Dick Kamp: Risk management, risk attitude and materiality

October 17, 2023

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

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

With the upcoming transition to the new pension system, the risk management framework also needs to be reconsidered. An important part of the risk management framework is the risk attitude.

I notice that in many places people are considering tightening the risk attitude of the pension fund, for example because they are going through the phases of the data quality framework of Pensioenfederatie. This tightening can be very inspiring when understanding the implications of the transition to the new pension system. The question can also be asked what this means for the current risk framework in the current pension administration system.

During the transition to the new system, the pension will be highly individualized. The existing collective assets are distributed to the individual participants and then all changes to that assets are allocated and administered to the individual participants.

This allocation and the explanation thereof can also be regarded as a direct accountability to the participants. If changes subsequently have to be processed as a result of corrections to errors made or late (administrative) processing, it 'doesn't feel quite right'. The participant's confidence then takes a serious hit. This leads to a very undesirable situation.

Tolerance for errors becomes lower

In short, the reformulation of the risk attitude with regard to pension and investment administration will most likely show that there is a lower tolerance for errors in administrative processing. The timely processing of changes is also part of this. It is good to realize that the current business operations of pension administrators are often still based on the current collective pension schemes. The assessment of the correct functioning of the management processes in the form of ISAE 3402 and SOC1 reports is based on so-called annual account materiality.

The future business operations of pension administrators must be sufficiently robust to ensure correct transaction processing at the individual level with the highest possible probability. Think of a sofa. How often is there an error on a daily statement? My experience is, not very often. That is why there is great confidence in the (administrative) processing by a bank. What can we in the pension sector learn from this?

Materiality limit is defined more sharply

What does this mean for the pension fund's risk management framework? It stands to reason that the materiality limit should be defined more sharply. This means that the step from gross risk to net risk may become larger. An assessment will have to be made of the effectiveness of the control measures in place at the pension administrator. In practice, the evidence for this is usually provided from ISAE 3402 type 2 reports.

The question is whether the ISAE 3402 type 2 reports are still sufficient. After all, the sample sizes involved here are based on the materiality of the annual accounts. This raises the question of whether the current ISAE studies should be adjusted or whether additional (internal) controls at the pension administrators should contribute to obtaining sufficient certainty regarding the estimates of whether they remain within the (recalibrated) risk attitude. After all, the risk attitude has been tightened.

More mutation types are being automated

It is obvious that pension administrators will fully automate more types of changes in their business operations and, where this is not (yet) possible, they will ensure that authorization of a change is enforced system-wise. So more attention to first-time right. In some places we also see the development of so-called data profiling tooling. This tooling is repressive in nature and can therefore be regarded as a supplement to strengthened business operations.

The foregoing raises the question of whether the recalibration of the risk attitude should not actually apply now, because every change may currently affect the value of the participant's pension capital allocated at the time of entry. In that case, the materiality of the evidence on the actual net risk already plays a role. This then entails the dilemma that current business operations may not yet be set up for this and additional checks must be carried out.

Dear director, are you reviewing your risk attitude and the associated materiality? And are you clearly aware of the consequences of this for the accountability of the implementation for your pension provider? And how do you view the effect of the upcoming individualization of the risk attitude for administrative implementation today?

The Future Pensions Act has an impact in many areas. Also on perhaps less obvious ones. Be attentive!

This is the twenty-first 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