FTK should target the real cover ratio – Frijns Committee
NETHERLANDS - The financial assessment framework (FTK) for pension funds must be aimed at the real cover ratio, rather than the nominal funding ratio as at present, an adviser committee to the Dutch government has recommended.
In order to allow a board to be fully in control of all phases of the investment process, the government must issue additional legal requirements for expertise, according to a report produced by the committee on investment policy and risk management and commissioned by social affairs minister Piet Hein Donner.
The committee headed up by Jean Frijns, former CIO of the €200bn ABP civil service pension scheme, suggested pension funds should base their investment policy more on the risk levels scheme members are prepared to accept, rather than being mainly driven by returns.
"Pension funds with many older participants should take less risks than schemes with mainly young workers, and they also must make clear choices about the risks to be run by the differing groups of participants," said the advisory body.
Pension funds must develop an easily explainable approach for their investment policy and risk management to help communicate the choices and risks to members, the committee recommended, and added that the board should regularly publish its choices.
The Frijns Committee further suggested that pension funds should set a strict lower limit regarding their cover ratios, under which the pension fund cannot recover without external monies or additional changes to the scheme.
"If this lower limit is breached, an adjustment of the pension contract would be required," the committee suggested, further arguing that this rule would provide clarity to participants about the moment they could face a cut in benefits rights or a demand for increased contributions.
The Frijns Committee noted an ageing population has increased the vulnerability of pension schemes, as they are receiving less in contributions while facing increasing liabilities.
"The fact that over 60% of schemes' assets are destined for pensions to be paid within 10 years complicates pension funds' ability to cushion financial shocks," the advisory body explained.
It also pointed out that schemes now have increased dependency on financial markets, as they have raised their investments in equity, property and alternatives. This is especially important as the mandatory use of the mark-to-market rate for calculating liabilities has increased the volatility of pension funds' cover ratio.
It also argued smaller pension funds should periodically check whether their size is still sufficient to deliver an optimal board composition and proper implementation of governance processes.
Dutch pension funds lost combined assets of €120bn in 2008, of which the committee attributed €20bn to implementation losses.
That said, the Frijns Committee recognised 2008 was a "very bad year", and said it has not found anything to indicate pension funds are performing badly because of their structure.
The advisory committee has appealed to pension funds to translate their recommendations into best practice.
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