Dick Kamp: Risk management and morality

September 17, 2024

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

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

What role does morality play in formulating the mission, vision and strategy? And how do you see this reflected in the daily activities and in realizing the strategy?

Morality can be defined as a set of actions and behaviors that are socially or socially considered desirable[1]. Morality can be found in the policy choices that a pension fund makes and in the consequences thereof. Consider, for example, the way in which a pension fund wants to deal with ESG.

When it comes to discussions about investment policy and its objectives, morality seems to be pushed somewhat into the background at pension funds. Returns seem to be the main motivation and moral principles are not supposed lead to a limitation or lower return. The question is whether this is justified. I think it's time for reflection. Create a moment of rest. However difficult that may be, especially in these busy times with the implementation of the Wet toekomst pensioenen (Wtp).

Morality is different from arranging things procedurally neatly (compliance). It is about the content of choices and their consequences. Morality can vary from person to person and can even vary or change over time. It also comes very close to the human being himself. It is a set of principles that are applied. A limitation in actions because it is considered 'better'.

Aspects of morality

Articulating desired moral behavior of the organization has a number of aspects.

Firstly, articulating desired moral behavior indicates that the organization is aware of the possibility of non-moral or non-integrity actions occurring. By means of, for example, the annual SIRA (the systematic integrity risk analysis), the organization identifies risks of acting without integrity, the control measures in place and the extent to which the net risk falls within the risk appetite of the board. Compliance with DORA is also largely aimed at managing the risks of criminal activity with regard to the IT environment. This way of dealing with morality is primarily defensive, i.e. aimed at preventing or limiting immoral behavior.

The question with morality-driven action is whether it only leads to defensive behavior to prevent non-moral activities, or also to creative activities. In other words, is the world becoming a little better and more focused on the next generation(s)? That's the second aspect. One expression of this is defining ESG policy. With ESG policy, and especially by promoting SDGs (Social Development Goals), the pension fund is mainly concerned with creation.

In addition to choosing which SDGs to pursue, there are more moral choices to be made by a pension fund. What about the interpretation of balance in choices in the context of the transition to Wtp? A balanced consideration of interests is a form of making moral choices between the interests of stakeholders. This is very topical in the context of transitioning to the new pension system, for example. The legislator has defined an open standard for this. This means that the pension fund must complete this by itself. All the more reason to take time for reflection and rest to consider how morality can be given substance. Later in this article I give some examples of this.

The choice for an interpretation of morality can also be seen in the context of the development of the value proposition of the pension fund. Making and realizing moral choices then becomes an active part of the strategy and activities of the pension fund.

A third question is whether morality cannot also be regarded as glue or cement between those directly involved, say: (former) participants. Moral choices can lead to (former) participants feeling comfortable with the pension fund because of the attitude, behavior and choices of the pension fund and the way in which the board communicates and accounts for this.

To prevent it from remaining somewhat abstract, it is good to give some examples.

1) Ethical or responsible investing

The pension fund takes its morality into account by making conscious choices for moral principles when investing. What is invested in and what is not? This has partly been enforced (for example, exclusion of cluster munitions) and partly this has been chosen (choice of SDGs, investing in wind farms in our own country). What is important about morality is that it is emphatically a voluntary and conscious choice for the pension fund and fits in with its policy in this regard.

2) Social involvement

The pension fund consciously opts for a form of social involvement, for example by encouraging self-reliance for the elderly or providing financial education. Other forms of involvement are of course also possible.

3) Participant involvement

The pension fund may choose to support its participants in another way in addition to the primary task of making payments. An example could be by providing suitable housing and care for (older) retired participants, or supporting financial planning for young participants with starting families.

A possible response to the application of consciously chosen morality is to point towards the (possible) negative aspects, such as loss of return or high costs. There are a number of studies[2] that show that a conscious SDG investment policy does not have to be at the expense of returns. And of course, investment decisions must be based on well-founded considerations of risk and return. The possibilities are now there.

The possible concrete implementation of social or participant involvement can lead to higher costs. As pension funds increase in scale, on the one hand the basis for financing these higher costs increases and on the other hand the (social) expectations of participants also increase. In other words: the possible cost disadvantage becomes relatively less, while expectations regarding the 'value proposition' of the pension fund increase.

Dear board member, is morality a relevant aspect for you in your daily and long-term actions? Will you take the time and rest to further consider the importance and perhaps also the form in which morality is expressed (responsible investing, social involvement, participant involvement)?

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