The European Insurance and Occupational Pensions Authority (EIOPA) has launched its consultation into the six proposed models for its holistic balance sheet (HBS).
In addition to consulting on definitions behind pension promises, sponsor support and contract boundaries, EIOPA will look to the European industry to define how any HBS supervisory frameworks could work in practice.
If the first proposal, EIOPA said schemes would be faced with two requirements – either full funding on a Level-A basis, or Level-A funding plus additional solvency capital requirements (SCR).
Level-A technical provisions are calculated by discounting liabilities on a near risk-free basis.
EIOPA said IORPs would have one year to secure funding to the required level, using financial assets to reach Level A, and using additional sponsor support should the requirement include SCR.
Schemes with no hedge-able liabilities would have one year to transfer risks to an insurer or another IORP.
EIOPA said even schemes with unlimited sponsor support would still have to reach Level-A funding using financial assets.
It also stressed that IORPs would not be allowed to recognise pension protection schemes, or the ability to cut benefits in the case of a failed HBS.
The second model proposed IORPs holding financial assets to cover Level-B best estimates, where schemes would be given an “extensive time period” to recover if assets fell below the threshold, and member states allowed to impose additional requirements.
Level B refers to calculating liabilities on a near risk-free basis but accounting for the expected return on scheme assets.
Similarly, the proposal sets out both a minimum Level-B funding level and this level plus additional SCR.
However, both levels can be reached through the formalisation of a recovery agreement with the sponsor and the IORP, rather than using strict time periods.
IORPs where sponsors bear risk would be required to hold SCR. However, the strength of the sponsor could reduce this to zero.
Weaker sponsors may face SCR, although EIOPA said the impact would be limited where national regulators already imposed risk-based buffer requirements.
The third HBS framework splits out the options based on pillars one and two of the IORP Directive.
Pillar one looked at the certainty of schemes providing benefits, while pillar two looked more at IORPs’ expected response to future situations.
For the pillar-one proposal, schemes would be required to hold SCR but with flexible recovery periods. The HBS for the pillar-two model would be more of a risk-management tool, rather than include capital requirements.
However, in both pillar proposals, schemes could use sponsor support and pension protection schemes to reduce SCR or demonstrate suitability against future scenarios.
The fourth framework mirrors that of the first.
However, the HBS can include the reduction of benefits for retirees, as well as in the event of a sponsor default.
It can also use sponsor support and backing from a pension protection scheme to reduce SCR.
EIOPA said, in national systems where pension arrangements were completely specified, the security of the schemes would be enough to absorb SCR.
It added that there could be upheaval where national arrangements were not completely specified, as well as where this led to IORPs lacking the assets or support to manage the HBS or stress tests.
The fifth framework mirrors that of the third in using both pillars one and two of the IORP Directive.
However, the pillar-one minimum capital requirement level does not follow the SCR, but rather dictates that schemes should hold financial assets to cover Level-A technical provisions.
It also states that EU member states could impose additional buffer requirements and allow IORPs to negotiate recovery periods rather than set them out in legislation.
The pillar-two option focuses on Level-A technical provisions and an SCR based on a risk margin.
However, it allows the reduction of benefits and using sponsor support, as well as a pension protection scheme to prove sustainability.
The pillar-one requirement, EIOPA said, would interfere with national systems by creating a harmonised approach.
Pillar two would affect national systems with unsustainable pension promises and weak sponsor support.
The sixth framework for the HBS suggests IORPs, under a pillar-one system, would be subjected to the valuation standards, minimum-funding requirements and recovery periods as set out in the current IORP Directive, but supplemented through national regulation.
In the pillar-two system, IORPs would once again be required to assess the HBS and SCR as a risk-management tool.
National regulators would have to force IORPs and sponsors with insufficient assets, sponsor support and pension protection schemes to cover SCR or reduce benefits to increase the certainty of meeting promises.
EIOPA said pillar-one proposals would essentially leave the status quo among national markets.
However, pillar two would see the HBS valued on a market-consistent basis and schemes accounting for a “comprehensive set of risks”.
The proposals from EIOPA come as part of a 111-question consultation regarding the implementation of the HBS.
An EIOPA spokesman said: “EIOPA is undertaking this work on its own initiative in its role as independent adviser to the European political institutions.
“The consultation paper proposes improved definitions and methodologies to value the holistic balance sheet, covering areas such as the valuation of sponsor support, the benefit-reduction mechanisms and discretionary decision-making processes and the definition of contract boundaries.”
The consultation runs until 13 January 2015.
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