Pension Fund Governance Structure and its Need

Since pension funds manage assets worth billions or even trillions of dollars. This means that it is crucial to create a structure that manages the pension fund itself.

Since the pension fund industry is highly regulated, it is important for the fund to have a structure in place which allows for quick and effective decision-making. This is where the pension governance structure comes into play.

Having an effective governance structure is vital to any organization and this includes pension funds. In this article, we will have a closer look at the governance structure of pension funds.

What is a Governance Structure?

When it comes to pension funds, good governance means a clear, unambiguous, and non-conflicting assignment of rules and responsibilities to different people within the organization.

The purpose of this internal allocation of responsibilities is essential to ensure that no single person or a small group of people can hijack the working of the fund and use it to their own personal advantage.

A good governance structure builds a system of checks and balances which ensures that the investment actions of the pension fund are taken in accordance with the investment policy of the firm and not based on the whims and fancies of an individual.

Structure of Pension Fund Governance

Good governance of a pension fund is only possible after creating a basic structure that controls the functioning of the pension fund. It is standard practice across the industry to divide the pension fund into three distinct layers.

  1. The first layer is the board of trustees. These people provide high-level strategic guidance to the firm. They are not responsible for helping the fund manage its day-to-day operations.

    It is common for pension funds to have at least five members on board who have expertise in different areas of the functioning of the fund. This layer is involved in making the policies.

  2. The second layer is the accountability council. These people act as the middle management of the pension fund. It is common to have forty to fifty such executives in a medium-sized pension fund. The number of executives further varies based on the size of the fund.

    The job of the accountability council is to take ownership of the policies once they have been made and ensure that these policies are strictly implemented.

  3. The last layer is the executives who actually implement the policy. It is the task of the executives to ensure proper and timely implementation of the policies on an individual level.

Why is a Governance Structure Necessary?

A clearly defined governance structure is necessary because of the reasons mentioned below:

  • A good governance structure is required to ensure that the pension fund is aware of its own risk profile. The pension fund must carefully study its own liabilities and risk appetite and define a clear policy regarding the measurement and management of such risks.

  • It is the job of the pension fund governance team to come up with important metrics such as the minimum funded ratio as well as the maximum possible contribution. These metrics have an important impact on the overall liquidity situation of the fund.

  • It is the job of the governance team to ensure that the policies of the fund are not contradictory in nature. Also, the governance team is in charge of ensuring that all the policies and the subsequent changes made to those policies are clearly documented and stored in a central repository.

    The governance team then controls the flow of this information. Some policies are publicly available whereas some other policies are shared only on a need-to-know basis.

  • The governance team also has to create rules regarding the centralization or decentralization of authority. The ideal pension fund delegates the responsibility to the lowest level where it can be effectively discharged.

    The governance team also creates a feedback mechanism that allows the proper monitoring of these responsibilities from higher levels of management.

  • The governance team is also in charge of conducting periodic internal audits. This is done to ensure that the risk management processes are in place and are being managed effectively.

  • The task of valuing the assets and liabilities of the pension fund and deciding on the funding status is also taken care of by the governance committee. Decisions relating to overall investment strategy as well as the role which various asset classes are expected to play in this strategy are also supposed to be clearly explained.

    Since these decisions emanate from the fund’s beliefs about the macroeconomic factors, it is the job of the governance team to conduct meetings and codify these commonly held beliefs so that they can be used for decision-making and also be reviewed at a later stage.

  • The task of deciding whether the activities of the fund will be managed internally or whether they need to be outsourced to a third party also has to be done by the governance committee. The subsequent appointment of managers, custodians as well as other important office bearers also has to be done by the same team.

The bottom line is that good governance is truly important. It can truly be the difference between a well-managed and a poorly managed pension fund. Over the years, investors, as well as regulators, have recognized the importance of such governance. It is for this reason that they have taken steps to encourage better governance of the funds.

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Pension Funds