NETHERLANDS - The average pension fund could reduce its required financial buffers by up to 3% if it applied the risk and return parameters proposed by the Dutch Association of Investment Professionals (VBA), the organisation has claimed.

In a recommendation of proposed improvements to the financial assessment framework (FTK), Hans de Ruiter, chairman of the VBA, suggested schemes should develop policies to limit the effects of extreme risks either through increasing their financial buthe use of put options or credit default swaps.

"Internal models are recommended anyway, as the risks of alternative investments are not properly addressed by the present standard FTK model," he argued.

"Moreover, pension funds will be forced the consider all relevant risks when developing a solid model, as just following compliance does not automatically mean that they are in control," added De Ruiter.

The investment body also stressed the real cover ratio, rather than the nominal one, should be the bedrock of the assessment framework - a view taken by both the Frijns Committee and the Dutch Actuarial Society (AG).

De Ruiter argued the swap curve - representing a liquid market - is also a better criterion for valuing liabilities, as the presently-applied forward curve is not considered to be a proper indicator of future interest rates.

The VBA prefers long-term equilibrium rates for long-term projection, as this is consistent with how projections for future returns are made, he explained.

The lobbying organisation also claimed a mark-to-market valuation of both investments and liabilities would be the best way to provide a real and representative picture of a pension fund's cover ratio and balance risks, despite the increased volatility that comes with it.

In the VBA's opinion, valuations must be consistent and arbitrage-free, but apply lower priority to conditional rights, such as indexation.

The mandatory reservation of conditional benefits, which depends on a pension fund's financial position, should also be scrapped, as this is seen an invitation to schemes to save less as well as hampering transparency of pension contracts, according to the investment experts.

The VBA argued increased transparency, about shortfalls and surpluses, in particular, would allow interested parties and supervisors to check a scheme's policy against its investment principles.

The VBA has also recommended geometric rather than arithmetical returns by applied "as the first is providing a better insight in the long-term accrual of assets and also implicitly includes risks".

VBA's proposed default parameters for the lowest returns are lower than those of the FTK, whereas its recommendations for average parameters slightly exceeding FTK assumptions.

However, the VBA's average variant - midpoint of the return and risk interval - is based on smaller shocks which translate into lower financial buffers, the organisation admitted.

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