By Matt Ritchie
The release of the European Insurance and Occupational Pensions Authority's advice to the European Commission on a review of the IORP directive has generated a significant amount of comment throughout the industry, despite the authority's paper containing few surprises.
The authority is advocating a 'holistic balance sheet' approach to assessing scheme funding, which would take into account sponsor support and contingent assets as well as financial assets, while the value of liabilities would include a capital buffer as well as the value of benefits.
The proposal to apply a Solvency II-type capital adequacy regime to pensions has been a contentious point throughout the review, and law firm Sacker and Partners was “deeply concerned” at the prospect of Solvency II being applied to UK schemes.
Sackers partner Zoe Lynch said EIOPA had been given a “narrow remit” by the commission, asked how funding requirements should be further harmonised, not whether they should be. The holistic balance sheet approach and solvency capital requirement would signal the end of the DB scheme in the UK, Lynch said.
“The proposed introduction of the HBS approach represents a real risk that employers will abandon the idea of funded schemes (both DB and DC) if the solvency or minimum capital requirements are applied. The downgrading of pension benefits is a likely consequence of such increased regulation and cost - effectively the opposite result to the outcome of member protection that the commission is seeking to achieve.”
Head of research at Punter Southall Jane Beverley agreed that the advice largely starts from the wrong premise, due to EIOPA being unable to consider whether Solvency II was the right place to begin a review of the IORP directive.
“We would urge the EC to heed EIOPA’s suggestion and to revisit the very foundations of the current proposals. The case that Solvency II should be applied to pensions has never been properly made nor subject to a full public consultation. Imposing the quantitative requirements of Solvency II on pension schemes (even if partially obscured by a holistic balance sheet wrapper) could have disastrous effects on pension scheme members, who would see future benefit provision reduced to help in meeting funding requirements for existing benefits; on employers who would be required to pay higher contributions to their pension schemes, and on the wider economy, as a result of major behavioural changes to investment strategy. The EIOPA advice, detailed and comprehensive though it might appear, has not been able to address the real questions at issue.”
Partner at consultancy LCP Alex Waite was unsurprised that EIOPA would press on with developing the holistic balance sheet approach, and said this “noble and ambitious objective” would be appropriate in certain circumstances.
“However, it is clearly not a cost-effective mechanism for dealing with the vast number of widely differing occupational pension schemes across Europe. It will be interesting to see whether the principles are diluted as the process develops.”
J.P. Morgan Asset Management European head, strategy, Paul Sweeting echoed concerns around the proposed solvency regime, and said the advice does little to allay concerns about the outlook for defined benefit schemes in Europe.
He said the paper was based on the philosophy that pension funds should be able to “secure all benefits for members at all times”, implying schemes should be treated in the same way as insurance companies.
Insurance companies are fewer in number than pension funds, and their systemic importance to the broader economy meant they warranted the scrutiny of Solvency II, Sweeting said.
“However, individual pension funds are very rarely systemically important. If a firm becomes insolvent and leaves behind an insolvent pension scheme, this event rarely threatens the broader financial infrastructure.
“In other words, the aim for pension schemes should instead be to ensure that all members receive their benefits when those benefits are due. The difference here is subtle. The focus should be on members receiving their benefits, but this does not mean that those benefits should necessarily by paid by their schemes. In other words, there should be some pooling of risks across pension schemes, such as can be provided by compensation arrangements like the Pension Protection Fund,” Sweeting said.
Consultancy firm Towers Watson welcomed EIOPA's position on a quantitative impact assessment, which the authority said was essential for any legislative proposal.
Senior consultant at Towers Watson Dave Roberts said EIOPA had taken a firm line on the impact assessment, to the point where it said its advice on new funding rules was conditional on the outcome of a quantative impact study.
“So although the commission has the green light to proceed, there is a potential roadblock ahead. The impact assessment is expected to be delivered in the third quarter of this year. If the commission is to take this seriously, its desired timescale for delivering a draft Directive - by the end of 2012 - should be reviewed.”
Read EIOPA's advice here.