The European Insurance and Occupational Pensions Authority (EIOPA) has issued a mammoth consultation paper, on the solvency of EU based occupational pension plans – or institutions for occupational retirement provision (IORPs). The paper, which has been issued by EIOPA on its own initiative, considers in some detail how various aspects of the so-called ‘holistic balance sheet’ might work, including how to value sponsor support and the extent to which pension protection schemes ought to be recognised. It also sets out six options for how the holistic balance sheet could be used as part of the funding and regulatory regime for IORPs, all of which would have a significant impact on defined benefit (DB) occupational pension plans in the UK.

Key points

The main concerns for UK DB plans with EIOPA’s proposals are:  

  • the possibility of the holistic balance sheet being used to introduce new solvency requirements for IORPs “by the back door” as part of the governance requirements contained in the proposed new IORP Directive;
  • the fact that the holistic balance sheet could be used to drive an explicit new solvency requirement for occupational pension plans;
  • the suggestion of a solvency regime being developed which would apply insurance-style funding requirements to IORPs and require full funding within one year; and
  • the fact that some of EIOPA’s proposals, for example, those connected with the recognition of pension protection schemes and non-legally enforceable employer support may conflict with the current position under UK law.  

What is the holistic balance sheet?

The holistic balance sheet is a tool that is being developed by EIOPA, which could be used to create a harmonised EU-wide solvency measure for IORPs. The holistic balance sheet compares a plan’s assets (which would take account of sponsor support and, potentially also, pension protection schemes, such as the Pension Protection Fund) with its liabilities (which may need to be calculated on a near risk-free discount basis and which could also include a risk margin and a capital reserve requirement, similar to that applied to insurance companies).

How might the holistic balance sheet be used?

EIOPA’s consultation paper seeks views on six different options for the way in which the holistic balance sheet might be used as part of an EU-wide regulatory framework for IORPs. The six options range from maintaining the existing EU solvency requirements for IORPs and only requiring IORPs to use the holistic balance sheet as a risk management tool, through to using the holistic balance sheet to apply insurance style solvency requirements to IORPs and requiring them to be fully funded within one year.

All of the options set out in the consultation paper would have an impact on DB plans in the UK. The first option outlined above, which would be likely to have the least impact, would still require DB plans to prepare the holistic balance sheet, which would include a solvency capital requirement, as part of their risk management processes. Although this would not lead to a direct funding requirement being placed on the plan sponsor(s), the consultation paper states that DB plans that cannot produce a balanced holistic balance sheet (e.g. due to weak sponsor support) “would be obliged by the national supervisory authority to modify the pension arrangement to ensure that pension promises can be fulfilled”. In a UK context, where DB plans are unable to reduce accrued benefits (unlike IORPs in some other Member States), it is difficult to see where else this could lead other than to such plans being closed to future accrual (where this has not already been done) and/or requiring more financial support from the plan’s sponsor(s).

At the other end of the spectrum, the option of using the holistic balance sheet to apply insurance-style funding requirements on IORPs would clearly have a seismic impact on DB plans in the UK, their sponsors and the wider economy. Under this option, DB plans would have to:

  • value their liabilities on a near risk-free discount basis;
  • hold sufficient assets to cover their liabilities, a risk margin and a capital solvency requirement (similar to that applicable to insurance companies);
  • make good any deficit between their assets and liabilities (including the risk margin and capital solvency requirement) within one year.

If this option were ever implemented, it is likely that it would add hundreds of billions of pounds to the liabilities of DB plans in the UK. This in turn might lead to the insolvency of many DB plan sponsors who simply could not afford to bring their plans up to the required funding level within such a short period.

Towards a new solvency requirement?

The revised IORP Directive, which has been proposed by the European Commission and which is currently being considered by the Council of Ministers and the European Parliament, does not contain a new solvency requirement for IORPs. However, EIOPA’s consultation paper makes clear that it is still very much on the agenda. Therefore, it is crucial that UK employers, DB plans, unions and industry bodies respond to the consultation and engage with the European institutions and UK policymakers. It is important  to make clear how damaging a more stringent funding requirement for IORPs would be for DB plans and employers in the UK, and for the wider UK and European economy. We also need to continue to work with other Member States who would be affected by this, to ensure this message is heard.

This consultation closes on 13 January 2015 with responses having to be made on EIOPA’s standard ‘template’. Respondents should note that each answer is analysed by EIOPA independent of responses to other questions. So, if you simply cross reference another answer in your response this will not be considered.

Background

The holistic balance sheet was initially proposed by EIOPA as a tool for creating an EU-wide solvency requirement for IORPs in its response to the European Commission’s Call for Evidence on revision to the IORP Directive, which it delivered in 2012. Despite the fact that the outgoing European Commission decided not to include new solvency requirements for IORPs in its proposal for a revised IORP Directive, which it published earlier this year, EIOPA is on its ‘own initiative’ continuing to work on and develop the methodology for the holistic balance sheet.

The current consultation follows the quantitative impact study (QIS) on the impact of the holistic balance sheet which EIOPA carried out in 2012, the results of which were published in 2013. As well as identifying the potentially very significant impact of using the holistic balance sheet on DB plans in the UK and other Member States, the QIS also identified a number of areas where further work was needed if the holistic balance sheet was to be used as a solvency and/or risk assessment tool by IORPs.

EIOPA intends to use feedback gathered from the current consultation to develop a draft technical specification which it intends to publish in early 2015 for use in a more detailed QIS next year. EIOPA will use the results of this study to develop on its own initiative technical advice for the European Commission on EU-wide solvency rules for IORPs.

Further information

Click here to access the consultation paper and click here to read EIOPA’s nutshell guide to the holistic balance sheet.