The EU Commission has published the findings of a consultancy process on pension solvency it launched last year. Cornelia Schmid assesses the process and outlines the view of the German corporate pension fund association (aba)

Last September the EU Commission launched a public consultation on the harmonisation of solvency rules applicable to Institutions for Occupational Retirement Provision (IORPs) covered by Article 17 of the IORP directive and IORPs operating on a cross-border basis. IORPs subject to Article 17 underwrite liabilities to cover against biometric risks, or provide guarantees of a given investment performance or a given level of benefits.

Altogether, it raised 34 questions. The two most important were whether a further harmonisation of the solvency regime for IORPs covered by Article 17 of the IORP directive and IORPs operating on a cross-border basis is desirable or not, and whether Solvency II rules being developed for insurance undertakings should be adapted for these IORPs.

The Commission received 60 responses by the November deadline and in mid-March it published a feedback statement summarising contributions from the consultation1. The responses came from diverse sources, including supervisors, member states, national and EU trade bodies and individual entities. Most came from four countries - UK (23), Germany (17), France (10) and the Netherlands (8).

On 27 May the Commission will hold an open hearing on the consultation on the harmonisation of solvency rules for IORPs subject to Article 17 and cross-border IORPs in Brussels2. The aim is to draw first lessons from the public consultation. Four panels are scheduled. The first, on solvency rules for pension funds, will assess whether solvency rules should be harmonised within the EU. The objectives and principles of prudential supervision for IORPs will be reviewed. The second will review whether there a level playing field issue between pension funds and insurance undertakings. The main question is whether the current solvency rules for IORPs subject to Article 17 should be replaced by Solvency II rules. A third on technical provisions and solvency rules in a cross-border context will focus on issues like technical provisions, first experiences with cross-border activity and concrete evidence of potential regulatory arbitrage between member states.

The fourth panel on broader issues raised during the consultation will discuss issues like investment rules for DB schemes, occupational pension provision in different member states and the impact of the overall pension system.

The German association for company pension schemes (aba) participated in the consultation. Its 26-page position paper may be summarised as follows:
• Pensionskassen and Pensionsfonds in Germany are subject to directive 2003/41/EC of 3 June 2003 and therefore qualify as IORPs. Pensionsfonds may offer fund-like pension plans or insurance-like plans. Only in the case of insurance-like plans does the institution itself assume any liability. We assume that Article 17 of directive 2003/41/EC applies only to insurance-like pension plans offered by Pensionsfonds.
• In light of the demographic trend and the associated need to expand the extent of funding, a secure and efficient pension system is more important than ever. Security is therefore a central objective of capital adequacy requirements. However, consideration must also be given to the financial and ‘social' cost of any programme that adjusts the level of security.
• Existing protective mechanisms for Pensionskassen and Pensionsfonds are, in our opinion, adequate, especially since the employer is ultimately responsible for the payment of promised benefits (an employer's ultimate liability is defined in Sentence 3 of the German Pensions Act).
• The quantitative rules of Solvency I currently in force appear to be sufficient for German IORPs, especially in light of the new qualitative requirements introduced by the ninth Amendment to the Insurance Supervision Act (MaRisk).
• Directive 2003/41/EC (the IORP Directive with Solvency I in Article 17) is sufficient as a minimum EU standard for IORPs, at least for now, especially with respect to equity capital adequacy requirements.
• IORPs that really operate across borders are clearly in the minority at the moment. In our view, a complex new system of EU-wide equity capital adequacy requirements should not be created until we have had the chance to gain sufficient experience with the existing system.
• A forward-looking risk-based approach can be followed, in our view, without increasing solvency capital requirements. The proportionality principle must relate not just to the size of the IORP, but to its risk structure. In particular, the mark-to-market valuation of liabilities required in Solvency II would be inappropriate for IORPs and should be rejected. Any change must be preceded by a comprehensive field test to investigate the probable impacts on IORPs.
• There are no major competitive distortions between IORPs and life insurance companies due to systemic differences between the two (particularly with respect to corporate purpose, position of ultimate guarantor and risks).
• The IORP directive specifically allows competition between IORPs, which is created by the different rules in the various member states. These differences result in competition, but not in regulatory arbitrage. Regulatory arbitrage could arise if the IORP directive is not implemented to a sufficient degree in certain member states or if the implementation is based on incorrect interpretations of the directive. However, these problems must be addressed on a national level.

Compromise on Solvency II

IORPs Article 17(1) continues to work under Solvency I rules. At the end of March, a political compromise was reached between the Council and Parliament concerning the Solvency II directive. The formal adoption of the text in Council and Parliament is still awaited. The compromise that will bring a new solvency regime for insurers also affects IORPs, and it contains good and bad elements for IORPs.

The IORP directive will be modified in order to maintain current solvency rules for IORPs (Article 305a of the Solvency II compromise). Article 27, 28, 29, 30, 65 of Directive 2002/83/EC (Solvency I) and Article 16a of Dir. 1973/239/EEC will be inserted into Directive 2003/41/EC. An amendment of Article 17 (2) was necessary. It was not intend to apply the Solvency II directive to IORPs due to a legal link (references to Articles 27 and 28 of directive 2002/83/EC in Article 17 of directive 2003/41/EC). The problem arose as the IORP directive includes a provision (Article 17) that refers to the current solvency directive for insurers, Solvency I (the precursor to Solvency II).

The modification required to maintain current solvency rules for IORPs will not lead to an endless Solvency I regulation for IORPs. Recital 95(b) calls for a quick review of IORP directive and the development of a proper system of solvency rules for pension provision.

The Gallic pension module
Member states have the right to introduce a "duration-based equity risk sub-module" of the solvency capital requirement for insurance companies which provide occupational retirement provision in accordance with Article 4 of Directive 2003/41/EC or promoted retirement benefits (new Article 305b of the Solvency II compromise). In particular, France asked for a separate risk module in the Solvency II directive in order to obtain a relief of the solvency capital requirement for their pension business. The attractiveness of the equity risk sub-module of the solvency capital requirement depends strongly on the scale of equity investments. A ‘Solvency II light for promoted retirement benefits' could be the result.

If insurers want to use the equity risk sub-module of the solvency capital requirement for their business with the promoted retirement benefits, they have to fulfil three conditions. First, they will have to ring-fence those assets and liabilities of this business without any possibility of transfer. Second they can operate this business only in the member state where the undertaking has been authorised and third, the average duration of the liabilities corresponding to this business have to exceed an average of 15 years.

We believe that the Commission has made good headway with its consultation on IORPs covered by Article 17 of the IORP directive and IORPs operating on a cross-border basis. The review of the solvency rules for IORPs needs its own process and the Gallic pension module is not a good starting point for IORPs.

(1) The responses are available at http://ec.europa.eu/internal_market/consultations/2008/occupational_retirement_provision_en.htm
(2) The programme and information on how to register are available at http://ec.europa.eu/internal_market/pensions/commission-docs_en.htm

Cornelia Schmid is an economist at aba, the German association for occupational pensions