This blog, by Bart Heenk, was first published on Mallowstreet.
If there is one thing pension funds can learn from the military it is that it is not the plan that matters and planning is everything. The army spends 80% of its time training and 20% in operations. This allows them to prevent crises before they become reality. Military planning is used to build agility in dealing with risks and war gaming is essential to build intellectual ‘memory muscle’. Pension funds can learn from this.
The financial crisis of 2008 has shown that all major risks were interrelated and most of us were ill-prepared and some took precisely the wrong decisions by panic selling in the depths of the crisis or halting rebalancing trades. When long-term capital market assumptions are based on long-term mean reversion of markets, one very bad decision in a crisis can have a substantial impact on these assumptions, to the extent of rendering them worthless. So, have we learnt our lessons from the financial crisis and are we better prepared now?
At a recent roundtable jointly organised by Strategia Worldwide1 and Avida International, senior pension fund executives and trustees discussed their biggest risks and how prepared they were for dealing with those risks. Risks mentioned ranged from cyber-crime and the associated reputational damage and inability to pay out pensions, to insufficient liquidity in the fund to simultaneously meet margin calls from derivatives counterparties and transfer requests related to pension freedoms following market turmoil.
Whilst most pension funds around the table admitted that they had done very little planning, some of the participants had run war gaming sessions in order to prepare the organisation for crises. They learnt not to focus on procedures or a manual (a plan) but on process (the planning). This is precisely what the military does. War gaming is essential to build the intellectual memory muscle to be ready in times of crises. One thing is certain: no plan survives first enemy contact. Or, in our pension fund language, a crisis is never exactly how it was anticipated. Consequently the value of war gaming is not in producing a plan but in the planning process itself. When a crisis hits, the organisation will have practiced so much that crucial issues like command structure, team composition and relationships, everyone’s roles and stakeholder communication have become second nature. This allows the organisation to focus on the essentials in a crisis, and act quickly and decisively. War gaming also has preventative benefits and can help identify those risks that can be mitigated already.
Interestingly, whilst this is something that is commonly practiced by corporates in, for example, the airline, petrochemical and extraction industries, their pension funds tend to be much less well prepared for crises. The financial crisis of 2008 was a fantastically valuable learning opportunity but unfortunately many trustee boards have largely forgotten the lessons partly as a result of changes in the composition of the board. Quite a few pension funds will have a crisis plan but if it is not regularly practiced these plans will prove to be of little value when a real crisis happens.
Strategia and Avida want to help pension funds to become better prepared for crises and are thinking of putting together a joint service proposition that entails war gaming sessions once or twice yearly, plus a SWAT team that is on standby for when the pension fund needs extra resources to deal with an eventuality. The idea being that most pension funds are resource constrained and do not have sufficient capacity to deal with an out of the ordinary situation.
This initiative will hopefully help pension funds to learn some very valuable lessons and prepare them better for the next crisis that will undoubtedly hit us one day.
1 Strategia Worldwide helps companies, investors and funds across many sectors protect value by taking a comprehensive approach to risk and then designing integrated strategies to manage them.