End to the first act
Six years since the idea was first raised, the European Commission has finally drawn a curtain on its proposal to apply rigid risk-based solvency requirements – pillar one of Solvency II – on occupational pension funds in IORP II. At least for now, since Michel Barnier, the commissioner for the single market, has made it clear that this is a postponement, not a policy abandonment.
The proposal to apply Solvency II-type rules met a chorus of disapproval from almost all quarters from the outset, other than from the insurance lobby. But the counter arguments fell on deaf ears.
The arguments against the application of insurance-like solvency capital requirements, and the holistic balance sheet proposal, are well rehearsed. Pension funds are not life insurers and discharge their liabilities over a period of many decades.
As trusts (or the equivalent), they exist solely to meet the obligations to beneficiaries. They are not in competition with insurers as such and certainly not in the same market segments; while insurance-based workplace pensions may be suitable for smaller schemes, and are widely used, they are rarely, if ever, efficient for larger ones.
The impact on asset allocation has also been a main focus for critics, since Solvency II type rules would drive pension funds away from the same long-term asset classes – infrastructure or private equity, for instance – that might allow them to better optimise their risk and return requirements and benefit the wider European economy.
The intellectual basis for risk-based solvency capital requirements has also come under extreme scrutiny, particularly the suitability of value-at-risk calculations. The holistic balance sheet proposal and QIS exercise have been roundly criticised.
More contentiously, some have argued that the Commission may be exceeding its mandate in seeking to regulate workplace pension agreements, since these fall under the social and labour law, which is outside the Commission’s scope.
It appears to have been the preliminary results of EIOPA’s first QIS in April that have swayed the Commission. Since this Commission’s term comes to an end next year, it is also unlikely that a full draft directive could have been brought forward in time.
It is tempting to think any resurrection of the pillar one proposals will recede conveniently to the end of this decade or into the next. But fans of the BBC sitcom Yes, Minister will know that some policy ideas embed themselves in an organisation so firmly that they are near impossible to quash.
A slimmed down IORP II will still contain pillars two and three of Solvency II – covering governance and risk management, and disclosure and transparency respectively.
So much effort has been spent on the solvency requirements on pillar one that the other two have been somewhat overlooked. Their impact should not be underestimated as their incorporation in Solvency II could mean the adoption of a different regulatory and risk management culture for some EU countries.
They alone may lead to an improvement in risk management culture, and even possibly to consolidation if funds, sponsors or regulators see benefits in seeking economies of scale.
This is not necessarily to be feared but the industry as a whole could certainly do without the long and drawn-out process that Solvency II is currently experiencing. And although the curtain may have fallen for now on pillar one, there will be new challenges – dealing with a new pensions portability proposal, for instance, and possible moves towards mandatory shareholder voting.