In a victory for defined benefit (DB) pension plans and sponsors, the European Insurance and Occupational Pensions Authority (EIOPA) has decided not to recommend the introduction of a new, more stringent solvency regime for European occupational pension plans (IORPs) “at this point in time”. This follows three years of work by EIOPA on developing a common funding and valuation model for DB IORPs across Europe and many years of lobbying by ourselves and others to point out the potential downsides of introducing a new, more stringent funding regime for DB IORPs.
However, EIOPA has not ruled out the prospect of this completely – so vigilance will continue to be required - and it has also recommended the introduction of a new standardised risk assessment and transparency regime for such IORPs. We are not clear what value this will bring.
The debate about whether to impose a more stringent European solvency regime for DB IORPs has been running for some time. Around three years ago, EIOPA began work on its own initiative on the solvency of IORPs. As part of this, in October 2014, it consulted on various proposals for a common funding methodology, known as the “holistic balance sheet”. This was followed last year by EIOPA’s quantitative assessment, designed to assess the financial impacts on DB IORPS of using an EU wide solvency assessment regime, based on the holistic balance sheet. It also assessed the appropriateness of the various proposals set out in the 2014 consultation. On the back of this, EIOPA said that it would advise the EU institutions on whether or not to introduce a new European solvency regime for DB IORPs.
No new solvency regime for IORPs
EIOPA’s advice to the EU institutions is set out in an official Opinion which it submitted on April 14th. EIOPA stops short of recommending the introduction of a new solvency regime for DB IORPs saying that such a move was not appropriate “at this point in time”. EIOPA now considers this “one size fits all” approach is likely to be neither appropriate nor effective since IORPs in different member states have very different characteristics and are “experiencing varying challenges". And so say all of us!
Risk assessment and transparency regime
Although EIOPA ruled out a new solvency regime, for now, it is recommending that DB IORPs across Europe be required to produce and disclose, on a regular basis, (a) a market-consistent balance sheet and (b) a standardised risk assessment using EIOPA’s common funding methodology.
The proposed market-consistent balance sheet is based on EIOPA’s proposals for the holistic balance sheet. As such, under EIOPA’s proposal a DB IORP’s liabilities would have to be valued on a near risk-free basis for this purpose. The balance sheet would also recognise all available security and benefit adjustment mechanisms, including sponsor support, pension protection schemes, conditional and discretionary benefits and benefit reduction mechanisms. To ensure a consistent application of the principle of market consistency, EIOPA proposes that guidance should, as far as possible, be provided at the European level.
Alongside this EIOPA is also proposing that DB IORPs should have to conduct a standardised risk assessment, analysing the impact of a set of common, pre-defined stress scenarios on the balance sheet. It recommends that the following risk factors, considered most relevant for IORPs, should be included in this: operational risk, risk-free interest rate risk, property risk, equity risk, spread risk, currency risk, concentration risk, counterparty (including sponsor) default risk and longevity risk.
DB IORPs would be required to calculate the balance sheet and conduct the risk assessment regularly and report the results to their national supervisor on an annual basis. EIOPA also favours the “disciplinary effect” of IORPs publically disclosing the key results.
This common risk assessment and transparency framework would sit alongside national regulatory requirements. National regulators would be responsible for supervising this new framework and EIOPA calls for national regulators to be given sufficient powers to take appropriate actions, such as improving the financial position of a DB IORP, reducing its risk exposure and/or enhancing the management of risks, in response to the outcome of an IORP’s balance sheet and risk assessment.
A simplified regime is proposed for smaller IORPs.
The move away from the idea of a new, more stringent funding regime will come as a relief to most DB plans and their sponsors across Europe. As EIOPA’s own Opinion states, this could have increased pension liabilities across Europe by 27%.
We understand that EIOPA intends to stop working on developing a new solvency regime, which means that this threat is now more remote. However, it cannot be ruled out for ever, particularly as EIOPA’s Opinion comments on its suitability only “at this point in time”. This leaves open the prospect that the DB solvency issue will come back on to the agenda at some point. Indeed, as it currently stands, the draft new IORP Directive (which is unaffected by EIOPA’s Opinion) would require the Commission to review the solvency requirements for DB IORPs within six years of the Directive coming into force – expected later this year.
The proposed new risk assessment and transparency regime will add a significant new administrative and cost burden to DB IORPs (EIOPA estimates that the additional cost to UK plans will be £167million per year). It also risks causing confusion and complexity by creating yet another measure of pension liabilities. Given the significant differences between pension systems and pension plans around Europe, it is questionable what value this new regime will have and how much it will add to member protection. Consequently, we expect there to be significant opposition to the proposed introduction of this new regime, which is by no means a foregone conclusion.