Dutch Pension Muppet Show

There's a lot of fuzz about the performance of the largest (€ 246 billion assets) Dutch Pension Funds ABP and the somewhat smaller (€ 91 billion) PFZW (former PGGM). According the Dutch television program Zembla and Bureau Bosch Asset Consultants, Dutch pension funds would have consistently underperformed.

ABP commented: "The yearly return of 7.1% on average since 1993 is much higher than returns on government bonds would have been and is in part thanks to our equity investments."

PFZW overshoots ABP wit the comment: "PFZW's calculations show a return of 8.4% on average during the past 20 years which is much higher than the 10-year Dutch government bonds of 5.3% on average during the same period."

Great statements, but who's right?

Performance Test
Let's quickly "do the proof" by comparing (benchmarking) the 'modest' yearly performance of ABP with the yearly performance of 10 year Government Euro Bond Yield Benchmark as provided by the ECB.

Both pension funds are not limited to  the Dutch market, therefore  performance is not related to Dutch Government Bonds, but to 10-Y Euro Government Bonds.

As the yearly performance of ABP in a particular year is in fact a kind of 'compound performance' of the years before, it's more realistic to relate ABP's (yearly) performance to the 10-years moving average of 10-Y Euro Bonds.  

What becomes clear from is that ABP's volatility overshadows the 10-year Bond's volatility by far. As a consequence ABP's out-performance should be significant.

Let's test this by looking at the YTD (Year To Date) performance of ABP on the long run:

The average performance of ABP 1993-2010 indeed turns out exactly 7.1% as published, but hardly outperforms the 10-year Euro Bonds Moving average of 6.8%.

0.3% '18-years out-performance' (OP-18) for such a high volatility is strongly discussable. The long term out-performance 1994-2010 (OP-17) was 0.0%. The out-performances of shorter periods (OP-[18-x]) are not stable and strongly swap from positive to negative.

Benchmarking Pension funds performance with Euro Bonds 0f 20 years or longer would be even more adequate and in line with the duration of pension fund's liabilities. Taken into account that 20 year Bonds on average score a 0.25% à 1.00% higher return than 10 year Bonds, it can be concluded that Dutch pension funds on average do not out-perform Government Bonds. Not to mention the influence of the yearly investment-costs of at least 0.2% on the returns.....

Pension Fund PFZW

Pension Fund PFZW is completely lost on their non-transparent and backwards changing performance of 8.4% over the last 20 years.

From their annual (inconsistent) accounts it can be concluded that their 2001-2010 performance came down to 4,8%. This performance is exactly the same as the performance op ABP in that period and underperforms the moving average 10-years Euro Bonds with 0.7% !!!

Conclusion

It's clear that pension funds don't convince in the outperformance of Government Bonds and that the pension industry is in desperate need for an impartial benchmark with regard to out or underperformance of Bonds.

The comments from ABP and PFZW, Boenders and Cocken are like 'shooting from the hip' and must be qualified as highly unprofessional.

Dutch pension fund members are watching an extra edition of the Muppet show. Who's gonna stop this pension media madness and bring some order in the pension room?


Related Links and Sources:

- Source: 10 year Government Euro Bond Yield Benchmark
- 'grave miscalculations' in Zembla (Boender aand Kocken
- Watch: Zembla 
- Download: Spreadsheet with calculations as presented
- IPE: Heavyweights ABP, PFZW come out swinging against Zembla
- Bloomberg: 10-year, - -  30-year performance Gv. Bonds

Solvency II: Standard or Internal Model?

Solvency II is entering the critical phase.Time is running out!

But...., as a wise proverb states:

"When The Actuaries Get Tough,

The Tough get Actuaries"

However, the market for actuarial resources is limited and Solvency II Actuaries that  combine strategic and technical knowledge with 'common sense' are like  white ravens.

In the case of Solvency II, actuaries and models are moving forward in a particular way.

Standard Model
Originally, the 'standard model' was foreseen as a simple model for small and mid-size insurers (apart from very small insurers that were excluded). Big insurers, with more developed actuarial models, larger scale and more resources, were expected to work out a more sophisticated 'internal model'.

As the Solvency II Time Pressure Cooker gets up steam, things start turning.

Small and mid-size insurers found out that the 'standard model' was highly inefficient and the wrong instrument to steer adequately on risk management and to determine adequate solvency levels in their company.

Just because of their limited size and product selection, small and mid-size insurers often already have a well tuned risk management system in place and implemented throughout the organization. The manager, actuary (being the risk manager as well) and CFO of such companies therefore have enough time to develop a formal Solvency II 'internal model' that could be easily implemented throughout their organization.

Internal Model
Quit the opposite happens in the world of big insurers.

Big insurers coordinated Solvency II at Holding level and started to challenge their business-units around 2009 to develop and implement Solvency II programs on basis of an 'internal model'.

Collecting homework at the Holding in 2010, it became clear that a lot of technical issues in the models were still unclear. Moreover, models were not integrated (= condition)  in the business and counting up several 'internal models' showed up several consolidated inconsistencies. 

The complexity of developing a consistent risk model turned out to strong. Some big insurers are now considering to fall back on the 'standard model' (or partial model) before it's too late: the shortest errors are the best.

Looking back it's not surprising that big insurers need more time to operationalize a fine tuned risk model. It took specialist Munich Re 10 years to implement an internal model.

This development is also an indication that some big insurers are strongly over-sized. In order to keep up with the speed of the market, big insurers have to be split up into a manageable and market-fit size.


Related Links:

- Surviving Solvency II (2010)
- The influence of Solvency II on an insurer’s strategic policy
- White Ravens and Black Swans (Math Fun)

Actuarial Chess?

As actuaries we often have to explain HOW variables like profits, mortality, investments or costs will develop in the future.

In doing so, it would really help and strengthen our credibility if we were able to explain also WHY these variables developed in the past as they have developed, as a result of certain circumstances (other 'explaining' variables).

On basis of these WHY-arguments and the specific expected future circumstances, we could increase the credibility and diminish the volatility of our predictions.

This HOW-WHY-Insight urges us for example to analyze "medical developments" in case of predicting longevity and to study "economic developments" with regard tot predicting future costs, inflation or investment rates.

Moreover this understanding obliges us to develop our capabilities and competence to explain certain given outcomes like "increasing longevity" and "increasing stock return volatility".

Test Your 'Outcome Explanation Competence'

This 'Outcome Explanation Competence' (OEC) is key in actuarial science. No actuary can do without!

To test your OEC level, solve the next chess problem.

Black has made the last move... Which move?

You'll find the solution of this chess problem as a part of the next 5 minute 'Thinking Out of the Box' test ( on SCRIBD)......

5 Minute 'Thinking Out of the Box' Test

Just like in 'climate change predictions', our OEC (the 'competence to explain past phenomena') is necessary for us actuaries to be confident about our theories and predictions about the future.

However, developing OEC might not be enough as the explanations of the past could turn out to be fundamentally invalid with regard to the future. New techniques  like High-frequency trading (HFT) might come up. Or... in chess vocabulary: 'A pawn may promote to a Bishop' (frequency: 0.2%)

The conclusion must be that Actuarial predictions are a kind of 'Actuarial Chess':
So start practicing as an Actuarial Chess Master by Explaining the past and Guiding the future.