Recommendations Aim to Strengthen Law Requiring Independent Evaluations of Pension System Investments
The Investment Committee of the Pension Review Board of Texas agreed on Sept. 29 to take the next step in strengthening Senate Bill 322, the 2019 law requiring independent evaluations of pension system investments. As a result, during its Nov. 12 meeting, the Board is likely to pass and send the recommendations to the Legislature for possible implementation in 2021.
The legislative recommendations come after months of discussions about reports that the Pension Review Board, the state agency mandated to oversee all state and local public pension retirement systems in Texas, received from 55 Texas pension funds for their compliance with SB 322. That 2019 bill requires an “independent firm with substantial experience in evaluating institutional investment practices and performance to make recommendations for improving the retirement system’s investment policies, procedures, and practices.”
Board members picked over the reports during previous meetings. Of keen interest to staff and Board members was the observation that the reports which did not contain recommendations for change were done by evaluators who already had existing relationships with the pension funds. SB 322 enables a pension system to select its own evaluation firm, and a firm could be one with which a pension fund already had an existing relationship, so long as the relationship did not manage investments directly or indirectly for a system.
In line with those earlier observations, during the Sept. 29 PRB Investment Committee meeting conducted as a video conference due to the novel coronavirus pandemic, PRB staff actuary Kenny Herbold recommended legislative revisions to change the selection process. The changes would restrict a pension fund from using an evaluator who originally helped the system develop its existing policies, procedures, and practices.
>WATCH THE MEETING: Click for a Recording of the Video Conference.Herbold also recommended that, instead of the pension fund, city sponsors should be responsible for selecting and hiring the third-party evaluator. He noted how Texas law requires the Teachers Retirement System and the three Houston pension funds to have a third-party actuary, hired by the governmental entity, to conduct a risk-sharing valuation study. These studies then become part of a process for establishing an agreed-upon contribution rate.
Herbold cited those previous legislative changes as precedent for requiring the city sponsors to participate, and presumably pay for the third-party investment evaluator. This new process, Herbold said, would put more reasonability on the sponsor, create independence in the evaluation process, and bring another level of transparency to investment decision making.
Herbold said he believed these changes would prevent the existing investment consultant from reviewing their own work, thereby creating perceptions about a lack of independence.
Art Alfaro, executive director of the Texas Association of Public Employee Retirement Systems, agreed that the city sponsors would likely want to pick up the costs to get a truly independent evaluation consultant. TEXPERS is a nonprofit professional educational organization whose members are trustees, administrators, employee groups, and vendors involved in the management of retirement funds.
“TEXPERS has always opposed unfunded mandates on Texas pension systems, and the legislature has accommodated our position in the past, especially because the state does not contribute to local plans and are not liable for local pension funds,” Alfaro said. “The PRB recommendations deserve further study once they are finalized, but we can see the value of what the PRB is saying. A city sponsor would benefit from paying for a third-party evaluation consultant. We will be following this matter closely on behalf of our members.”
“Regardless of whether you are making a recommendation or not, there should be an explanation of how that determination is made,” Herbold said.
His presentation to the Board indicates this would enhance stakeholder understanding of the investment decision-making process and help foster “informed decision-making.”
Herbold also wants third-party evaluators to more clearly identify their “substantial experience in evaluating institutional investment practices and performance.” Some of the SB 322 reports did not clearly identify the evaluator or their qualifications. This legislative recommendation would require evaluator qualifications to be described and for the relationship between the evaluator and the pension fund to be disclosed. The disclosure would acknowledge whether any potential conflicts of interest exist and whether the evaluator received payment for their service. And the disclosure would spell out whether the firm is directly or indirectly managing investments.
Another recommendation would require more documentation about how the report is formed and shared between the pension fund and its city sponsor before submitting it to the Pension Review Board. Members of the Board’s investment committee have questioned whether the evaluations are being viewed or taken seriously by pension fund trustees. The documentation would clearly establish how the retirement system considered the evaluation and show stakeholders the actions the retirement system intended to take on any recommendations of the third-party evaluator.