Dick Kamp: Risk management and the standards framework

Dick Kamp: Risk management and the standards framework

Risk Management Pension system Pensionfunds
Dick Kamp

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

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

Boards of pension funds face a major challenge with the introduction of the Wtp. The social pressure to enter with the accumulated past is high and there are still a number of decisions to be made regarding assignment acceptance, the policy up to entry, the entry itself and the policy after entry. It is therefore important that these decisions are made in conjunction with each other.

Coherence in policy presupposes that there is a commonly supported basis for all decisions to be made. This commonly supported basis is called the standards framework. But what is the standards framework actually and how is it applied?

The standards framework

The framework of standards is essentially a set of agreed rules against which you want to test decisions (for example for balance), which turns policy issues into mathematical formulas in 'the ideal world'. It would look something like this: Policy issue x possible solutions x framework of standards = new policy. Unfortunately, 'the real world' is more unruly. Policy issues are usually qualitative in nature and therefore difficult to add and multiply. How can a consistent and sound policy be achieved? There are two components to this. The content component and the process component.

The content component: external standards

Unfortunately, the framework of standards of a pension fund is not an unambiguous document 'on the shelf' of a pension fund. It is a composition of different elements. It consists of externally defined standards, such as the Wtp and subordinate regulations from DNB and AFM. Other external standards include the Pension Funds Code and best practices and guidelines of DNB, AFM and the Pension Federation.

There appears to be a hierarchy of standards: higher standards, such as the Pension Act, lower legislation and the Pension Funds Code, and also lower or more derived standards, such as best practices and guidelines.

The content component: internal standards

The same hierarchy is also found in the internal standards of a pension fund. The higher standards concern, for example, the vision and mission document. But this also includes the principles of balance agreed within the pension fund. In addition, a pension fund has 'lower' standards. These are derived from the higher internal standards and the external standards. These concern all the different policy documents that a pension fund adopts. This includes, among other things, the investment beliefs, the investment policy, the outsourcing policy, the communication policy and the data quality policy.

The challenge of the pension fund board is that there must be a coherent set of internal and external and high and lower standards. There must be logic in the (own) formulated policy. This logic is of great importance in the explainability and feasibility of policy to the relevant stakeholders of the pension fund.

The process component

Coherence in policy is created by following a structured and logical process. The BOB model for decision-making used by most pension funds is an important element in this. Explicit attention is paid to the process steps of Image Formation, Judgment Formation and Decision Making. In particular, the correct elaboration of the assessment phase is an important guarantee. And therein lies the critical element. In the assessment phase, a choice is made for the framework of standards against which a policy proposal is then weighed. This framework of standards was therefore not 'coincidentally' devised at the time of writing the policy document.

The standards framework used is the explicit expression of the formally established standards of the pension fund. Derivative aspects of the vision and mission of the pension fund and also, for example, the formulated balance framework provide the inspiration for the standards framework in the assessment phase. This is of course done in accordance with established standards, legislation and regulations, guidelines and best practices from, for example, the Pension Federation and other policy documents of the pension fund.

The judgment phase

In the assessment phase, a board must explicitly ask itself whether the policy intention is appropriate and in conjunction with previously established policy. And also whether the application of the standards framework provides sufficient guidance for communication with the relevant stakeholders. Recording the assessment is therefore essential for substantiating subsequent decision-making and substantiating it to stakeholders.

Sometimes the standards framework needs adjustment because it is not sufficiently appropriate for the issue at hand. It may also be that due to changing circumstances, external or internal, the standards framework no longer fits. In that case, a reconsideration must take place. In practice we see this when defining the equilibrium framework. Under the new pension system, the old equilibrium framework (including due to changed investment risk distribution over generations and a different interpretation of solidarity between participants) no longer appears to be appropriate for pension fund boards and is being redefined. But this is just an example.

Policy issues

Finally, dear board member, you see the importance of the standards framework and how it is applied in policy and decision-making and ultimately in business operations.

Do you believe that there is sufficient coherence in the framework of standards used by the pension fund, that it is sufficiently up to date with current administrative insights and is also correctly applied in the decision-making processes for the challenges that currently lie ahead?

This is the twenty-sixth 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.