fresno county employees’ retirement association governance roundtable october 18, 2006 tom...
TRANSCRIPT
Fresno County Employees’ Retirement Association
Governance RoundtableOctober 18, 2006
Tom Iannucci, Cortex Applied Research
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Agenda
1. Governance background
2. Board interviews/surveys
3. Discussions:1. Roles and responsibilities2. Committees3. Policy to be prepared
4. Wrap up
2. Governance Background
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Fiduciary Duties
Loyalty to the beneficiaries as a group and prudence in managing the beneficiaries’ property and serving their interests.
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Fiduciary Duties (cont’d)
Loyalty:
Primary duty is to the participants/beneficiaries
Managing the different “hats” we wear
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Duty of Loyalty
Many forms of conduct permissible in a workaday world for those acting at arm’s length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. As to this there has developed a tradition that is unbending and inveterate. Uncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the ‘disintegrating erosion’ of particular exceptions. Only thus has the level of conduct of fiduciaries been kept at a level higher than that trodden by the crowd. It will not consciously be lowered by any judgment of this court.
Chief Judge Cardozo (Meihnard v. Salmon)
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Demonstrating Prudence
Prudence is process:
Clear delegation
Knowledgeable decision-makers
Sound policies
Due diligence process
Effective delegation
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The Challenge
Plan Operations
MemberDemographics
Benefit Policy
Wage Policy
Funding Policy
ActuarialLiabilities
ActuarialAssets
TRUSTEES
InvestmentPolicy
InvestmentStructures
InvestmentActivities
ActuarialAdjustments to Assets
Cash Flow
RiskTolerances
RiskManagement
TurnoverMortalityRetirementsAgeMarried
Client ServicesRecordsPaymentsExpensesAccountingFinancial Reporting
IndexingBenefits
InflationGrowth
?Monthly Pension
at Retirement
Contributions
Asset MixStrategyAsset ClassesExpected Performance
In HouseExternalActivePassiveForeignDerivatives
PurchasesSalesIncomeAppreciationCustodyPerformanceAccounting
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The Answer
More involvement in decisions/operations?
More committees?
More meetings?
Longer meetings?
Answer: A policy-focused board!
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A Policy-focused Board …
Focuses on: setting goals and direction, controlling risk, ensuring accountability, and Building organizational infrastructure
It does above by getting educated, setting sound policies, and building reporting systems.
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The Pension Business
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Effective Boards
Boards cannot be truly effective unless they understand the business they are governing: What is the ultimate purpose? What drives performance? What are the biggest risks? Which decisions are most important? What needs to be measured?
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The Purpose
KCERA January 1, 2003
Pay to Ms. X. Smith $753.00-- Seven Hundred Fifty Three------/100
Big Bank T. Paymaster
KCERA February 1, 2003
Pay to Ms. X. Smith $753.00-- Seven Hundred Fifty Three------/100
Big Bank T. Paymaster
KCERA March 1, 2003
Pay to Ms. X. Smith $753.00-- Seven Hundred Fifty Three------/100
Big Bank T. Paymaster
KCERA April 1, 2003
Pay to Ms. X. Smith $753.00-- Seven Hundred Fifty Three------/100
Big Bank T. Paymaster
KCERA July 1, 2003
Pay to Ms. B. Smith $753.00-- Seven Hundred Fifty Three------/100
Big Bank T. Paymaster
KCERA May 1, 2003
Pay to Ms. X. Smith $753.00-- Seven Hundred Fifty Three------/100
Big Bank T. Paymaster
KCERA June 1, 2003
Pay to Ms. B. Smith $753.00-- Seven Hundred Fifty Three------/100
Big Bank T. Paymaster
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The Pension Business
Discount Rate
Low
High
High Contributions
Liabilities
Risk High
EfficientFrontier
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The Pension Business
Discount Rate
RiskLow
High
High
EfficientFrontier
High Contributions
Liabilities
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How Important is Asset Mix Policy?
It depends:
It explains 90% of variability in return over time for a typical fund
It explains 100% of the absolute level of return
Source: Brinson, Hood, Beebower; Determinants ofPortfolio Performance
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Arithmetic of Active Management
Fees Fees
Passive $ Active $
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Distinguishing Skill vs. Luck
Probability ofUnderperformance
Expected ----------- Holding period ----------Excess Return 5 yrs 10 yrs 30 yrs
1% 42.8% 39.9% 32.9%2% 36.0% 30.6% 18.9%3% 29.6% 22.4% 9.4%
Even if a manager has skill, there is a significant probability that the manager will under-perform for extended periods of time.
* Adapted from: Jeremy Siegel, “Stocks for the Long Run”.
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Major Risks – Funding & Investments
Affordability of benefits
Funding shortfall/contribution volatility
Actuarial assumption risk
Actuarial error
Concentration risk
Conflict of interest
Excessive costs
Imprudent manager selection process
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Major Risks – Benefit Administration
Poor benefit policy
Inaccurate or late benefit payments
Loss of tax exempt status
Communications risk
Human resource risk
Malfeasance or fraud (internal controls)
Mismanagement of MIS projects
Disaster recovery
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Hierarchy of Investment Decisions
1. Mission/Objective of the Fund
2. Risk tolerance level
3. Asset allocation
4. Benchmarks
5. Asset class strategies
6. Manager selection process/criteria
7. Other investment policies and risk parameters
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Hierarchy of Benefit Administration Decisions
Actuarial methods and assumptions
Pension benefit policy
Service quality targets
Organizational structure
Budget
Business plan
Compensation policy
Staff performance evaluation measures
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Major Risks - Governance
Conflicts of interest
Failure to demonstrate prudence
Lack of board knowledge/training
Excessive travel and other expenditures
Micro-management
Breakdown in group dynamics
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Anatomy of Decisions
Boards often view multi-faceted activities as a single decision
In fact, most decisions involve different types of decisions: Policy decisions Strategy decisions Implementation decisions
Some decisions should rest with the Board, some should rest with staff or agents
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Anatomy of Decisions
Annual Communications Plan
Hire Communication Consultants
Prepare Communication Materials
Deliver Communications
Communication Goals & Guidelines
Policy
Strategy
Implementation
Communications Budget
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Accountability
In order to legitimately hold an individual accountable, one must provide: Clear objectives/mandate Authority to make the decisions necessary to
carry out the mandate Necessary resources
Can’t be the doer and the overseer
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Effective Boards: Important vs. Urgent
(A)
Important &
Not Urgent
(B)
Important &
Urgent
(C)
Not Important &
Urgent
(D)
Not Important &
Not Urgent
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Effective Boards (cont’d)
Effective Boards try to: Maximize the time they spend in Box A Spend no time in boxes C and D
By focusing on Box A, effective Boards hope to minimize the need to spend time in Box B.
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Effective Use of Board’s Time
Issue is not frequency of meetings, but quality:
The right agenda Policy and oversight focus
Board member preparation
Meeting materials (quality and timing)
Education
Staff policy analysis and recommendations
2. Board Interviews/Surveys
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The Good
Good mix of backgrounds and training among board members
High level of confidence in current Retirement Administrator
Board invests considerable time
Board practices significantly improved in recent years: More engaged More transparent More information
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The Not-so-good
Perceived lack of clarity regarding roles of board and staff
Dissatisfaction with meetings:– Long and inefficient– Heavy agendas– Too much materials– Seldom closure– Decisions are drawn out over numerous meetings– Repetitive discussions– User-friendliness of board packets
Mixed views on effectiveness of committees
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The Not-so-good (cont’d)
Everyone acknowledges importance of education, but there are mixed views on implementation: Conferences vs. in-house Mandatory vs. encouraged
Stronger orientation needed
More focus on investments and ethics training
Need to review our policies periodically
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Not-so-good (cont’d)
Numerous policy gaps: Communications (vis-à-vis staff, members,
vendors) Planning Retirement Administrator evaluation Service provider evaluation/RFPs
Frustration with disability process: Implementation vs. strategy
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Cortex’s Assessment
Prior boards and administration left little in the way of a policy framework/institutional memory
Current board has been mired in fighting fires over past several years (i.e. reactive mode)
There is now a commitment to moving to a proactive governance approach
Challenges lie in both the lack of a framework and executing the existing framework
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Cortex Assessment (cont’d)
Multi-pronged action plan:
Find/create efficiencies
Policy work
Training and education
Information and reporting
4. Discussion
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Roles & Responsibilities
Board, Chair, Committees, individual board members, Retirement Administrator
Discussion topics: Vendor selection Manager interviews Staff hiring/firing Strategic/business plans Policy analysis/recommendations from RA
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Vendor Selection
Which vendors/advisors does the Board consider to be primary advisors which the Board must select? (Other advisors/services presumably can be selected by the Retirement Admin.)
What level of involvement/information does the Board expect with respect to the selection of vendors/advisors by the Retirement Administrator?
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Manager Interviews
The Board currently interviews all investment managers on an 18 month cycle. Can the Board’s involvement in this area be reduced? If so, how?
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Staff Hiring/Firing
Please confirm the role the Board believes it should play with respect to the hiring and firing of staff other than the Retirement Administrator. Senior management vs. staff
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Planning
Does the Board expect formal strategic/ business plans be developed?
If so, what role should the Board and Retirement Administrator play in developing such plans?
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Policy Analysis
What are the Board’s expectations of the Retirement Administrator with respect to policy analysis and recommendations? Verbal vs. written report? Analysis of alternatives? Concrete recommendations?
What are the Board’s expectations of its committees with respect to the above?
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Role of Chair
What are the primary functions of the Chair position? Provide vision and leadership? Run effective meetings? Police the Board? Other?
Provide supporting details
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Board Member Expectations
What are the key things the Board expects of individual board members in order to maximize the effectiveness of the Board as a whole?
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Committees
Please discuss any changes you would like to see regarding committees: Number of committees Mandates of committees How committees operate Other
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Please select the 5 policies you would like Cortex to prepare
1. Trustee education
2. Policy development process
3. Board operations
4. Code of conduct
5. Service provider evaluation
6. Board communications
Board self-evaluation
Retirement Administrator performance evaluation
Planning policy
Monitoring & reporting
Other
5. Wrap-up