Views on improving the integrity of global capital markets
21 March 2011

Pension Plans — Assuming the Best in the Worst of Times

Posted In: Fiduciary Duty

CFA Institute has spent considerable time developing a code of conduct for pension trustees. The Pension Trustee Code of Conduct (PDF) is not a how-to manual or another entry into the parade of best-practice guidelines for pension fund governance. Rather, it is intended to serve as a bold reminder of the strict and monumentally consequential obligations that apply to stewards of retirement assets. These are considerable responsibilities under normal circumstances. However, the weakened financial condition of plan sponsors — the funding hardships faced by municipal and state governments in particular — has served to compound matters for pension officials.

During the period of record market gains leading up to the financial bailout, life was good. Plan resources were at all time highs, investment returns were plum, and even the under-funded plans were confident that the market would cure all ills. But, as the saying goes, “all good things must come to an end.” The question now is how badly will it end? Faced with declining returns and uncertain employer budgets, the responsibilities required of pension trustees have seldom taken on such significance.

Even in normal economic times there are a number of decisions that can affect the all-important funding level of a pension plan, including elements of actuarial science that are beyond this brief comment. Suffice to say, a critical determination is the rate of return that is assumed on the pool of existing assets, i.e. how much of an investment return will the fund generate.

Put simply, the golden rule of pension trusteeship is whether the expected fund balance, plus investment returns and employer contributions, are adequate to meet the plan liabilities now, and in the future. It is a fragile balance for trustees. Indeed, when investment returns are strong, employer (government) contributions are low. Imagine the pressure on pension boards to keep returns as high as possible to offset the need to tap into taxpayer-funded state and local budgets. Look no farther than the Wisconsin budget turmoil and focus on public employee pensions to understand the political dynamics at work here. The huge California pension plan is among dozens of others similarly challenged to minimize employer contributions in tough budgetary times. (See “California Still Dreamin’ on Pensions,” by David Reilly, Wall Street Journal’s Heard on the Street, March 17, 2011.

It is a noteworthy moment when in the course of budget difficulties, a pension trustee is prompted to do things in the name of preserving the status quo or to avoid hard political issues such as the level of government contribution. No doubt the politics of the matter can and will drive decisions that will challenge nearly every fiduciary obligation involved. The CFA Institute Pension Trustee Code of Conduct is clear on this point — fiduciary duty does not diminish in these circumstances and trustees should certainly consider the solvency of the plan sponsor. However, any pension trustee worth their salt must not allow pension contributions to be the first and primary tool for budget repair. Camouflaging such actions in the guise of artificially high rate of return assumptions is no different.

With each instance of compromise on fiduciary duty, it becomes a slippery slope. When tied to the politics du jour, the entire premise of fiduciary responsibility is in jeopardy.

About the Author(s)
Kurt Schacht, JD, CFA

Kurt Schacht, JD, CFA, is the Senior Head, Advocacy Advisor, Capital Markets Policy at CFA Institute, where he oversees advocacy efforts and the development, maintenance, and promotion of the highest ethical standards of practice for the global investment management industry.

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