1. The Batavia.
The 17-th century, the so-called golden century in which Hollandmade its fortune through international trading, as we would call it nowadays still gives food for thought to economic history specialists. The Netherlandsmade a fortune with imports and exports on the Baltic. The trade with Indonesia, then called the Spice Islands, was profitable but risky. I will leave aside the Baltic trade and focus on the trade with Indonesia, which was a monopoly of the VOC—the Verenigde Oost-Indische Compagnie (United East India Company). The route the VOC took to the East Indiespassed close to the reefs of the mythical and undiscovered Terra Australis Incognita. One of the ships which came to know these reefs was the unlucky ship “Batavia”.
In command of the Bataviawas Francisco Pelsaert, the senior merchant. It was company policy to appoint a merchant in command of the flagship. Profits before everything! That however did not find favour with the ship's skipper Ariaen Jacobsz. Another important person on board was the undermerchant by the name of Jeronimus Cornelisz. And, as in any good story, there was a fair young Lady "Lucretia van der Meylen" who was travelling to meet her husband in Batavia. Also aboard the ship were a bunch of seamen and a contingent of military men, who would play an important part in the drama.
The Skipper apparently tried his luck with Lucretia. That did not work but her maid had less moral scruples. At the Cape of Good Hopethe skipper had a wild and violent drinking party and to his enrage, Pelsaert had to correct him publicly. Now Cornelius, the undermerchant, suggested mutiny to the Skipper: with some help it would be possible to throw Pelsaert overboard and take the treasures. Before that could happen, however, the Bataviaran aground on the coast of Western Australia. Passengers were off-loaded onto a nearby island later known as Batavia's Graveyard. Pelsaert, the Skipper and some 30 sailors with most of the food and water landed on a smaller island. Pelsaert realised he was in danger of a mutiny because of insufficient supplies and took off with two boats. He told he did so to find water on the mainland, but he set sail for the East Indies instead.
The unfortunate remaining survivors were to play a part in one of the most horrible tales of mutiny and murder ever told. The undermerchant - now the most senior company man - turned out to be a psychotic killer with an uncanny ability to manipulate. He split the survivors amongst some of the closer islands, none of which had any water. Apart from taking the unwilling Lucretia as his concubine, Cornelius systematically took the life of anyone who could be a burden on the limited resources, or a threat to his reign of terror. I have no intention to spoil your appetite so I refrain from mentioning any detail.
Cornelius, however, made one fatal mistake. He sent one group of soldiers in search of water to another island and left them there, hoping they would die. What Cornelius did not know, was that he had sent the soldiers - the only group of men that could threaten his regime - to the best island. The island had a natural store of water and there was ample supply of birds and eggs. He had to regain control of this island in order to survive. The soldiers realised their position and waited for the attack. That attack came and for the next two months Cornelius tried to gain control but failed. When the last battle between the mutineers and the soldiers was in full swing a ship appeared on the horizon. The Commodore was none other than Francesco Pelsaert who had made it to the East Indies. But why did he return?
To answer that question, we go to the city of Batavia to meet Jan Pietersz Coen, the CEO of the VOC. The message Pelsaert brought him must have been devastating. The loss of the Batavia was a financial disaster. The Batavia carried over 40.000 silver coins and other treasures. Coen was a tough guy, more a soldier than a merchant. Loss of lives did not count much for him. And mutiny was a capital crime. So Pelsaert was forced to go back and return with at least part of the treasures.
On first sight the story of the mutiny on the Batavia has nothing in common with retirement provisions. On the other hand, there are some lessons to be learned from history.
2. Pricing and solvency.
The Lords of the VOC already knew: cost gaet voor de baet. You have to invest in order to make a profit. Invest they did: instead of purchasing a State bond with a guaranteed interest, they took very large shares in the vessels bound for Indonesia. The outcome was never certain. Similar to the world of retirement provisions: pensions cost, but the outcome is never very certain. In the past, pension pricing has never been a big topic in the Netherlands. The Dutch occupational pension system has developed for decades. In the 1950s, 1960s and 1970s a shift from fixed amount schemes via average pay schemes to final pay schemes occurred. At the same time, the ‘standard’ pension became established: 70% of last pay. This 70%-figure included the State pension under the Old Age Pensions Act (AOW). Pension funds used the windfall that for them occurred from the gradual increases in the AOW to fund the improvements they made to occupational pensions. Subsequently, the adverse economic trends in the early 1980s ultimately led to the Wassenaar Agreement. The resulting fact that wages were rising very slowly, if at all, also curbed the cost of occupational pensions. In the past, very generous and strong supplementary pension schemes were therefore set up by adaptation and development, whereas the associated costs have never been fully reflected in the cost of labour.
In the early 1990s the government felt that time had come to raise the question of the deferred tax revenues incorporated in pension fund assets. The message to the fund managers and social partners was clear: there are limits to overhoarding pension assets. That view has been duly respected since then. Employers have certainly gained an advantage here via contribution discounts and holidays.
In addition, the altered risk perception in the investment field has also influenced the attitude towards funding. During the 1990s the idea of investments as a source of funding gained ground. Ultimately, investment became the primary source of funding, leading to a degree of ‘addiction’ to contribution discounts. For some groups, the pension fund actually became a key source of profits.
Since the year 2002 times have changed; nowadays we realise that pensions cost what they cost. There is no free lunch. If you promise a pension you have to pay for it, be it by funding or pay as you go. And we have to ask ourselves: is it possible to uphold our retirement provisions? We inherited from the past a mixture of pay as you go (state pensions of the first pillar; also the inflation protection in the second pillar) and funding (second pillar; nominal pensions). In a stable economy there is no difference between funding and pay as you go. In a growing economy pay as you go may appear cheaper, in bad times funds may give some protection. It may be a sensible mixture but again: in the end a pension costs what it costs. Our pension systems itself may be too costly. Nowadays we realise that a search for yield alone does not suffice to solve this problem. The Lords of the VOC knew about inherent risks. But they were solvent enough. Cornelius also experienced what price risk may bring: he had gold and silver enough but no control over the important assets: water and food. In the end he was not very solvent. That´s because he also had a problem with his solidarity…
Cornelius´ world was not very stable. In fact circumstances were very dangerous. He reacted by shipping the old, the weak and ill to the other islands where there was no water and they were sure to die. I would say: that was not a very sensible public relations policy. It would have been wiser had he carefully counted his funds of water and food and his human capital. He also should have made a plan of how to use it and for how long. No doubt much more of his fellows would have survived including himself.
Nowadays we face similar problems. The paradise of booming economies is gone, equities no longer give astronomical yields. And there is a long term problem approaching on the not so long term: the aging problem. Here I certainly do not suggest a Cornelius-approach. The IMF in its August-report says, and now I quote, “Historically, low proportions of pensioners in the overall population and larger workforce from the 'baby boom' generation kept the burden of pension outlays somewhat modest. DB schemes seemed a manageable proposition to many companies. But as populations age, the relative size of pension liabilities and investment risk grow. The growth in liabilities has been greater than expected, as increases in longevity have consistently exceeded earlier actuarial forecasts.”
The IMF-report of August shows that in a group of selected European countries (France, Germany, Italy, the Netherlands, Switzerlandand the United Kingdom) life expectancy at birth rose from 67.6 years in 1955 to 77.7 in the year 2000 and is expected to be 83.2 years in 2050. So another 5 years of longevity will be added by then to the 10 years we already gained since 1950. And for those who don't intent to retire before they are 65: the remaining life expectancy at that age is now around 18 years. It will be more then 21 in 2050. This not only provides plenty of leisure time, but also 3 additional years of pension obligations, which will increase cost by about 10 to 15%.
I quote the IMF report further: “Questions of managing and maintaining funding levels have become more urgent, and some providers will find it increasingly difficult to meet their payment obligations according to their existing benefit structures. For policymakers, the relative burdens and merits of each of the three pillars is increasingly a prominent topic of political and social debate.” I can tell you this debate is very lively in our country at the moment, we may be in for a very hot autumn. You probably are interested in hearing more about it.
It is business as usual. The Dutch are risk averse and are prepared to pay a high price for certainty. Possibly we have the highest life insurance per person ratio in the world in combination with significant (130% GDP) accumulated retirement provisions in the second pillar.
Despite this risk adversity, there are no guarantees given within the second pillar. In the early 1990s the healthy financial position of the Dutch occupational pension system, valued on the basis of fair value, could even have made it possible to secure indexation. Things have changed and those days are over.
Demographical developments, more labour mobility, cultural changes and industrial sectors developing and exiting at a faster pace, have considerably reduced the support for sharing losses within the second pillar. Concerning these developments, the political debates have just begun. Pension funds will have to get used to the idea that those debates will not be restricted to the pension fund industry but will also take place in the street and within the political arena.
For pension funds too there is a tendency towards more transparency and in this respect the funds deserve praise for their rapid response to a changing environment, although there is still much to be done. Increasing transparency will show that our defined benefit system has some defined contribution system elements as well (to be more specific this system also includes intergenerational tensions). Since those who bear the risk do not have the freedom to choose their pension fund manager and those who make the decisions will eventually not pay the price.
Although solidarity is an important factor in our pension schemes, I think we should be aware of the fact that there is a limit to solidarity. If we stretch compulsory solidarity beyond this limit, we enter into the domain of those who try to predict an intergenerational conflict. Although I don´t underestimate the seriousness of the debate, I don’t want to contribute to unreasonable fears. Moreover, it is important to realise, that such a conflict is not necessarily driven by true intergenerational solidarity, but rather by perceived solidarity. Perceived solidarity may be rather low when younger generations are not aware of the benefits they receive from previous generations, or when they no longer trust future generations to show the same solidarity with them that they themselves are forced to show. If pensions increase, underfunding will become even more serious, and later generations start to fear that for them there will be no pension at all. It really is no good public relation policy to state that Dutch pension funds are always able to curtail their liabilities if and when ends do not meet. This may jeopardize the trust the younger generation has in the pension schemes. To address this type of risk is a challenge to all of us.
It would be wise to make risks controllable. And we should look for ways to accomplish this without taking the 180 degree swing from defined benefit to defined contribution. Although DC-systems look very attractive for employers and pension funds, intergenerational solidarity is virtually non-existent and the employees are left with all the risks. Certainly a last pay system with guaranteed inflation correction is very expensive but could be replaced by averaged-pay systems. In these systems risks are shared between employer, (former) employees and pensioners. And, of course, the age at which people retire is an important determinant of the sustainability of a pension system. It will be clear to most of us that very few indeed are still working at the age of 65.
As a supervisor I am careful to make statements about pension agreements. However it is very clear to me that pension agreements are costly. If employers and employees cannot bear these costs the agreements must be adapted to a sustainable level. Only raising the risk, in a compulsory system, is no option. Sometimes, I read suggestions that I participate in a plot to raise the pensionable age in a sneaky way. Let me tell you I’m not that devious. I happen to understand how costly pensions are and I will make that message clear to anyone who is willing to listen. We must ask ourselves what level of solidarity is suitable and achievable in a mature society of individuality, transparency, freedom of choice, and individual responsibility. It will do no good to leave everything as it is: if you are not convinced of that you really don’t understand the world around you. This brings me to my last point:
4. Transparency of risks and governance.
The story of the Batavia contains many elements of risk and governance. The Lords of the VOC took a great deal of risk when they sent such a large amount on such a long and hazardous journey. The rewards however would be enormous, if everything went well. And they knew what they were doing: the Batavia was well-armed, well-manned and well-equipped. She could stand up to any kind of danger from the outside. However the real danger came from within. From a skipper who was more interested in his female passengers than in his ship, crew and navigation. And from an undermerchant with a keen eye for his own luck regardless the consequences. In this situation the governance had to come from Pelsaert, the uppermerchant and commodore of the ship. However he couldn’t or wouldn’t, and maybe he knew too little about navigation (it was the skipper who navigated the smaller boat later on to the East Indies). His governance failed a second time: it was at the moment he chose to leave behind the men and women who trusted him. And when the boss was away Cornelius certainly took his chance. But Cornelius was a very bad risk controller: he had no idea what he was doing by sending the soldiers to the other island.
Unlike Cornelius a supervisor always has to be sure these supervised are aware of the risks they take. And not before long a new supervisory instrument will be introduced in the Netherlands: the “Financial Assessment Framework”. It is intended as an assessment tool that will enable pension funds and insurers to structure their business operations and risk management practices soundly. Our objective thus matches the institutions’ own responsibilities. Moreover, the financial assessment framework also provides an instrument to the certifying actuary.
The financial assessment framework lists the following elements of sound risk management:
- an explicit statement of the technical provisions in the balance sheet and so better insight into the value of the liabilities based on assumptions deemed realistic ;
- an explicit analysis in the solvency margin of the capital required under prudential supervision;
- consistent valuation, on a comparable basis, of assets and liabilities in the adequacy test, based on actual value;
- consistent treatment of the various pensions and insurance products;
- emphasis on risk analysis and management and on an associated series of indicators while maintaining a solvency position measured annually on the balance sheet date.
Under this approach, the solvency requirement can be more finely tuned to an institution’s risk profile. This stimulates sound risk management since it generally implies that less capital is tied up, apart from the statutory minimum of shareholders’ equity. Moreover, we can accurately focus discussions with the institutions on the more explicitly-worded requirements and on the approach taken by the institution. With this step the PVK also accommodates the wishes of the institutions themselves.
One of the goals of our mission after our merger with the Dutch Central Bank is the stability of the financial system and of the institutes which are part of that system. Financial stability depends very heavily on the feeling of trust in society. That feeling of trust was endangered the last couple of years. Also our pension funds were battered by heavy seas and the storm is not yet over. Decreased solvency induced extra donations which was an unavoidable but unpleasant response. It curtailed indexing mechanisms in many cases, which in the end is not different from cutting directly on the pension. No good PR, but, more important, it endangers trust, which in itself is a pillar of stability. We must take that to hand in a more transparent and well-based way. Supervisory (and pension fund governance) is no goal in itself, but must contribute to stability and trust and at the moment maybe foremost to regaining that trust.
5. The fate of the mutineers.
Well, I kept you in suspense for some time but now the moment has come to answer one last question: What happened when Pelsaert —on orders of Coen, his supervisor—returned to the Abrolhos?
It was not long before the mutineers were all rounded up, questioned and tied. The ensuing trial at the place of terror was thorough and is quite well documented in Pelsaert's own journal. Some mutineers were reluctant but most seemed quite willing to tell what happened. Some were hanged on one of the islands but most of them were executed at Batavia. Two young boys escaped their dead: Pelsaert felt sorry for them and left them on the coast of West Australia. At least one of the boys must have survived the wilderness for some time: stories are told about West Coast Aboriginals with blue eyes and a light coloured skin. Cornelius was hanged on Seal Island, on the morning of 2 October after having both hands cut off. His second in command was killed in the battle with the soldiers. And his third in command was taken to Batavia where he was convicted as a mutineer and broken from 'under and upwards' on the wheel.
I will spare you any further details, but as a supervisor… All I can say, we don’t use these methods any more.