Dick Kamp: Risk management and the employment conditions triangle

October 15, 2024

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

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

The world consists of triangles. A triangle provides stability. A table with three legs is sturdy. It is the same in the pension world. The most well-known pension triangle is that of premium/risk/ambition. This is central to consultations with social partners and the pension fund.

But there is another triangle, namely the triangle of employment conditions consultation. There is uncertainty about the operation of this triangle. I will first outline this uncertainty and then discuss the triangle in more detail.

What is the case? In the premium/risk/ambition triangle, the pension outcome (read: ambition) depends on the premium paid and the realized investment returns (read: risk). When the ambition is 'easily' achieved or even exceeded, what happens to the premium? Will it go down? That seems like logical reasoning. And for who are those savings?

The components of the triangle of employment conditions consultation are: total costs of employment conditions/pension/'other' parts of the employment conditions. The total of employment conditions is also called the 'employee value proposition'. Slightly simplified, this consists of the following parts[1]: primary employment conditions (salary, bonus), secondary employment conditions (holidays/pension, etcetera), career opportunities, working climate and corporate culture.

The risk outlined above concerns that financial resources 'disappear' from the triangle of employment conditions consultation (premium reduction) as a result of achieved results. So saving on pension leads to saving on employment conditions. Perhaps not a strange thought for those who have been working in the sector for a long time. After all, the phenomenon of premium holidays existed in the last century. This meant that an employer did not have to pay a premium if the financial position of the pension fund was very good. This meant that the accrual of new entitlements could be financed from the accrued capital. The benefit of this was 'collected' by the employer.

It should be noted that the employer was often responsible for shortages at that time as well. There was often also a so-called additional payment obligation. There was no free lunch. Now, a different time has arrived. For most pension schemes, the participant is the risk bearer. The premium and the ambition are the result of the employment conditions consultation between social partners. The ambition under the FTK is the amount of the pension entitlement, usually with a desire to partially keep up with inflation.

Back to the risk. What if, under the Wtp, the realized pension outcome 'threatens' to exceed the formulated ambition? Will the premium then go down? And if so, where does that money go?

There are two issues at play here. Firstly, there is periodic consultation about the content of the (first) triangle: premium/risk/ambition. It is highly questionable whether past results give reason to settle something in the triangle in the future. After all, after good times, bad times can come. It is therefore my expectation that the consultation on the content of the premium/risk/ambition triangle will only be looked at prospectively. So only return expectations and investment risks at the time of consultation. And with higher expected returns, this can result in a lower premium.

In the recent past we have seen that with lower expected returns the premium was adjusted upwards and at the same time the ambition (the accrual percentage under the FTK) was lowered.

This is where the second triangle comes in. The pension premium is part of the secondary employment conditions. When less premium is required to achieve the desired ambition as expected, it is obvious that this will free up resources to improve other parts of the secondary or primary employment conditions. The forces within the employment conditions consultation between social partners will (have to) guarantee this. It is therefore up to the parties to agree that no money will disappear from the system.

In my opinion, this insight raises two issues to consider.

Firstly, the strength of the employment conditions consultation is in the interest of the system and becomes more important under the Wtp. Secondly, there is an explicit place and objective of the implementation of the pension scheme in the total value proposition of employment conditions. It is not isolated. When further developing the value proposition of the pension fund itself, it is therefore important to know the location and objectives and to further develop them if possible. In other words, board members will have to ensure that the value proposition also gains meaning in consultations with social partners.

Dear pension fund manager, do you know the location and purpose of the pension employment condition? And what development do you see and contribute in consultation with social partners?
 

This is the thirty-second 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.