a new kind of regulator should focus on the key risks to pension scheme members - and be seen to be doing so.

Public references to a possible downsizing of the pensions (fund investment management) industry at a time when pension schemes need most help will also impact on the role of the trustees. However, within the pension scheme infrastructure, the trustees have the primary responsibility for safeguarding the interests of pension scheme members. The trustees are legally responsible for the sound operation of the pension scheme. In some situations the regulator may rely on the judgement of the trustees in deciding whether a breach of the legislation is material in nature and, therefore, should be reported to the regulator. As the role of the trustee is largely a supervisory one, it is essential that they also adopt a risk-focused approach to the good governance of their schemes.

The principle underlying pensions legislation is that the trustees are primarily responsible for the good governance of occupational pension schemes. Trustees of pension schemes are not paid executives. It is not their function to carry out day-to-day management, nor are they equipped to do so. Their function is to exercise a supervisory role. One of the responsibilities of trustees is to ensure the risks they face on behalf of members are effectively managed and controlled. Proper identification, control and management of risk will protect members, employers and trustees and in consequence is highly beneficial.

Trustees and their pensions manager should take steps to have well formulated procedures through a clear, straightforward and pragmatic approach to risk management. This approach does not have to result in huge amounts of additional bureaucracy but it can ensure that the risks faced by trustees on behalf of members are effectively managed and controlled.

The question of identifying, managing and controlling risk is one with which companies are currently grappling. The Turnbull Report recommends that company boards should have in place a sound system of internal control to address all significant risks to the business, together with regular evaluation and review procedures. Notwithstanding the increasing complexities of running a business, on evaluation, this guidance is relatively straightforward and it is sensible for trustees to apply these principles to their pension schemes. In the scheme's case, the management of risk is a collective responsibility shared between the trustees. The effectiveness of the internal controls and the risks themselves can be reviewed and evaluated from time to time.

What about the process of risk management?

'Risk' can mean different things to different people in different situations. What is a risk? Put simply, it is "something that prevents or hinders the attainment of objectives". Successful risk management for pension schemes involves the trustees taking a positive role in the identification of scheme risks and the development of relevant risk management objectives.

Trustees may choose to rely on other parties to undertake specific functions but they need to identify the risks associated with those functions themselves. Risk management for trustees is important for all schemes, irrespective of their size or complexity. It is a continuing process within which trustees must identify their objectives (i.e. how they want the scheme to operate), identify and prioritise the risks they face and agree how they are going to control those risks in such a way as to reduce them to an acceptable level. These risks must be monitored and reported on an on-going basis and their management should be improved as part of a continuous process.

Trustees need to be aware of their duties and responsibilities and the scheme's objectives. They must be able to identify the various 'activities' associated with the running of the scheme, who has 'ownership' of them, be satisfied that the appropriate party is carrying out those activities and be aware who has day-to-day responsibility for monitoring them. Once the trustees have identified the risks that are most relevant to them, careful management is required and trustees must determine and record their control strategy for each of the risks they have identified.

Trustees should be effectively measuring, monitoring and assessing the risks they have identified. They should determine how the monitoring and reporting will take place and ensure that timely and reliable information is available. This information, which really underpins the trustees' risk management process, is vital and trustees must ensure
that there is an adequate information
system because they need to know that all activities are being properly undertaken as the trustees intended.

In effect, each trustee is a "Risk Owner", responsible for the corporate pension
scheme risks, as members of the Trustee Board, and will oversee implementation and operation of the risk management process.

The pensions manager, scheme secretary or other nominated person can be nominated as a "Risk Champion" to oversee the day-to-day management of risk. They are key to the success of the risk management process and may provide the in-house specialist input.

Trustees' approach to risk management must evolve. By evolving it will allow trustees to meet the requirements and approach of a changing regulatory environment and industry practices that are applicable to pension schemes aspiring to modern standards of governance. The benefit to a pension scheme is that by having these procedures in place and embracing these external standards, it will help trustees identify and manage events that might otherwise stop them achieving their pension goals.

As with all important decisions made by trustees, the implementation of a risk management policy requires a process
to be in place and documented. The implementation of such a process may result in different information being presented to the trustees. The type and frequency of information will vary from scheme to scheme depending on the specific risks affecting the scheme. The effectiveness of the information received will be vital to ensure adequate risk management.

There are many examples of good practice in trustee governance of pension schemes and we know that many trustees are keen to share and build on this experience. It is good to be able to discuss and develop trustee experience and innovations in order to embrace best practice as it continues to be developed and to have regard to any external standards recommended from time to time.

The size of pension schemes, in terms of assets under management, contributions and impact on the sponsoring employer and members, makes it sensible to review the overall risks involved. The basic internal control objectives do not differ as between different types of pension scheme. However, the methods by which the objectives are achieved can differ significantly between the larger pension schemes which are able to support an 'in-house' team and smaller/medium sized schemes which, for a variety of reasons, employ a mixture of advisory and employer resources. The involvement of various advisers and the not infrequent lack of consistent attention by some trustees can lead to significant gaps appearing in the internal control process. For many smaller schemes it is not practicable to install extensive (and expensive) risk management procedures. Despite this, however, fundamental risk management objectives should remain consistent with that of the larger schemes.

The key is to keep it clear, straightforward and realistic and not to create huge amounts of additional bureaucracy of benefit to no one. Applied in this way, managing trustee risk can also become an integral part of an employer's programme of continuing development for the trustees and, if applied sensibly, will benefit everyone.