Pension funds may yet be spared the application of Solvency II insurance style capital adequacy rules - and an associated shift in asset allocation away from equities. At issue are assets worth €1.87trn - the estimated combined value of assets backing occupational defined benefit (DB) schemes in Europe.
The European Federation for Retirement Provision (EFRP) previously indicated that if Solvency II rules were to be applied to pension funds, liabilities could increase by 40-60%.
In the face of strongly felt opinions from both opponents and proponents, in the contest over prudential rules on assets, Chris Verhaegen, secretary general of the EFRP, argued ‘mechanically' applying Solvency II to the pensions (IORP) directive would threaten financial stability, reduce economic growth, increase the cost for employers, provide lower pensions and accelerate the trend of companies closing DB schemes.
The EFRP gives a breakdown of costs the pensions industry might face if the Solvency II provisions were adopted. Austria, for example, would have to increase its funding by 12%. This could be achieved by reducing the share of equities in the asset mix by 23%, or, theoretically, by buying fixed income funds maturing 14 years later. Equivalent figures are: Belgium -41%/+6 years; Germany -7%/+8 years; Ireland -62%/+15 years; the Netherlands -39%/+9 years; Spain -46%/+23 years; UK -57%/+10 years.
The protests have already reached Charlie McCreevy, European Commissioner in charge of the internal market. He has given the strongest hint yet that the Commission is now moving away from applying the insurance capital adequacy measures to pension funds. "A very strong business case would be required before we starting shifting Solvency II rules to pension funds …I have no intention of sponsoring proposals that would risk closing down DB pension schemes," McCreevy said.
His assessment was followed by a Commission decision to hold a broad-based inquiry into the matter. Though not formally announced at the time of going to press, the have-your-say forum could easily delay any firm decision by the Commission by months. Objectors must welcome such respite, plus a valuable opportunity for a rethink.
For their adversaries, the regulators, Karel Van Hulle, the Commission official in charge of pensions, said recently pension plans must still be diverse and allow companies numerous ways to fund them. "But supposing you save all your life, and then on retirement you find that there is nothing in the pot. We need security and transparency in the system."
A more gloves-off message comes from Ieke van den Burg, Dutch member of the European Parliament. She proclaimed, at a recent pensions conference in Brussels, organised by the European Fund and Asset Management Association, that there is not just a need to regulate the use of bonds and equities in pension plans, but also "innovative products". By these she meant instruments such as CDOs, credit default swaps, and other derivative financial instruments "where regulation is really necessary".
She claimed the EU's current pension regulation "is inadequate, in that it completely relies on national prudential rules and methodologies, which may create risky situations and regulatory arbitrage, seducing funds to the lightest regulatory regime".
In practice, the current legislation to protect future pensions comes under 27 national codes, one for each EU member state. Currently, a research exercise is looking into exactly how the 27 different EU jurisdictions do manage their pension security, especially for DB schemes. This investigation is in the hands of the Frankfurt-based Committee of European Insurance and Occupational Pensions Supervisors (CEIOPs), which advises the Commission. CEIOPs will probably report in March.
In all this, a possible tightening of European pension funds' solvency risk strategies appears to be in contrast to developments elsewhere in the world. In the US, the Pension Benefit Guarantee Corporation safety net intends to raise its investments in equities to 45%, approximately double the present allocation. Conversely, the UK Pension Protection Fund holds only 20% of assets in equities.
But the announcement of this shift came in for strong criticism from John Ralfe, adviser to RCB Capital Markets, and Zvi Bodie, professor of finance and economics at Boston University School of Management. They described the relaxation to "a company which insures hurricane damage investing its reserves in beachfront property".
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