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Heavyweights reject Solvency II

Policymakers, pundits and pensions gurus gathered in Brussels recently to attend the European Commission conference on the Green Paper on pensions. And while the event's official line may have been safety, sustainability, transparency, working together - with László Andor, commissioner for employment, social affairs and inclusion, pointing out that funding wasn't everything and that defining ‘adequacy' wasn't easy - the unofficial line was very much a rejection of applying Solvency II rules to pension funds.

One by one, representatives from the industry waited their turn to pour cold water on the possible application of the rules, mooted earlier this year in the EU Green Paper, with the Dutch contingent, in particular, singing from the same hymn sheet. Paul de Krom, the new Dutch minister of social affairs and labour, argued that contributions could soar by as much as 30% if Solvency II rules were applied to pension schemes.

"A private insurer cannot be compared to a pension fund," he said. "Once a pension fund is established, participation is mandatory, and this makes its prospects fundamentally different from private insurers. If market rules were fully applied to pension funds, this could easily lead to a 20-30% rise in pension contributions."

As far as the Netherlands was concerned, he said, this would be unacceptable, adding: "The readiness of employers and employees to take part in pension schemes would be undermined, and this would lead to reduction of pension scheme participation and, subsequently, lower income for pensions."

Martin van Rijn, chief executive at PGGM, echoed many of de Krom's sentiments. "We could introduce more adaptations for economic cycles, we could introduce automatic adaptation to ageing, we could strengthen governance and risk management, or we could increase solvency rules. But we should be very careful about that. It would lead to rising costs and lower pension results, and it's questionable that it would lead to higher trust."

The Dutch were not the only delegates with concerns that the Green Paper's wording on Solvency II - fairly benign on the face of it - might, in fact, be the thin edge of the wedge. Steve Webb, UK minister for pensions, said his country saw "no compelling evidence" to suggest that the Solvency II approach was appropriate for occupational pension funds.

He said he was concerned that the application of a Solvency II-type regime to these schemes could increase employer liabilities substantially - "even for schemes that are judged to be otherwise adequately funded" - by leading many employers to re-evaluate their commitment to the scheme. "Alternatively," he added, "it could result in a reduction of benefits."

Of course, not everyone joined in the kicking fest. Gabriel Bernardino, chairman at CEIOPS, took pains to remind delegates the legislation actually wasn't all bad, and that pension funds should not to dismiss Solvency II out of hand.

"Solvency II is something that is very important for pension plans to look at," he said. "We shouldn't take a top-down approach and apply it blindly - we should go from the bottom up, look at what we have under the pension plans and determine the most sound principles that can be applied. At the end of the day, most of these principles can be applied. After all, we didn't build Solvency II in six months - we've been working on this for many, many years."

I'm OK, you're OK
National autonomy was another theme that played out over the course of the day, with delegate after delegate reminding his fellows that there was no ‘one-size-fits-all' solution to the problems facing the European pension industry. It was natural, then, that Nicholas Barr, professor of public economics at the London School of Economics, should win over the crowd from the outset by opening his keynote speech with the avowal that no single pension system could ever be seen as the ideal.

True, every pension system must address common objectives, such as consumption smoothing, poverty relief and redistribution, as well as common constraints, such as fiscal and institutional capacity, the shape of income distribution and even political sensitivities. Yet the pattern of constraints differs quite a lot across countries, Barr explained, so policymakers naturally attach different weights to the different objectives.

"Look at the demonstrations in France," he added. "We've had a debate in Britain about accelerating the rate of increase of pensionable age over the past two weeks, and we've had a very quiet and thoughtful debate - clearly, political sensitivity varies across countries."

This ‘I'm OK, you're OK' message was of course music to the ears of many delegates concerned about meddling by Brussels. Nevertheless (and there is always a ‘nevertheless' in these situations) Barr went on to describe various attributes of what he considered to be a good system, focusing on four relatively new policy directions: non-contributory pensions; redefining retirement; simple and cheaply administered defined contribution (DC) arrangements; and notional DC systems.

Respecting the ‘non-contributory basic pension' - a public pension paid at a flat rate on the basis of age and residence, rather than contributions - Barr argued that the old contributory principle had been based on the assumption that workers would enjoy long, stable jobs for most of their lives, and that coverage would therefore grow apace. But this scenario - with the man as breadwinner supporting wife and family in a single career over his whole life - hasn't existed since the 1950s, if it ever did exist.

A non-contributory system, Barr said, such as those seen in Australia or the Netherlands, is better for numerous reasons: it strengthens poverty relief in terms of coverage, adequacy and gender balance; it improves incentives relative to income-tested poverty relief; it provides good targeting ("age is a useful indicator of poverty"); it fosters international labour mobility through pro-rata arrangements; and it holds up well in the face of shocks because risk is shared across all current taxpayers.

Respecting retirement, Barr was an unequivocal supporter of increasing ages. "There isn't an ageing problem," he said. "People are living longer, healthier lives - arguably the greatest triumph of the twentieth century. There isn't a problem about people living longer, but there is a problem about people retiring too soon."

Barr then cited a welter of studies showing how a rather shocking number of people didn't know the difference between a stock and a bond, and how experimental evidence showed people were predisposed to avoid long-term planning. What to do? According to the professor, the answer is to keep it simple: use automatic enrolment, reduce the number of choices, design a good default option that includes life-cycle profiling and decouple fund administration from fund management.

These suggestions, and several others Barr made, were all well and good. But the $64,000 question, of course - and the one many delegates would have asked - is what role should the Commission play in all this? The professor starts "non controversially", suggesting it could foster the sharing of best practice and setting out the advantages of certain institutions and even "encouraging" such institutions.

"But there's a potentially more active role, which could include advisory activities or possibly indicative minimum standards, such as replacement rates, or the size of buffer funds, or issues of transparency and portability," he added. "I do see the case for a somewhat broader role for the Commission. Population ageing is a very large problem - it is one that will last a long time, and the problem is growing. Co-ordinated action is needed."

 

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