Keith Ambachtsheer, a pensions guru on both sides of the Atlantic, has a different slant on what can make defined benefit schemes sustainable long term. Speaking recently in the US to a conference of teacher retirement plans, he told delegates: “You need a whistleblower.”
Toronto-based Ambachtsheer, who acts as a pensions adviser to both Dutch and North American plans through his KPA Advisory Services, has a clear idea what whistleblowing entails. “This is a totally objective person who enforces certain principles with respect to measurement and disclosure of the status of systems through time. And when there is a problem with those systems to activate some mechanism to deal with the problems.”
He adds: “You could call him a referee on the playing field.” Applying this to pension systems worldwide, the Dutch approach ranks very high in his view in terms of their current “whistleblowing capabilities”. In other words making pensions regulation effective.
There have been a raft of changes in the Netherlands on the regulatory front, not least the arrival of Dirk Witteveen as regulator as the DNB absorbed the regulatory functions of the PVK. “The set up of this system is basically to have one regulator for banks, insurance and pensions,” he says. “But this is an individual who clearly is not afraid to step out.”
“Why shouldn’t pensions be regulated on the same basis as the insurance and the banking system? There are the notions of fair value, disclosure and risk capital. If the pension system involves guarantees, you then have to find the nature of the guarantees, value them and assign it to whoever is bearing the risk. Those are the principles that have been inserted into the Dutch pension system.”
These led to great discord and consternation initially within the pensions community, he points out. “But Witteveen and his colleagues put certain principles on the table that are hard to quarrel with in the final analysis.”
So when the pension funds claim that the regulations are forcing them to be short-term, the regulator’s response can well be “no, we are not. If you are putting risk on the balance sheet, you will have to cover it and have risk capital”, argues Ambachtsheer. “You can take on all the risk you want then!”
When all the “all the gnashing of teeth” was over, the pensions community recognised that they had to lower the value of the guarantees. “The result was a move from a final earnings-based, fully indexed benefits. That was a target and never a guarantee, but if you do value it as a guarantee on a fair value basis, it is worth 30% of pay or thereabouts.” The end result is that if the money is not available to support that level, the guarantees have to be changed.
“That’s what happened by dropping the guaranteed level down to nominal career average, without any promises about indexation. That reduces the value of the guarantee by around 40 to 50% probably,” he says. The net effect is that the Dutch system is in surplus, instead of being underfunded.
But the Dutch system may not be quite out of the woods yet, he warns. “There are still some potential shoes to drop.” As the system is constituted, are the wrong people providing the wrong guarantees, as some argue? “For example, the young giving guarantees to the old, when they are in a position to take a lot of financial risk with their euros contributed to retirement savings. But how can they, if you box them into a system providing guarantees to the old?”
Looking to North America, he focuses on Canada as being in an intermediate position, relative to the US and Europe. “Whether you are a public or private sector plan, you are required to undertake solvency valuations. In the US, any ERISA plan such as corporate or multi-employer plans, also have a solvency testing requirement, but the public sector plans in the US do not.”
The only potential whistleblower in these public plans in the US is the plan actuary, he points out. “But if they blow the whistle too loudly they will get fired.” If these public funds were valued on the same basis as Dutch plans are, he reckons they are typically 50% funded or less.
Ambachtsheer is keen to progress dialogue between the Dutch and North American funds, under the auspices of the International Center for Pensions Management (ICPM), part of the University of Toronto. This was launched earlier this year, following a colloquium last autumn, which some of the major Dutch funds attended to see if such exchanges could prove fruitful.
“The aim is to get more integrative thinking going in this area, around such issues as governance, agency, risk management, financial engineering and investment beliefs.”
In early summer, a workshop had a PGGM spokesman demonstrate its new balance sheet valuation model, which can value the contingencies of the pension plan as options.
“Pension plan evaluation is basically done on a deterministic basis – you make some assumptions, you get your numbers and that’s it. But in the contingency form, you put a value on the uncertainty in the system. That leads you to coming up with some estimates on the asset side of the balance sheet as to what you would have to pay insurers to take on the contingent claims on the balance sheet. And on the liability side, the outcome an estimate of what somebody would pay whoever held these contingent claims on the possibility that at some point in the future the plan would be in surplus. In other words, giving someone a call on that surplus.”
The next step in the dialogue is another colloquium being held shortly, where a major Canadian fund Ontario Teachers will discuss the question of proper valuation of its liabilities and the sustainability of the plan. “We also plan to do a Harvard Business School type fictitious case study built on a composite of funds and the issues they face.” This will be complete with teaching notes. This is being run in conjunction with the 15 ICPM research pension partners from both sides of the Atlantic and including .
“The idea is through ICPM to bring together globally the best thinking both at practitioner and at the academic level to try to examine some of these current issues to see if can move the yardstick some,” says Ambachtsheer.
This should lead to a much better understanding of what the challenges really are. “They have been hidden by the degree of disclosure applying. We have not been using the most modern up-to-date tools to develop insights into the nature of these risk sharing arrangements and the implications for their sustainability.”
The danger of not responding to these challenges and not having a whistleblower function in place is that these public sector schemes turn eventually into pay-as-you go arrangements. “Such pay-go plans with final earnings based indexed pensions cost 50% of pay to deliver.”