GERMANY/EUROPE - Relying solely on a mark-to-market valuation of pension assets and liabilities is too short-sighted and should therefore not be applied to pension funds, according to Stefan Nellshen, chief financial officer at German pharma giant Bayer AG and its Pensionskasse.

"Crises like the current one make it obvious that pure mark-to-market thinking leads to short-term impulses by manager. suggested Nellshen at the annual autumn conference of the German occupational pension federation aba in Stuttgart today.

"Even the rescue packages for the banking sector are turning away from applying only a mark-to-market valuation of assets," he added.

Applying the Solvency II directive to pension funds - as is still being demanded by insurers - in its current form would require retirement vehicles to use mark-to-market valuation of both their assets and liabilities.

But Nellshen pointed out valuing assets by mark-to-market the current market price - increased the already high interest rate risk of pension fund portfolios.

"It also leads to higher volatility and drives managers towards pro-cyclical investment which could negatively influence the fund's long-term strategy," argued the Bayer CIO.

"Mark-to-market [valuation] also ignores long-term investment strategies of retirement vehicles. When you have mostly 'buy-and-hold' titles in a portfolio, short-term volatility in the market does not matter that much, but it does under mark-to-market evaluation."

Nellshen suggested were Solvency II rules applied to pension funds, there is also a risk the various regulatory requirements would contradict each other as, for example, stress-testing would require funds to evaluate their assets under long-term needs while Solvency II requires the opposite.

He also criticised the risk margin assumed under Solvency II, which includes the risk of transferring assets to a third-party in case of insolvency

"This scenario is not realistic for most retirement vehicles as the assets go back to the company in case of insolvency, not to an unknown third-party," said Nellshen.

According to his calculations, a defensively-invested pension fund  - allocated as 11% equities, 80% bonds, with the rest in real estate and alternatives - would be 100% funded under IAS19, but would drop to a 70% funding level should Solvency II rules be applied to pension funds.

"This is a significant increase of necessary capital - and such an increase could damage occupational retirement provision in Germany," Nellshen noted.

He fears sponsors' corporate financial ratings could be damaged by increased capital requirements while it might encourage employees to turn away from Pensionskassen and pension funds, and go back to direct pension promises or lesser-regulated CTA arrangements.

He also raised concerns about the prospect of pension promises being developed with lower guarantees, as they would be "counterproductive to social aims of German politics", according to Nellshen.

Clemens Frey, from KPMG, suggested pension vehicles - other than those offered by life insurers - have an almost zero risk of client drop-out as most corporate schemes have mandatory membership for employees.

The EU commission started a fresh consultation on Solvency II and its application to pension funds at the beginning of the month.

A new Solvency II compromise for insurers filed under the French EU presidency meanwhile failed in the economic forum of ministers of the European Council, so a new discussion will begin on 2 December.