Dick Kamp: Risk management and pension ambition

October 3, 2023

^{This column was originally written in Dutch. This is an English translation.}

By Dick Kamp, Director Pension, Investment and Risk at Milliman Pensioen

In this article we take a 'fast forward' to the situation in which pension funds implement the pension scheme under the new pension contract. The social partners have asked the board of the pension funds to implement the pension scheme they devised. The premium-risk-ambition triangle has been completed by the social partners.

In this triangle, the premium is the financial budget that will not change for a certain period (for example, five years). The risk concerns the investment risk, derived from the risk preference of the participants, with which the existing capital and the premium to be received will be invested. All this results in ambition. This is the pension outcome expressed in the replacement value, adjusted for inflation.

The question now is what the pension fund board is committed to. Is that due to the risk involved in investing? After all, that is what the board of the pension fund has direct influence on. And is that also the ambition, or the result of the capital, the premium deposit and the investment policy pursued?

Towards a result obligation?

I have not yet seen the text of a new style implementation agreement. But from a legal perspective I can imagine that some kind of result obligation is agreed on the investment policy to be pursued. I expect that agreements on ambition will mainly be made in terms of effort. The question is what the participants will think of this.

I expect that participants will increasingly understand that the expected pension outcome (the ambition) depends on the investment policy to be pursued and developments in the financial markets. After all, the design of the new system is based on this. It is expected that the comparability of credited investment returns at age cohort level will increase.

As long as the ambition is realized, or the expected pension is in line with the communicated expectations, participants will be satisfied. There will be periods over time when investment returns lag. Pension outcomes will therefore lag behind expectations. Participants are expected to look more actively at the differences between pension funds. They will also question the board of the pension fund more critically.

Expectation versus responsibility

At that time, the board of the pension fund can rely on the agreed risk. The participant will address the board about the ambition. You can therefore say that the board at least has a moral obligation to do its utmost to achieve the ambition. How can the board manage the possible discrepancy in expectations and responsibility? I think there are at least three things at play.

Firstly, the wording of the agreement in the implementation agreement or implementation regulations. This must be such that it is appropriate for the expectations of the participant. I understand that an ambition cannot be guaranteed, but the pursuit of it can.

Secondly, the design of the (strategic) investment cycle (see my previous article about this). The current cycle is based on a three-year strategic adjustment. The question is whether that is not too long a term. In my opinion, the current consolidation of people and resources makes a more sophisticated design of the investment cycle possible. I call for a pension sector-wide investigation into this.

Thirdly, and certainly not lastly, pension communication. The biggest risk that the pension fund (and therefore the sector) runs is that participants lose faith in the pension fund and pension. Communication strategies need to be considered for the (anticipated) situation in which the ambition is not achieved or only achieved to a very limited extent, or in which it is a very 'bumpy ride'. This is also in the interest of the sector.

Dear pension fund manager, when making agreements with social partners and setting up the organization after joining, do you also take into account the risk of not achieving the ambition?

This is the twentieth column in a series on risk management. The series aims to encourage the reader to consider risk management as an integral part of running a pension fund.

More columns by Dick Kamp