Dick Kamp: Risk management and observation
This column was originally written in Dutch. This is an English translation.
By Dick Kamp, Director of Pension, Investment & Risk at Milliman Pension
I recently read Autocracy Inc., the latest book by journalist Anne Applebaum. I was particularly intrigued by her ability to recognize patterns and developments that others overlook.
In this case, she observed that dictators and autocratic countries systematically work together and thereby influence the entire world. An interesting observation. And if you think about it, you see this all the time. Someone observes a pattern, or thinks they observe one, analyzes it and draws conclusions from it.
Psychologist Daniel Kahneman has also written about this. If you are on the savannah and see movement in the grass, a 'break in the pattern', it could be a lion and you must flee immediately. As mentioned, we humans are constantly scanning and analyzing our environment. We try to draw conclusions and decide to take action. Doing nothing can also be an action.
Kahneman distinguishes between system 1 and system 2 thinking. In system 1 thinking, we draw conclusions and react immediately, which is very useful when meeting a lion, for example. In system 2 thinking, we think for longer and then draw conclusions.
In system 2 thinking, it is important to think in a structured manner. There are courses that enable us to develop a frame of reference ourselves in terms of knowledge and thinking methods, or experts can be consulted. By thinking in groups, for example a committee or the board of a pension fund, you strengthen the system 2 thinking process. The quality of perception improves, as does the ability to respond to that perception.
A structured way of responding is also known as policy, especially if this method is formally established and ratified as the method to be used from now on.
A pension fund, like any other organization, carries out activities according to a set plan. That plan is based on assumptions. As long as these assumptions hold true, the activities can 'simply' continue. After all, everything is going as expected. If the assumptions no longer hold true, then action must be taken.
In that case, there are two possibilities. It could be a one-off special event. In that case, the pension fund's activities are usually adjusted temporarily and everything else is left as it was. It could also be a case of ongoing change in the design or implementation of the activities, requiring them to be permanently adjusted.
How do you find out if there is an ongoing change? That is why observation is so important. Perception is the continuous observation of one's own environment (one's own ecosystem) and the broader environment (outside the ecosystem) and the patterns that you think you see and hold against the articulated and perhaps also non-articulated assumptions, in order to try to draw conclusions from there.
In the pension sector, we have seen that this is very difficult. Consider the slowly declining interest rates in the 2010s. A kind of silent killer. Everyone saw it happening. But reacting proved very difficult. After all, when and how?
I want to make a case for conscious observation, especially in a time of great change. Let's try to recognize patterns. When risks arise, we quickly think of events involving flashing lights and sirens. But that is not how risks begin. I remember well that I was one of the first to identify the danger of the Covid virus (January 2020). I was ridiculed. Unfortunately, I was proven right.
The beauty of it is that we humans are masters at observing patterns. We are constantly analyzing. What is needed is a structural place on the administrative agenda to discuss these kinds of observations in a reflective sense. And that is happening. Think of the investment and risk reports. I am also increasingly seeing that there are fixed agenda items to discuss possible emerging risks. The danger I want to mention here is that of the automatic pilot. Due to the issues of the day, these agenda items are often 'rushed through'. Does that sound familiar?
I would therefore like to make a case for reflective observation and also for reflective mutual discussion. A 'moor day', once every few months, is very suitable for sharing reflective observations with each other. In this way, the major (strategic) risks can be identified and managed. So, in contrast, no full agenda on the moor day with good advance preparation.
Dear board member, how do you observe and how do you gather the observations of your colleagues and advisors and ensure they are given sufficient reflective consideration?
This is the thirty-seventh column in a series on risk management. The series aims to encourage readers to consider risk management as an integral part of running a pension fund.