Pension Fund Risk Management: Act Before the Fact

I've been in sunny Las Vegas the last few days, courtesy of the Association for Financial Professionals (AFP). Part of AFP's concerted effort to provide its members with additional risk management resources, I led a Sunday workshop on getting started, creating an effective process and choosing an appropriate risk metric.

During my talk, I cited the importance of having a risk culture in place, without which (in my view) it is virtually impossible to make meaningful changes.

So what is a risk culture? How does it reflect an organization's willingness to act before the fact? Can some organizations differentiate themselves by taking a prescriptive approach to minimize litigation, reputation and non-compliance risk? What are some characteristics of a company with a risk culture?

Here are a few thoughts.

1. A company described as having a risk culture is one for which risk management is embedded in every aspect of the company's operations and not seen as a separate, stand alone activity. It is integral to each policy, procedure, strategy and tactic adoped by the firm.

2. By acting before the fact, a company can save money and time by anticipating problems and determining appropriate solutions now, avoid unwanted stress from outside investigators - regulators, litigators, watchdog groups - and maximize shareholder wealth by identifying oportunities for improvement.

3. Studies increasingly suggest that shareholders and consumers favor companies that do the right thing on their own rather than being forced into good behavior. This implies that effective risk management has an economic value beyond the obvious loss avoidance potential.

4. When evaluating whether a company has a risk culture, consider the following questions.

(a) Do senior level executives and board members "talk up" the company's commitment to a risk culture?

(b) Are risk management policies and procedures made public? At a minimum, employees and shareholders need to know.

(c) Are risk issues communicated clearly and with sufficient detail?

(d) Are employees reviewed and/or promoted on the basis of their adherence to risk management objectives? By extension, are they demoted or otherwise penalized for not wearing the risk badge of honor?

(e) Have ample systems and staff been provided to support a meaningful risk management effort?

(f) Does the company have a Chief Risk Officer? If so, does that person report to the board and enjoy adequate independence to make exceptions to the rule, as needed?

Applied to pension funds, the issue of a risk culture and taking steps to act before the fact is huge. ERISA fiduciary breach litigation is skyrocketing as are ERISA liability insurance costs, not to mention the economic urgency for mitigating risk in the presence of large and growing liabilities.

What better way to convey a message to shareholders and plan participants alike than to say "We recognize risk and actively manage it. It does not manage us."

Here are some things that companies (and public plans) can do to get started.

1. Create a table that lists various types of pension fund risk drivers, estimated probability of occurrence and financial impact.

2. Create, and publicize, a risk management policy for each plan. It should include the vetting process for money managers with respect to their risk management policies and procedures. In addition, it should address alternative strategies for controlling risks identified in step 1. (The list is long. Write us if you want to know more.)

3. Hire a Chief Risk Officer (CRO) who has responsibility for retirement plans. In most companies, it is simply not feasible to have a benefits CRO. However, a CRO with responsibility for enterprise value creation and/or protection should be asked to consider all benefit plans when building a storm-proof risk shelter.

4. Get the team onboard by including risk issues in performance reviews. For example, someone with pension investment responsibilities should be rewarded on the basis of risk-adjusted performance.

5. Recognize that a process is ongoing and requires care and feeding.

It's never too late to get started. To do otherwise invites trouble. Gambling is great in Las Vegas but do you really want to explain losses or sub-par performance to the inquiring public, let alone a regulator or opposing side attorney? posted by Susan Mangiero at 10/17/2006 02:32:00 AM