Topic 1: Governance of Pension Plans
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Learning Objectives
At the end of this topic, you should be able to answer these questions:
- What is governance?
- Why is governance required?
- What are the differences between Corporate Governance and Pension Governance
What is the Governance?
Governance is a term that is widely used in a variety of contexts to describe the process of accountability between two parties where one is obligated, through formal or informal contract, to implement tasks and responsibilities on behalf of the other. For businesses or firms, Shleifer and Vishny (1997) define corporate governance as “…the ways in which suppliers of finance assure themselves of getting a return on their investment.” For pensions, the suppliers of finance, or principals, are the pension plan subscribers. Their agents , the other party in the contracting relationship are the various service providers tasked with different responsibilities in the pension management process. The governance framework is not only to ensure accountability and compliance but also to create a decision-making context that leads to superior outcomes or returns on investments.
There are four topics in the governance module. In this topic we discuss a standard view of the structure of pension management and governance. In the following topic we learn that the requirement of pension governance arises because of ‘broken agency’ and strongly non-contractible incomplete contacts. The analysis shows that effective pension governance requires the reduction of opportunism as a behavior. This sets up the discussion in the third topic, for an examination of the role of learning mechanisms and the specific form of learning that will reduces the scope and scale of opportunistic behavior between principals (pension subscribers) and their agents (financial service providers). In the fourth and final topic we discuss some mechanisms that will facilitate the effective working of the learning mode that reduces opportunism in pension governance.
Figure 10 provides a standardized overview of various players and relations in the management of asset based pensions, that are prefunded by accumulating financial assets or savings during the working life of the pension subscribers. Such prefunded pension plans can be of two types. They can be either individually subscribed and managed or they can be managed at an organizational level. The organizational level pension plans can be part of the workplace benefits, or they can be the outcome of public policy. The public policy plans are also called compulsory payroll deductions and are mandated by law with a defined benefit component, which can be means tested. Typically, most organizational pension plans do not have an opt out feature and are mandatory for all members of the organization or the society that sponsors such a pension policy. In Canada, the Canada Pension Plan is an example of such a plan.
If the plan is individually owned, the pension s