Commentary: What’s next for government and higher education retirement plans in the U.S.?

Few U.S. industries are entrusted with the hopes and dreams of millions of Americans, but pension and retirement funds have that privilege — and responsibility. Amid the COVID-19 pandemic, pension and retirement funds for U.S. state and local governments and higher education institutions have demonstrated a resilience worthy of that duty.

Today, the leaders of such funds must navigate a changing environment while managing employer interactions and delivering financial well-being to members, pensioners, and beneficiaries. Conversations with trustee boards, senior management and key policymakers offer insights on three key trends that will impact pension and retirement funds in the near term.

The uncertainty of the pandemic emphasized that government and higher education retirement plans can be exposed to significant investment risks. In this regard, many pension leaders and trustee boards take a conservative approach to assess and mitigate asset management risks. Yet, improperly identified and managed operational, cybersecurity, third-party or business-continuity risks may be overlooked, raising two key questions: How does aggressive risk-taking align with good governance, fiduciary duty and member best interest expectations? And, what level of ERM maturity and evidence are adequate?

Too many organizations and their boards focus only on the compliance side of ERM: "Keep me out of trouble." Few evolve to the value-adding mindset of "help me make my business and outcomes better." Leading organizations and boards focus on "the five Cs" to assess, determine and evolve their ERM framework and implementation to deliver better outcomes:

1. Culture, appetite for risk and governance set by the board: Are they clearly defined, agreed, communicated and operating effectively?
2. Commensurate: Is our risk culture, risk governance, ERM framework and our solutions across all parts of our business aligned to the level of our risk exposure, risk appetite, organizational size and complexity (members, assets, plan complexity, plans serviced), and importance to and expectations of key stakeholders, including sponsoring employers and government and as fiduciary?
3. Cascaded: Do our ERM framework and solutions cover all parts of our business, including third-party providers and partners?
4. Commissioned: Are our audit and risk board committee members, chief risk officer, ERM unit and risk stewards adequately empowered to identify, manage and report any existing and emerging business risks and incidents collaboratively, and influence any relevant business decisions or outcomes?
5. Collaboration and communication: Are all relevant stakeholders collaborating effectively on risk and ERM, and are risks, incidents and outcomes effectively managed, measured, evidenced, reported, communicated and disclosed?

Pension trustees and funds should examine their risk appetite and determine whether it aligns with their levels of exposure and whether they have any ERM maturity gaps to be addressed. This will confirm that leaders can make informed decisions on how to evolve accordingly.

In our 2018 global pension study, about 50% of all interviewees indicated that the maturity of their investment operations is not aligned with their investment portfolio risks and expected investment outcomes. As some of the world's largest asset owners and investors, government and higher education retirement plans have become increasingly complex as they continue to expand portfolios, asset classes and managers, and bring management in-house.

Investment operations are often fragmented. Data, technology solutions and capabilities, and reporting are disconnected, and integration across asset classes and portfolios is often lacking. Gaps may be due to rapidly evolving investment compliance requirements, increased reporting requirements, shifting toward more active implementation styles and launching separately managed accounts and direct investments. In addition, market volatility over the past year, along with an accelerating focus on long-term sustainability, underscores the need for comprehensive and timely data analysis, leading to enhanced decision-making.

Operating with insufficient investment resiliency is a risky approach, especially in an age of increased public scrutiny and given growing governance and fiduciary expectations. Leaders must ask themselves: Are we sufficiently focused on investment operations-related strategic and operational risks? And, if the answer is no: How do those gaps impact investment risks and outcomes, today and tomorrow?

Recently, several leading government and higher education retirement plans have joined global peers in transforming their investment operations to increase resilience and transparency. There is a growing effort to enhance front-, middle- and back-office capabilities, improving data and technology solutions across traditional or real asset classes. Additionally, we are witnessing an increase in reviewing and tightening the governance of investment managers or asset servicing relationships and interactions.

Carrying unnecessary risks to investment operations, leading to potential limitations on investment decision-making, seems counterintuitive in a volatile and lower-return future. Leaders should align and transform investment operations maturity and resilience while adequately focusing on investment operations risks.

The pandemic exposed significant financial, short- and long-term savings resilience issues. Now, more than ever, most pension fund members and beneficiaries of government and higher education retirement plans need help with their financial well-being. However, some leading funds are evolving their interpretation of what it means to carry out their fiduciary duty to act in members' best interests.

Such funds should pivot their scope, purpose and strategy toward broader financial well-being. Better enabling members with a range of retirement, health, savings and empowerment offerings, products, services and solutions can deliver better outcomes. Early pilots show promising value-adding benefits for members, sponsoring employers and agencies through overall long-term cost reductions. Leveraging the fund's trusted partner relationship with its members, existing infrastructure and purchasing power, approaches range from in-house delivery to partnering, collaboration or ecosystem orchestration. Digital self-service tools, coupled with financial literacy, financial budgeting solutions and digital "nudging" encourage necessary behavioral change.

Government and higher education retirement plans are in a dynamic "risk" business. The pandemic has fundamentally impacted how they manage, evolve and adapt their operations, governance, outcomes and stakeholder expectations. When and how funds respond to our changing world will determine how they will deliver on their mission to contribute to their members' financial well-being — and be the keeper of millions of Americans' dreams for the future.

Josef Pilger leads EY's global pension and retirement practice, and Courtney Murray is EY's U.S. government and public sector pension leader. Mr. Pilger is based in Washington. Ms. Murray is based in New York. This content represents the views of the authors. It was submitted and edited under Pensions & Investments guidelines but is not a product of P&I's editorial team.