NETHERLANDS - Guus Boender, the chairman and non-executive director of ALM and pensions advisor Ortec Finance, has welcomed proposals the Frijns committee's recommendations suggesting FTK should target the real cover ratio and enforce a hard lower limit to that ratio.
However, he also observed this would also have a profound effect on liability-driven investment (LDI) practice and effectively turn pension schemes into insurance companies.
"Frijns understands, where many others do not, why the difference between the nominal structure and the real structure is so important," Boender told IPE. "It has a direct effect on the kind of LDI that you should do, a direct relationship with how we define a good investment policy."
The current focus on the nominal cover ratio has pension plans running to hedge their exposure to the nominal rates used to discount liabilities. But minimizing real duration risk often has the effect of increasing exposure to inflation risk and, as Boender observed, inflation risk is the more significant for "the real long-term objective of the pension fund".
Conversely, attempting to hedge inflation or real interest rate risk also increases the volatility of the nominal cover ratio.
Boender has therefore questioned whether the extreme loss risk associated with the counterparty exposures inherent in swaps would be compatible with the hard lower limit to cover ratios.
The advisory committee headed by Jean Frijns, former CIO of the €200bn ABP scheme, recommended this lower limit from under which a fund could recover without external monies or some other "adjustment of the pension contract". (See earlier IPE story: FTK should target the real cover ratio - Frijns Committee)
A hard limit has the advantage of clarifying which part of a plan's assets can be used to take investment risk, Boender noted.
"We did not come to a unanimous conclusion here about what we think about all the Frijns recommendations," he said. But I am very much in favour of such a hard lower limit because it makes completely clear the extent to which a pension fund must act as an insurance company and to what extent it can take investment risk.
"Up to the hard level - say, 70% - pension funds would necessarily have to act as insurance companies, because if the lower limit is hard, then it's hard."
Although the solution could be provided by pension fund organisations, pensions composed of an insured component and a pure savings component - without guarantees and as much freedom as in investment trusts - would represent a profound change to the nature of the pensions promise.
For Boender, the payoff in clarity could be worth the cost in constraint, as he argued: "One of the most important things I've learned over my 25 years in this business is that it's very difficult to communicate the concept of risk - to anyone, including trustees.
"I think it might be easier for trustees to meet their responsibilities if it is made clear which part of the money they can take risk with and which part of the money they cannot take risk with. It's important from an understanding and communication point of view. Every constraint is expensive - and from that point of view constraints are never optimal - but from that point of view it makes a lot of sense," added Boender.
If you have any comments you would like to add to this or any other story, contact Julie Henderson on + 44 (0)20 7261 4602 or email julie.henderson@ipe.com
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