Alberta Pension Governance Research Project Final Report

Transcription

1 Alberta Pension Governance Research Project October 31, 2013 Submitted to: Alberta Treasury Board and Finance Government of Alberta Prepared by: Christopher Eaton Norma Nielson Laurie Milton Haskayne School of Business University of Calgary

2 INTRODUCTION Why was this study done and who designed and delivered it? The main purpose of this study was to provide a well researched perspective on pension governance to help inform the Government of Alberta s decisions on potential reforms. This is an important and timely issue with critical implications for policy, practice, and research. Reforms would likely affect diverse stakeholder interests and would attract the attention of many Albertans. Findings from the study will feed into Alberta s broader publicsector pension governance policy review that is currently underway. This study was designed and delivered by researchers from the University of Calgary s Haskayne School of Business sponsored by and in consultation with Alberta Treasury Board and Finance. Mr. Christopher Eaton served as principal researcher for the study and Dr. Laurie Milton and Dr. Norma Nielson served as advisory researchers. Major research activity related to the study commenced in May 2013 and wrapped up in October What do we mean by pension governance and pension governance model? Pension governance and pension governance model are terms with rich meaning and varied descriptions. Consider the following descriptions taken from the Canadian context, which have continued to evolve over a number of years: Pension governance refers to the processes and structures used to direct and manage the affairs of the pension plan, in accordance with the best interests of the pension plan participants. The processes and structures define the division of power and establish mechanisms for ensuring accountability (ACPM, 1997a, p. 4). Pension plan governance refers to the roles and responsibilities of all persons in respect of a pension plan to fulfill their fiduciary obligations Good governance requires appropriate control mechanisms that encourage good decision making, proper and timely execution, and regular review and assessment Good governance demands a clear accountability for every decision made with respect to a pension plan (OSFI, 1998, p. 2). Pension plan governance is about delivering on the pension promise consistent with the pension plan documents and pension legislation Pension plan governance refers to the structure and processes for overseeing, managing and administering a pension plan to ensure the fiduciary and other obligations of the plan are met An effective pension governance system: establishes a framework for defining the duties, associated responsibilities and accountabilities for all participants in the governance process, covers all facets of pension plan management, including communication, funding, investments and benefit administration, and provides careful oversight while enhancing protection for plan members and beneficiaries (CAPSA, 2004, p. 3). 1

3 We find it helpful to draw on the related field of corporate governance as well as the above descriptions to illustrate attributes of pension governance and pension governance models. Consider the following: Corporate governance involves a set of relationships between a company s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. Corporate governance is only part of the larger economic context in which firms operate The corporate governance framework also depends on the legal, regulatory, and institutional environment (OECD, 2004, pp ). To help organize our analysis and findings, we categorize attributes of pension plan governance models using a conceptual framework from the corporate governance literature. This framework allows us to integrate concepts from research, practice and policy in pension governance and the related field of corporate governance. The framework comprises four dimensions (which we later condense to three): Composition refers to the size of the board and the mix of different directors types (i.e., insiders vs. outsiders). Characteristics refer to the director s experience, functional background, independence, stock ownership and similar variables that influence directors interest in and performance of their tasks. Structure refers to board organization, division of labor among standing committees and the efficiency of its operations. Finally, process refers to the decision making related activities and styles of the board (Zahra & Pearce, 1989, p. 292). Note that this framework explicitly addresses people attributes (i.e., composition and characteristics) in addition to the structure and process attributes that figure so prominently in many of the above terms. Why did we focus on pension plan governance? Public sector pension governance challenges for Alberta and other jurisdictions are well known and associated policy and practice are in a state of flux. Over the past few decades, significant pension governance reforms spanning both public and private sectors have been studied, designed and implemented across Canada and in many other jurisdictions. Similar reforms have been proposed and considered in Alberta for some time. For example, the Cortex Report (1999) addressed a proposed pension governance model for one of Alberta s major publicsector pension plans. Many public sector pension stakeholders suggest that principles from that report guide any future reforms. Consistent with accepted conventions in pension policy work, we distinguish between issues related to plan design (i.e., What is the nature of the pension deal?) and those related to plan governance (i.e., How is the pension deal reached, administered, and modified, as necessary?). Which public sector pension plans did we examine? We examined four Alberta public sector pension plans governed by the Public Sector Pension Plans Act (PSPPA) and its associated regulations: Local 2

4 Authorities Pension Plan (LAPP), Public Service Pension Plan (PSPP), Management Employees Pension Plan (MEPP), and Special Forces Pension Plan (SFPP). We also examined the Alberta Investment Management Corporation (AIMCo) and Alberta Pensions Services Corporation (APS), corporations which are owned by the Government of Alberta and are the mandatory providers of investment management and pension administration services, respectively, for the four focal pension plans. The unique nature of these relationships and interactions make them an integral part of the focal pension governance model. What questions guided our research? Through this study, we addressed four key questions: 1. What makes a given pension governance model appropriate and successful? 2. How do these attributes apply to the pension governance context in Alberta? 3. Which pension governance model(s) would likely be appropriate for Alberta? 4. What are the key pension governance transition considerations for Alberta? Our findings for each of these questions are presented in the Research Findings section. How did we arrive at the study s findings? We identified, collected and reviewed relevant material from pension governance policy and practice and from academic literatures; conducted interviews with several knowledgeable individuals (not a public consultation or statistical sample ); analyzed and synthesized relevant material using established qualitative research methods; and developed and delivered research findings. Throughout the study, we attempted to distinguish among promising, prudent, prevalent and proven practices, based on evidence from the field or lab which spanned a continuum from more subjective to more objective. For comparison, we focused mainly on two Alberta public sector pension plans that are not under the Public Sector Pension Plans Act (PSPPA) Alberta Teachers Retirement Fund (ATRF) and Universities Academic Pension Plan (UAPP) and three pension governance models currently operating in other jurisdictions British Columbia, Ontario Teachers Pension Plan (OTPP), and Ontario Municipal Employees Retirement System (OMERS). RESEARCH FINDINGS 1. What makes a given pension governance model appropriate and successful? In this context, the notion of appropriate is mainly concerned with a model s legitimacy (i.e., whether its attributes help a plan meet stakeholder expectations), whereas the notion of successful is mainly concerned with a model s effectiveness (i.e., whether its attributes help a pension plan achieve stakeholder aspirations). Both of these notions appropriate and successful and their underlying objectives legitimacy and effectiveness are important to guide inquiry into pension governance models. Below we address the key findings from our study related to both of these notions, which are organized according to pension governance model structure, composition/characteristics and process. 3

5 The following factors seem to influence legitimacy and effectiveness of a pension governance model: size of plan/fund, sophistication of investment strategy, complexity of asset mix, extent of functional integration, number of sponsors, diversity of sponsor interests, and asymmetry of sponsor power. It is important to note that although these contingencies seem to be supported by the evidence analyzed through our study, they are speculative because of the limitations of the study s sample and methods. We consider each of these contingencies in detail below and in the subsequent sections of this report. Structure The evidence from virtually all sources indicates that clarity and fairness in the allocation of pension governance roles and accountability are critical for a model to be considered appropriate and successful. A number of jurisdictions in Canada and elsewhere have implemented jointly sponsored pension plans (JSPPs) particularly for defined benefit pension plans in the public sector. In the Canadian context, this is typically associated with a government devolving part of its sponsorship and/or trusteeship role and accountability to pension plan employers and members (employees). The rationale for these transitions involves increasing the transparency of pension governance and engagement by the parties whose interests are now and will be most directly affected the joint sponsors of the plans. Increased uncertainty regarding the sustainability of defined benefit pension deals and dependence on marketdriven investment returns has resulted in an increased formal and ongoing roles for sponsors (e.g., to periodically modify the pension deal) and trustees (e.g., to actively administer the pension plan/fund). There is also a trend toward establishing a governing body for plan sponsors and a governing body for trustees, partly to clearly separate the various duties of sponsors from the fiduciary duty of trustees. These structures are typically permitted or required in enabling legislation and regulations, codified in joint sponsor and trust agreements, and further clarified in policies and codes. Consider the following: OMERS is a jointly sponsored pension plan OMERS is now governed under a bicameral arrangement under which there are two corporations, each with its own board of directors. The Sponsors Corporation (SC) and board provide for strategic oversight and decision making by sponsors on major policy directions including benefits and contribution rates. In parallel, the Administration Corporation (AC) and board are accountable for the management team s day to day business operations of the plan, including the management of investment portfolios, paying pension benefits and ensuring compliance with financial regulations such as those governing actuarial valuations. This board has major fiduciary responsibilities in the sense that it must act only in the interests of pension plan members as a whole and hence in fiduciary matters must maintain full independence from plan sponsors ( Dean Report, 2013, p. 5). This separation also intensifies professionalization of the trustee governing body (typically a board) and attention to the administrator role, points addressed in the next section on composition/characteristics. 4

6 A preponderance of the evidence suggests the bicameral model is widely acknowledged as appropriate and successful for governance of public sector pension plans; however, overlapping responsibilities and transition periods present challenges. Overlapping responsibilities seem to be particularly contentious through the definition of the pension deal (e.g., the balance between plan contributions and investment returns) and valuation of the pension fund (e.g., the choice of actuary, methods and assumptions). It seems to take years of operation to sort out key roles, responsibilities and accountabilities of governing bodies before participants and observers will consider a bicameral model appropriate and successful. In general, the size of pension plan and fund seems to affect the ability of the plan to reasonably support more complex and costly structures in the pension governance model. The sophistication of the fund s investment strategy and the complexity of its asset mix typically result in more complex oversight structures for the trustee governing body and, potentially, the sponsor governing body. The extent of outsourcing (i.e., investment and/or plan administration delegated to external agents) appears to affect the governance demands to oversee the relationships and, potentially, require sponsors and/or trustees to serve on the governing bodies of relevant agents. Finally, the number of sponsors, diversity of sponsor interests, and asymmetry of sponsor power seem to affect the complexity of the sponsor governing body s structure and, potentially, the complexity of the trustee governing body s structure. The sponsor body is accountable to the various constituencies it represents. Its accountability typically includes an expectation that it will consult with its constituencies and consider their perspectives prior to making any material change to the pension deal. Such consultation may occur on an individual basis or through duly designated representative groups (e.g., employers, unions). In its fiduciary role, the board of trustees is accountable first and foremost to plan members. It is also accountable to the sponsor body, which is responsible for empowering, appointing and monitoring the trustees, and to the competent authorities, which are responsible for monitoring activity and enforcing laws and regulations. In this context, funding, benefit, and investment policies can be used to help protect sponsors (and indirectly taxpayers ) and members interests. For example, the sponsor body may pre determine thresholds for plan surpluses and deficits and associated mechanisms to freeze or adjust contributions and benefits or freeze or adjust investment strategies and asset mix, if and when such thresholds are breached. If these policy instruments are deemed insufficient, such thresholds could be included in enabling legislation and regulations or codified in joint sponsor and trust agreements. The major challenge with this approach is it would reduce the plan s ability to adapt to unforeseen circumstances. A decision to change the pension deal is the most significant decision for the sponsor governing body. Significant changes to the pension deal should be informed and infrequent to safeguard the pension deal for plan members and maintain confidence in the integrity of the pension governance model. In order for the sponsor governing body to make an informed decision regarding changes to the pension deal, the trustee governing body and any of its agents would likely need to provide the actuarial 5

7 valuation of the pension, any actual and/or anticipated breach of pre determined thresholds, range of potential options to remedy the breach, and implications of each potential option for the plan/fund. Boards of trustees may decide to delegate some of their fiduciary related pension administration roles and responsibilities to committees of the board (e.g., investment committee). Some boards of trustees adopt committee structures that are considered appropriate and effective in the realm of corporate boards of directors (e.g., for matters related to audit, nominating, governance and investment). Different boards of trustees may be configured quite differently depending on the nature and extent of any such delegations. In some cases (e.g., OMERS), separate sponsor and trustee governing bodies participate in joint bodies to facilitate communication and address issues, and the trustee governing body considers specific responsibilities as the full board rather than delegate them to a committee. Boards of trustees typically delegate some of their pension administration roles and responsibilities to internal agents (e.g., management and staff) and/or to external agents (e.g., investment management, benefit administration, actuary, auditor). These agents are directly accountable to the trustee governing body which typically selects, empowers, monitors them and, if necessary, terminates their specific relationship with the plan. According to some guidelines, actuaries and auditors have an additional, indirect accountability to competent authorities to report actual and/or anticipated deficiencies in the pension plan if such deficiencies have already been reported to the trustee governing body but were not remedied by that body. Guidelines indicate these accountabilities should be codified in professional standards of practice for actuaries and auditors and should be backed up by the possibility of sanctions. The trustee body typically needs approval from the sponsoring body to pursue certain strategies (e.g., in or out sourcing functions like investment management and plan administration) and major decisions that could affect the scale, scope and heterogeneity of the plan (e.g., growth to include new and/or different sponsors and members). Some joint sponsor/trust agreements and guidelines describe mechanisms to resolve disputes and compel performance, if necessary (possibly including arbitration). The relevant parties typically develop documents to formally establish and guide the structure and operation of the sponsor and trustee governing bodies (e.g., board and committee charters, position descriptions), internal agents (e.g., employment contracts, position descriptions), and external agents (e.g., engagement letters, service level agreements), and for all of these entities (e.g., codes of conduct). Composition/characteristics The number of sponsors, diversity of sponsor interests, and asymmetry of sponsor power seem to affect the size and backgrounds of the sponsor governing body, but not necessarily of the trustee governing body. The sophistication of the fund s investment strategy and the complexity of its asset mix typically result in more targeted experience and expertise (e.g., sectors) in the trustee governing body and, potentially, the sponsor governing body. The extent of outsourcing (i.e., investment and/or plan administration delegated to external agents) may have an effect on the size of and expertise in the 6

8 trustee governing body, to oversee the relationships and to serve on the governing bodies of relevant agents. The size of the pension plan (e.g., member headcount) and fund (e.g., asset value) do not, in themselves, seem to affect composition or characteristics. The size of the trustee governing body seems to be restricted on the upper end by the need to work together as a team and on the lower end by the need to allocate people to committees. Evidence indicates that the trustee governing body should have from 8 to 12 members, ideally with an odd number of members to avoid the possibility of a tie in voting. Multiple sponsors, diverse interests and asymmetric power in a pension plan tend to result in a larger, more broadly representative sponsor governing body. It is difficult to determine which sponsors and groups should be granted a seat at the table both initially and subsequently. Representation is typically based on the nature and extent of each sponsor s and member s stake in the pension plan. Stake is typically measured in terms of member headcount and may be reflected formally or informally in decision making (e.g., through leadership roles and weighted voting), although this can evolve into a contentious and divisive issue. Retirees should have a role, whether directly through representation on the sponsor governing body or indirectly through meaningful consultation. Sponsor representatives must possess clear and sufficient authority to act on behalf of and bind their constituents, and sponsor representation must achieve high member and group coverage (e.g., inclusion rates at both levels). Members of the sponsor governing body are typically appointed by each sponsor from among the applicable employer, employee and retiree ranks to represent sponsor interests and contribute in a policy capacity. In contrast, members of the trustee governing body are typically appointed by the sponsor governing body from among outside (i.e., non sponsor) candidates to bring relevant expertise and contribute in a professional capacity. Sponsors may act individually or collectively to appoint trustees, depending on the sponsor agreement. The collective professional capacity of the governing bodies in particular of the trustee governing body must be sufficient to adequately perform the key monitoring role over increasingly sophisticated internal agents (e.g., executive team and key investment management staff) and, if applicable, external agents (e.g., investment management service providers). This requirement is critical to ensure that the trustee governing body is able to fulfill its fiduciary duty. The approach to designating chair and vice chair roles in sponsor governing bodies (e.g., one for employers, the other for employees) has historically focused on sharing power among relevant groups. Governing bodies may need to consider rotation of these roles in the future (e.g., between employer and employee groups, among non dominant sponsor groups). For trustee governing bodies, the trend is away from the vice chair role as a power sharing mechanism toward a practical mechanism (e.g., leading when chair is absent or recuses). The concept of independence takes on a dual meaning: in this context, trustees should be independent from sponsors (and, likely, from internal agents); in corporate governance, directors should be independent from internal agents. At a minimum, the chair of the trustee governing body should be independent of the sponsors interests. It may be important to distinguish among competent (or prudent ) and expert when describing individual trustee roles 7

9 and the trustee governing body to clarify professional expectations and legal standards of performance (e.g., contrast expert in this context with financial expert and risk expert in corporate governance). Terms should be based on principles of continuity, change, performance and development across levels. Mechanisms to achieve continuity and change include staggered terms (e.g., no more than a certain proportion of terms that expire simultaneously) and term limits (e.g., total number of terms, duration of each term). Term limits are typically less restrictive than established and emerging practice in corporate governance. Mechanisms to achieve performance and development include conditional renewal (e.g., based on evaluations of performance across multiple levels) and orientation and training (e.g., initial orientation and ongoing education). Provisions should be specified to address vacancies arising from special circumstances (e.g., removal). As a group, members of the trustee governing body should have some input regarding trustee succession and possibly the chair role for the trustee governing body. The sponsor governing body should consider the busy director/trustee problem (i.e., other full time or nearly full time commitments, serving on multiple boards) in its appointment and renewal decisions. Practical tools and techniques from corporate governance can be and often are leveraged to enhance capacity at sponsor and trustee governing bodies. For example, competency matrices, search firms, and performance evaluations are typically used to identify and address any gaps in expertise. Expertise can be categorized as functional (e.g., pensions, investments, actuary, audit, risk, etc.) or contextual (e.g., investment regions, sectors, mechanisms, etc.). There are key differences in criteria for individuals considered for lay representative sponsor governing bodies and expert professional trustee governing bodies. However, it is important to recognize that selection of individual trustees should take into account their potential fit within the board as a decision making group, not just their individual competency (e.g., to fill a gap ). Trustees should also receive sufficient orientation and education to adequately understand the nature of their fiduciary duty (e.g., contrast trustee and director duties). Interviews underscored the importance of selecting respected people to lead the board (of trustees), management, and key functions (e.g., investment management). The initial team assembled for the new Ontario Teachers Pension Plan is often cited as an example: retired Bank of Canada governor, Gerald Bouey, as chair of the board of directors, former CEO of MetLife Canada, Claude Lamoureux, as CEO, and long time financial executive Robert Bertram as head of the investment management group. Each of these individuals was considered critical to the viability of the board and management team. Evidence suggests that a virtuous circle can be established, through which respect for an appointed chair (and potentially for other trustees) attracts top talent for key roles among management and staff. It is important to recognize that selecting people who lack such respect would likely result in a vicious circle. Board composition and director characteristics have received extensive theoretical and empirical attention from corporate governance researchers over the past few decades. However, early and more recent reviews of the relevant literatures and findings of meta analyses which aggregate results across 8

10 empirical studies provide mixed or equivocal results regarding the impact of composition/characteristics on performance. There is large and growing recognition that these relationships are distal, indirect and potentially nonlinear. Although researchers acknowledge that moderating and mediating effects of cognition and process are important and should be taken into account in empirical studies, they also appreciate the difficulty in properly measuring and incorporating these constructs and relationships in studies. A perspective is also emerging among some groups of scholars that many of the widely used theoretical lenses (e.g., agency theory) are inadequate and should be extended, integrated or replaced. Process Processes for appointing, orienting and educating members of sponsor and trustee governing bodies are addressed in previous sections. Additional details on processes to establish and modify the pension deal and pension governance model are addressed in the sections for subsequent research questions below. Processes and procedures for recruiting, selecting, appointing, advising and monitoring internal and external agents of the governing bodies, as appropriate, should be documented. Material related to each associated decision should also be documented. In particular, the trustee governing body should clearly describe its expectations regarding roles and responsibilities for all internal and external agents (e.g., using position descriptions, statements of investment policies and procedures, and service level agreements). The trustee governing body should also take care to follow established processes and procedures for hiring the chief executive officer and engaging the actuary, auditor, and any external agents that will perform core functions (e.g., investment management and plan administration). Support services for sponsor governing bodies is typically modest; support services for trustee governing bodies is typically more substantial, mainly arising from the latter body s more substantial workload. Support is typically dedicated to each pension plan but shared services models are used in some cases. Procedures for quorum and voting for trustee governing bodies may be modeled to a certain extent on widely accepted rules from corporate boards. In this context, quorum is typically defined as a simple majority comprising at least one trustee appointed by each sponsor. This approach may vary depending on the number of sponsors and extent of adherence to the separation of sponsor and trustee functions. Procedures for quorum and voting for the sponsor governing bodies are typically more complex to reflect the diversity of interests and the anticipated policy approach. In this context, quorum and voting rules may be more directly linked to the stake in the pension plan. At least for major policy decisions and perhaps for some others, quorum and voting rules could be linked to a representative s relative status (e.g., based on member headcount of the associated constituencies). However, it is important to consider the potential implications of implementing quorum and/or voting rules that require unanimous agreement (i.e., a veto for each) or perhaps offset these by incorporating provisions for arbitration. An agenda and background material for each governing body (and any applicable committee) meeting should be distributed to the members well in advance of the meeting date. Each agenda should be 9

11 developed by the designated member (e.g., chair), in consultation with other members and relevant agent representatives. From this material, each governing body should be able discern its top priorities. For example, there could be a clear distinction between routine and non routine business and information and decision items. Each governing body should pay close attention to major policy decisions and potential overlapping areas (e.g., valuations). It may be helpful for each governing body to discuss, agree and incorporate pre determined thresholds to identify unacceptable funding situations and preferred responses to prevent or mitigate the challenges of making major policy decisions in crisis. The governing bodies and some of their agents will need to be actively engaged in communication and consultation to satisfy governance requirements. Policy and procedures should clearly describe roles and responsibilities within and between the governing bodies (e.g., from coordinating committee work to consulting on overlapping areas), between the trustee governing body and relevant internal and external agents (e.g., growth and investment strategies, periodic pension fund valuations, etc.), and between the agents and other stakeholders, as applicable (e.g., reporting and disclosing information on the pension plan and fund to satisfy legal and regulatory requirements). Procedures should provide for ad hoc mechanisms to raise and resolve any issues that have the potential to create significant conflict. Remuneration for sponsor representatives is typically modest (e.g., make whole for any forgone employment compensation resulting from service) and is determined by the sponsor governing body in accordance with the joint sponsor agreement. Remuneration for trustees is typically competitive (e.g., best forgone alternative or a comparable threshold, often informed by peer benchmarking) and is determined by the trustee governing body in accordance with the joint trust agreement, and reviewed by the sponsor governing body in accordance with the joint sponsor agreement. The prudently incurred costs of operating the sponsor governing body and trustee governing bodies, administering the pension plan, and managing the pension fund are typically paid out of the pension fund. The governing bodies should ensure that effective internal control systems are in place to prevent and mitigate any abuse. In corporate governance research, most emphasis has been on the service and monitoring roles of boards of directors rather than their strategy role. This is a result of the dominance of legalistic and agency perspectives in the past few decades. However, these lenses have yielded mixed or equivocal results between service and monitoring roles and performance. There is an increasing focus on the role of processes to address this problem and obtain fresh insights into cognition and behavior across the director, committee and board levels. Empirical studies on these phenomena are exceedingly difficult to conduct because of access, measurement and boundary issues. Theory building and empirical research on corporate board processes has progressed albeit slowly and offers the potential to advance our understanding. Boards should engage in constructive conflict, avoid destructive conflict, work together as a team, know the appropriate level of strategic involvement, and address decisions comprehensively. 10

12 2. How do these attributes apply to the pension governance context in Alberta? The majority of evidence we collected and analyzed through this indicates there is considerable room for improvement in the governance models of the four focal pension plans: Local Authorities Pension Plan (LAPP), Public Service Pension Plan (PSPP), Management Employees Pension Plan (MEPP), and Special Forces Pension Plan (SFPP). Beyond the key operational issues, there are concerns regarding the long term sustainability of the four focal pension plans. Past changes and anticipated future trends in demographic and market factors indicate that sustainability will likely remain a challenge. Plan design changes are a key part of this puzzle to be sure, but plan governance reforms also seem to be a key part. Although the findings from this study demonstrate an array of governance issues across the four pension plans (which will be addressed in the next section), a few overarching themes became apparent. In general, there is a great deal of confusion regarding the sponsor and trustee functions of the four focal pension plans. Although on paper the roles, responsibilities and accountabilities of the Minister of Finance, employers, members, boards of trustees, and service providers may appear to be relatively clear, the evidence we collected and analyzed indicates the sponsor and trustee functions are unclear in practice. This uncertainty stems from issues that arose from LAPP s proposed reform more than a decade ago and is amplified by real or perceived conflicts of interest in key roles, responsibilities and accountabilities. As a result, some existing trustees of the focal pension plans believe their boards have the accountability associated with a fiduciary duty but they lack the requisite authority to fulfill such a fiduciary duty. Some observers have also expressed cost and service related concerns with the mandatory service providers: AIMCo for investment management and APS for pension administration. Alberta is well positioned to move forward with public sector pension governance reforms at present. Perhaps most importantly, there is a broad understanding and acceptance of key pension governance principles that were described in a review of LAPP s earlier proposed reform ( Cortex Report, 1999): 1. The functions of the sponsor and trustee must remain separate 2. Parties exposed to significant risk through the pension plan must have the authority and capacity to manage their risk exposure 3. From the outset, parties exposed to significant risk must have direct and active involvement in establishing the pension deal 4. The pension deal must provide for an alignment of interests among all affected parties 5. Mechanisms must exist for transparent accountability These principles have stood the test of time and represent a solid foundation on which to build a new pension governance model for the focal pension plans. They figure prominently in reform discussions. 11

13 Furthermore, in August 2013, Alberta s Minister of Finance, the trustee for all of the focal pension plans, shared guiding principles for the review of pension sustainability and governance. These principles are: Contributions are affordable and sustainable for employers and employees with minimal additional legacy costs or future increases borne by taxpayers. Benefits already earned are preserved. A high degree of benefit security is provided. Pensions provide reasonable income replacement. Benefits are competitive and enable recruitment and retention of high quality staff at all levels of the public sector. The system is robust and adaptable to changing circumstances. There is intergenerational fairness for members and taxpayers. Those who bear the costs and risks can manage them through the governance system. The governors of the system are accountable to taxpayers and beneficiaries. Adequate notice is given to plan members and employers. Pension governance reforms can benefit from experiences of relatively recent pension plan transitions of the Alberta Teachers Retirement Fund (ATRF) and the Universities Academic Pension Plan (UAPP). Public awareness of emerging private sector pension issues and momentum for associated reforms were established through Alberta and British Columbia s joint initiative (JEPPS, 2008). Similarly, awareness of emerging public sector pension issues and momentum for associated reforms were established through recent Alberta initiatives (e.g., Governance and Sustainability Review and Pension Governance Summit). There are a few other, quite practical factors that will likely facilitate progress on pension governance reform in Alberta at the present time. First, Alberta has a viable legislative path for the focal pension plans to emerge from their current governing legislation i.e., a transition from the Public Sector Pension Plans Act (PSPPA) to the Employment Pension Plans Act (EPPA). Second, guidelines that may be useful for pension governance are now available ( McCrank Report, 2007; AGS, 2008). Third, from an operational infrastructure perspective, Alberta has established AIMCo and APS to provide investment management and pension administration services to the focal pension plans on a mandatory basis. 3. Which pension governance model(s) would likely be appropriate for Alberta? In this section, we revisit the contingencies described above i.e., size of plan/fund, sophistication of investment strategy, complexity of asset mix, extent of functional integration, number of sponsors, diversity of sponsor interests, and asymmetry of sponsor power and apply them to the four focal pension plans in the Alberta context. Although there are a number of significant differences among the four focal pension plans, there are also a number of similarities among them. Furthermore, the broader 12

14 Alberta context is characterized by a supportive institutional environment in the form of an alternative legislative framework, accepted governance principles and guidelines, and relevant prior experiences. Throughout the research project, the evidence we collected and reviewed clearly supported variations on the bicameral model. This model is broadly consistent with preferences described by the four focal pension plans and key pension governance principles in Alberta and elsewhere. It is important to note that the theory and practice of the bicameral model do allow for considerable diversity; evidence from normative guidelines and practical experience show that this is not a one size fits all model. Variations on the bicameral model therefore figure prominently in our analysis of options for the focal plans below. Because the extent of functional integration, sophistication of investment strategy, and complexity of asset mix are substantively similar across the focal pension plans, we address them generally below. Local Authorities Pension Plan (LAPP) LAPP is the largest of the four focal pension plans. At the end of 2012, the plan had 223,643 active, deferred, and retired members and 428 employers primarily in health (50%), municipalities (30%), and education (20%) sectors while the fund had about $22.9 billion in assets and $27.8 billion in liabilities. Despite the large number of employers across multiple sectors, LAPP s membership is fairly concentrated. Relative to the other focal plans, LAPP has a low contribution rate and medium funding status. LAPP currently has a Board of Trustees and a Board of Directors with the same 14 sponsornominated trustees serving on both bodies. LAPP is currently supported by a small, dedicated executive team. Since its proposal in the late 1990s, LAPP has been an active proponent of pension governance reform. The LAPP Board communicates and consults with plan employers and members through a Stakeholder Consultation Group (SCG). LAPP s large number of members and employers, diversity of sponsor interests (across multiple sectors), and asymmetry of sponsor power make it potentially suitable for a full fledged bicameral model. In such a model, the sponsor governing body could retain a composition similar to the current LAPP Board, while a new trustee governing body could be smaller (e.g., 8 to 12), comprising professional members, selected for specific functional expertise, and appointed by the sponsor governing body. If deemed appropriate, the SCG could help facilitate the transition to a new pension governance model by leading development of new joint sponsor and joint trust agreements. Given the size of its plan/fund and the presence of an executive team, LAPP might be well positioned to take on its own investment management and plan administration services at some point in the not too distant future. Public Service Pension Plan (PSPP) PSPP is the second largest of the four focal pension plans. At the end of 2012, the plan had 78,788 active, deferred, and retired members and 31 employers, while the fund had about $7.3 billion in assets and $8.9 billion in liabilities. PSPP s membership is moderately concentrated, with the two major 13

15 stakes represented by the Government of Alberta and the Alberta Union of Provincial Employees (AUPE). Relative to the other focal plans, PSPP has a medium contribution rate and funding status. The current PSP Board comprises six individuals, three of whom are nominated by the Government of Alberta and three of whom are nominated by AUPE. The Board has established an Investment Committee which comprises the entire PSP Board and two or three external members who have experience in investment management. PSPP s moderate number of members and employers, relative similarity of sponsor interests, and relative symmetry of sponsor power make it potentially suitable for a modest bicameral model. In such a model, the sponsor governing body could retain a composition similar to the current PSP Board, while a new trustee governing body could be a similar size (e.g., 6 to 8), comprising professional members, selected for specific functional expertise, and appointed by the sponsor governing body. The new trustee governing body would likely make the current Investment Committee redundant. If deemed appropriate, the existing stakeholder forum could be used to facilitate the transition to the new pension governance model by leading development of new joint sponsor and joint trust agreements. Management Employees Pension Plan (MEPP) MEPP is the third largest of the four focal pension plans. At the end of 2012, the plan had 10,254 active, deferred, and retired members and 21 employers, while the fund had about $3.0 billion in assets and $3.3 billion in liabilities. MEPP s membership is concentrated, with the two stakes represented by the Government of Alberta and the plan members (employees). Relative to the other focal plans, MEPP has a high contribution rate and high funding status. The current MEP Board comprises seven individuals, three nominated by the Government of Alberta, three nominated by employees, and one (non voting) nominated by the Public Service Commissioner s Office. The MEP Board has established an Investment Committee which comprises the entire MEP Board and has engaged an external investment consultant. MEPP s small number of members and employers, relative similarity of sponsor interests, and relative symmetry of sponsor power make it only somewhat suitable for a modest bicameral model. In fact, MEPP resembles a single employer pension plan more than a potential jointly sponsored pension plan (JSPP). Given the profile of the plan/fund and these contingency factors, the current MEP Board may be suitable for a new pension governance model. As an alternative, MEPP could consider some form of combination with PSPP. A combined PSPP/MEPP might provide sufficient size, diversity of interests, and asymmetry of sponsor power to make it suitable for a modest bicameral model and capture the potential benefits that are typically associated with economies of scope and of scale. Obviously, any such combination would require negotiation among sponsors and attention to impacts on plan design. 14

16 Special Forces Pension Plan (SFPP) SFPP is the smallest of the four focal pension plans. At the end of 2012, the plan had 6,584 members and seven employers, while the fund had about $1.7 billion in assets and $2.2 billion in liabilities. SFPP s membership is fairly concentrated, with the stakes represented by plan employers and members. Relative to the other focal plans, SFPP has a high contribution rate and low funding status. The SFP Board has seven members, three nominated by employers, three nominated by employees, and one nominated by the Government of Alberta. The SFP Board has engaged an investment consultant. SFPP s small number of members and employers, relative similarity of sponsor interests, and relative symmetry of sponsor power make it not very suitable for even a modest bicameral model. Given the profile of the plan/fund and these contingency factors, the current SFP Board may still be suitable in a reformed pension governance environment. As an alternative, SFPP could consider some form of combination with LAPP. A combined LAPP/SFPP would provide sufficient size, diversity of interests, and asymmetry of sponsor power to make it suitable for a full fledged bicameral model and capture the potential benefits that are typically associated with economies of scope and of scale. Obviously, any such combination would require negotiation among sponsors and attention to impacts on plan design. Across all of the focal plans, any new pension governance model should provide for increased voice mechanisms and potentially exit mechanisms related to engagement of AIMCo and APS for services. Voice mechanisms could include participation on the AIMCo Board of Directors or establishment of formal performance standards through service level agreements. Exit mechanisms could include the ability to switch service providers, under a fair and orderly transition and cost sharing arrangement. Importantly, evidence suggests that economies of scope and of scale exist for investment management and plan administration. Such benefits could be forgone if one or more of the focal plans were to exit. 4. What are the key pension governance transition considerations for Alberta? The main source of evidence for transition considerations were interviews that involved the recent transition experiences in BC and Ontario (i.e., OTPP and OMERS) and various perspectives from Alberta. Data on similar transitions from academic, practitioner and policymaker sources is relatively scarce. Because of the complexity of the phenomenon, relatively limited sample of cases, and limited ability to corroborate with other data, the following observations should be considered somewhat speculative. First and foremost, it is important to build trust among stakeholders who will be most directly affected by the transition and stakeholders and observers who will be less directly affected but will have a strong interest in the process and outcomes for other reasons. There is a perception that pension governance reform in Alberta has been long promised and awaited (20 years is an oft mentioned period). Clarifying the role (if any) of existing boards in the transition and ensuring that stakeholders have opportunities for 15

17 meaningful consultation will be critical success factors for the transition. Stakeholders will likely use this to evaluate the Government of Alberta s commitment to a transparent and fair process and outcome. The process through which employee and employer sponsors are designated and empowered to shape the transition of their pension plans and the final list of these sponsors will also be closely monitored and evaluated for transparency and fairness. It might be helpful to invite comments on the criteria that the Government of Alberta should use to make this crucial decision and develop and distribute related information along with the final list of designated employer and employee sponsors. Such actions may address concerns regarding the Government s commitment to a transparent and fair transition. It would be helpful to provide detailed information about the process and timeline for the transition and any constraints (e.g., default status quo model if no agreement is reached) to help focus attention. Given the relatively short timeline and some skeptical participants, it may also be helpful to appoint one or more independent pension expert(s) who is (are) respected and trusted by the designated employer and member sponsors to serve as facilitator(s) and source(s) of information. Ideally such individuals could advise based on direct experience with similar transitions elsewhere (e.g., in BC or Ontario). The academic literatures on negotiation contain mixed evidence on the effects of incorporating strong incentives to encourage specific behavior undertakings with high stakes and limited timelines such as the transition to a new pension governance model. For example, addressing plan design changes at the same time as plan governance changes complicates discussions among stakeholders and emotional responses to proposed plan design changes could jeopardize agreement on plan governance reforms. Providing a default status quo pension governance model option might reduce sponsors motivation. It may be useful to identify several pension governance configurations and evaluate the alternatives in terms of relative desirability. For example, it might be acceptable from a governance perspective for some focal plans to appoint a strong independent chair and retain other members from current boards. The nature of trustees fiduciary duty should be clarified and mechanisms for orientation and education for trustees should be developed. Finally, it should be acknowledged that there will be a trial period before the transition can be properly evaluated (e.g., multiple years for each of OTPP, BC and OMERS). 16

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