Bottomline:
Investments can be complicated, but are just once piece of a trustee’s responsibilities.
Trustees aren’t required to be investment experts, but should always be striving to improve their understanding and consider what’s in the best interest of the risk pool.
What is Opportunity Cost?
The loss of potential gain from other alternatives when one alternative is chose.
What is a Fiduciary?
A fiduciary is legally and ethically held to ensuring any financial/investment services and expertise they provide your risk pool is solely in the best interest of your organization.
Bottomline:
While many risk pools face constraints in what they can invest in, diversification can still be found in a variety of ways. Trustees should strive to consider all possibilities and conduct reviews on a routine basis.
Bottomline:
The investment portfolio should be tied to the risk pool’s goals, objectives, and operations.
Conducting reviews of the risk pool’s regulatory constraints, risk appetite, and portfolio allocation not only finds potential avenues for improvement, but will also help trustees strengthen their understanding of the investment process.
How to Help Your Risk Pool's Trustees Fulfill Their
Investment Responsibilities
View PDF / Appendix >>
Given the growing concern over succession issues and Board of Trustees turnover within the Pooling community, we’ve developed a primer to help Trustees understand and review their role within the pool’s investment operations.
This primer highlights a Trustee’s investment responsibilities, as well as common errors. An Appendix is also provided to further detail the key elements of a risk pool’s investment process.
Executive Summary
- Trustees have a duty to act with reasonable skill and care, seek appropriate advice when needed, and keep investments under regular review.
- Investment decision-making must consider suitability, diversification, the delegation (not abdication) of investment management functions.
- Common errors made by Trustees are insufficient diversification or asset class consideration, as well as sporadic (or absent) reviews of fees or process; creating opportunity costs and/or weakened performance.
- Trustees should be prudent in understanding their risk pool’s regulatory considerations, internal risk appetite, and potential alternatives to the current portfolio structure.
What Are a Trustee’s Investment Responsibilities?
Trustees for government risk pools carry numerous duties as part of their overall responsibilities for the pool’s investment operations:
- To act with ‘reasonable’ skill and care;
Dependent upon the trustee’s personal knowledge. - To take advice where appropriate;
If not fluent with investments, trustees should get proper advice unless the cost of advice is prohibitive relative to the size of the risk pool. Any advice being truly considered should also carry a suitable level of risk and diversification. - To keep investments under review;
Investments should be reviewed regularly by trustees in conjunction with appointed advisors, as applicable.
Trustees must also include these key elements into their decision-making process as it relates to their investment responsibilities:
- Suitability
Trustees must take into account the needs of the policyholders, the purpose of the trust and type of existing investments. Trustees must also determine whether it would be more appropriate to invest in other investment classes. - Diversification
Trustees should be mindful of maintaining a spread of investments with a view to reducing the overall risk profile of the pool. - Delegation, not abdication, of investment management functions
While trustees may appoint a discretionary manager, the manager must provide a written investment policy statement, with trustees periodically reviewing that statement. The manager should advise how they incorporate the Trustees’ adopted investment policy when the manager makes investment decisions or recommendations.
Given these considerations, it is important that trustees understand their risk pool’s investment process in order to correctly apply these elements and fulfill their overall investment responsibilities.
What are typical errors Trustees make?
Trustees are often unaware of investment decisions that could have provided an opportunity for improvement, but are never shown on your financial statements:
- Not considering all possible asset classes or investments within that asset class can result in lower investment income
- Not considering the possibility and the potential impact from a more diversified portfolio can result in lower portfolio investment returns, adjusted for risk.
- Not reviewing your pool’s investment process periodically can result in poorer investment results.
- Not reviewing investment management fees can result in lower investment income and returns.
Another common error Trustees make is applying practices that are typical for personal investments, but are not applicable to a risk pool’s investment process.
- Personal investment portfolios differ greatly from a risk pool’s, for example objectives, time horizon, constraints, and tax situation.
- Likewise, trustees can also mistakenly apply investment practices they’ve seen for endowments, foundations, pension funds, etc. However, a risk pool’s practices greatly differ.
- Trustees should always consider enterprise risk factors specific to risk pools when making investment decisions.
Finally, many Trustees do not receive investment advice from a true Fiduciary, which may result in actions that are not in the best interest of your risk pool.
Key Considerations and Next Steps
Understanding Regulatory Constraints on Allowable Asset Classes:
Regulations can impose constraints on potential allocations to certain asset classes. Thus, a review of the applicable regulatory framework is an integral part of any asset allocation modeling.
Determining Risk Appetite:
Risk tolerance is vital to the strategic asset allocation process. The amount of risk an insurer or risk pool is comfortable taking on within the portfolio will shape the overall investment program.
A short questionnaire to staff, Board members and trustees can help put some constraints around any asset allocation models being reviewed.
Most importantly, scenario-based impact analyses can be helpful in identifying and adopting an appropriate asset allocation framework.
Review Current Asset Allocation and Potential Alternatives:
Insurers and risk pools can compare their current asset allocation to other potential models in various ways. Potential asset allocation models can be focused on the asset side of the balance sheet or can also include the impact of reserves.
Many also model asset allocations by considering reserves, surplus, and other financial considerations. Because risk pools already have leverage built into their financial statements, evaluating the additional leverage from investment allocation decisions is important to manage the enterprise risk.
It may also be beneficial to test how your portfolio may perform by simply changing the allocated amount to certain asset classes.
Continue to Appendix: Key Elements of a Risk Pool's Investment Process >>