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Special Report

Impact investing


From Our Perspective: Careful what you wish for

At the end of January, Michel Barnier, the European commissioner for the internal market, told an audience of Dutch pension funds definitively that the Commission
will not apply Solvency II rules to pension funds.

As indicated in these pages late last year, the Commission will instead develop separate solvency rules for European pensions - what is likely to be termed Solvency for Pensions. Commissioner Barnier even hinted at the likely shape of Solvency for Pensions rules when he said the FTK was a "source of inspiration for European pension legislation", and that it was already "ahead" of Solvency II.

What is the FTK and is it a good idea? The FTK (which stands for financial assessment framework) replaced the fixed 4% discount rate for liabilities of Dutch pension funds when it came into force in 2007. It prescribes a mark-to-market discount rate (using the euro swap curve) for nominal liabilities; it uses a value-at-risk assumption of 97.5% certainty for the recovery of assets within a one-year period (since extended); and it applies a nominal coverage ratio of 105% plus risk buffers.

The FTK has come under tremendous criticism for a number of reasons. The first main problem has been the use of the euro swap curve to derive a market discount rate, at a time when interest rates have been at record low levels for over two years.

Second, in valuing nominal liabilities, the FTK does not take into account the ‘real' nature of the pension ambition and tries to make pension funds do two things at once - to manage nominal risk but with a real ambition.

No doubt, certain officials at the Commission worry that pension funds do not have shareholders, as most insurers do, or a backer of last resort (the state) to bail them out, as with the banks. That mentality prescribes insurance-type solutions and might lead the Commission to devise the wrong type of solvency regime for Europe's heterogeneous range of second-pillar retirement funds.

Writing in the February issue of IPE, the renowned academic, consultant and father of the fiduciary management concepts, Anton van Nunen, argued that pension funds should be regarded as "corporations that manage investment risks in order to be able to meet certain liabilities…. Reality should be faced; pensions have never been 100% safe, and never will be."

Individuals, collectively through well-designed pension funds, can afford to take on various types of investment risk over the several decades of their working lives. This risk should be embraced, not shunned.

Many years ago, a leading figure in the Dutch pensions world once remarked that, through the then proposed FTK, the Netherlands was set to spend more on pension buffers than on flood protection. Accordingly, the EU should recognise that it needs to spend its intellectual capital on devising the right kind of solvency regime for occupational pensions. If it does not it will accelerate a trend towards the wrong kind of DC or impoverish corporations and individuals through unaffordable, high pension contribution rates.

And the Dutch FTK is already set to change to a twin-track model, with an FTK1 for guaranteed security and lower prospective benefits, and an FTK2 for lower security but higher prospective benefits.

As the Dutch system moves to more conditional pension rights, it aims to set off increased conditionality with a bare-bones unconditional underpinning of basic pension rights. The resulting two-pronged pension system requires a matching dual supervisory framework.

As the FTK evolves, Mr Barnier and his officials should certainly make sure they know which FTK they wish to use as their source of inspiration.


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