Pension Funds Face Facts

Date: Monday, May 4, 2009
Author: Market Media Online.com

'There's no simple answer,' says International Centre for Pension Management at the Rotman School of Management in University of Toronto.

By Karla L. Yeh, Chicago Correspondent

Chicago – Pension funds struggling to reverse significant losses from the financial crisis must refocus on adequate corporate governance, according to Keith Ambachtsheer, director the International Centre for Pension Management at the Rotman School of Management in University of Toronto. Markets Media spoke to Ambachtsheer, who also founded KPA Advisory Services, a provider of governance, finance and investment advice to governments, industry associations, pension plan sponsors and other institutional investors worldwide, about issues plaguing pensions across North America and controversies surrounding proposed funding legislation.

Markets Media: What is the most critical issue for pensions existing today and after a year of record losses, what must pensions focus on to get back on track?

Keith Ambachtsheer: At the employer level, there are two kinds of plans: defined benefit and defined contribution. The extension of the defined contributions goes into IRAs. The people that have their own personal pension accounts got whacked 20, 30 percent last year, but it's not an employer issue. It's a question of what these people do. If you're young and have worked, all the future contributions will be buying securities at better prices than before. But if you're somebody in your 50s, 60s, 70s and you have these pension accounts with a lot of stock in them, you just lost 30 percent of the pension with not great prospects for making that back up again. There's no simple answer to the question. It depends. On the defined benefit side, with high credit to and a good quality employer, public or private, you probably will not be impacted at all and you're still going to get your pension. But if the balance sheet is under-funded, then you're going to have to make that up, and the burden is on the employer. General Motors is dealing with a pension that's 50 percent funded, and there's a significant possibility that the employer won't be around 10 years from now. It might be restructured in a way that you might not get your full pension. With low quality credit, workers won't get anywhere near what the original pension formula was, that's the reality.

MM: What could be the best strategy out there for pension funds to recover?

KA: You see everything under the sun. Some employers are now on the defined benefit side and they're de-risking. It's probably not a great time to be de-risking. Other ones are totally on the other side of the spectrum. They're loading up on risk and making their assets look like liabilities. A lot of these funds don't have a lot of assets to meet liabilities. It depends on what pensions plan to do about their shortfall. You can take a lot of risk and hope things go back on side or decide you don't want to be on the risk business and de-risk to make up for the shortfall and let the thing run off. There's no standard approach, it depends on the individual employer.

MM: In the first journal ICPM published in October 2008, you highlighted the pension governance deficit. How should pension funds move forward in terms of governance?

KA: The big news was there aren't very many changes. There are still significant problems in governance of pension plans. There was then and there still is, unfortunately. There's no simple answer because the problems relate to the type of plan it is. Typically, in corporate plans, it's the management that does the governing. In state employee plans you have a much different way of putting the board together. The governor typically gets involved in that situation, and you end up with a different board. Some boards are not qualified to do oversight. There's a question of what role government should play in this. Dutch pensions are forcing boards to be qualified – if you don't meet the qualifications then they actually can dismember the board. I like that approach. People should be electing from a pool of people who meet qualifications in terms of competency. MM: How do pension funds in the U.S. compare to those in Canada and what can the two countries learn from each other? KA: Pension plans in the U.S. and Canada are not so much different. Canada does have a number of major pension funds that are actually quite well-governed because they were designed that way and part of the architecture of the plan was to ensure there would be good governance. You don't see that in the U.S. except by accident. But there are some not-too-good examples in Canada as well. A place like the Netherlands has thought it through the most. Their pension is considered to be a very important societal element. Everybody's a member of a pension plan in the Netherlands and there are sensible government regulations as to how it works.

MM: What initiatives will ICPM focus on this year?

KA: The June discussion forum focuses on the role that pension funds should be playing in financial system reform and in pension system reform. In October, we're in Melbourne talking about what can Australia and New Zealand teach the world about pensions and vice versa. The June forum is always here in Toronto and the centre has research partners from nine different countries. The October forum moves around to the home bases of non-Canadian research partners. We were in the Netherlands a couple years ago, we were in Tacoma, Wash., just this passed October, we're in Melbourne this October and we'll be in Copenhagen next year.

MM: What roles can pension funds play in financial market recovery?

KA: They can play a very important role in reforming the financial system. Collectively, [pension funds] are the beneficial owners of the means of products. They own significant amounts of corporations in the world and are knowledgeable owners, they can have a significant impact on corporate governance and how these companies are managed. They also have the oversight of basically holding boards of directors accountable for making sure that these corporations are producing value for their shareholders. If you look at what happened in the last few years, everybody seemed to be in it for themselves and not creating value for shareholders. That's something pension funds can change.

Keith Ambachtsheer became director of the International Centre for Pension Management at University of Toronto's Rotman School of Management in 2005. ICPM conducts research for pension fund legislation and regulation improvement, focusing on financial characteristics and viability of various forms of pension arrangements, identification of management of agency issues in the pension field, effective governance and organization design of pension funds, formation and revision of defensible investment beliefs, relevant definitions, measurement and management of pension stakeholder risk exposures and design of optimal implementation strategies. Ambachtsheer is president of Toronto-based KPA Advisory Services, which he founded in 1985.