EUROPE - The holistic balance sheet (HBS) will fail to assess the solvency of European occupational pension schemes accurately - with IORPs being asked to make risk and impact calculations with too many assumptions rather than accurate figures, increasing the risk of "pseudo" security, several industry heavyweights have said.
Responding to the consultation paper on the quantitative impact study (QIS) for the revision of the IORP Directive, launched by the European Insurance and Occupational Pensions Authority (EIOPA) in June, several European pension fund associations have argued that IORPs do not have the necessary tools to complete the calculations required for the HBS model.
They further argued that the QIS failed to assess the right types of risk for occupational pension funds.
The EIOPA's Occupational Pensions Stakeholder Group (OPSG) argued that even if IORPs managed to complete the calculations, the final outcome may nevertheless not be of use to supervisors and the pension sector.
"To calculate the HBS, IORPs have to make many assumptions, so the risk of pseudo security is severe and the model-risk of this approach is very large," the group said in its response. "Markets are incomplete - e.g. long maturities, wage inflation, long term volatility - and thus dependent on modelling assumptions, so the reliability of outcomes is questionable."
According to the OPSG, these elements would make it "very hard" to compare the HBSs of different IORPs.
The group also added that the HBS might not be a useful instrument in assessing the solvency of the fund.
"If the pension contract is complete and all security mechanisms are included in
the HBS, the funding ratio will always be 100%," it said.
As the consultancy firm Towers Watson explained in its response regarding UK IORPs earlier this week, capping pension support and the value of pension protection schemes - such as the Pension Protection Fund (PPF) in the UK - would restrict the asset and liability side of pension funds.
While additional pension sponsor support and the PPF's coverage could help reduce the solvency capital requirements, the HBS method would not allow pension funds to exceed a 100% funding ratio.
This is due to changes in market conditions, longevity and other elements that would come to directly impact pension funds' assets or liabilities.
The stakeholder group added: "This will lead to a net solvency capital requirement of 0. In this sense, the HBS could be a very expensive exercise that only confirms when a pension contract is complete."
In Germany, the country's association of occupational pension funds, AbA, expressed similar doubts over the tools IORPs would have at their disposal to implement the HBS approach and reiterated its concerns over a market-consistent valuation of assets and liabilities.
According to the association, short-term changes in market prices should not drive the management of institutions that cover long-term liabilities and follow long-term investment strategies.
"Given that members cannot call their benefits before they are due - unlike customers of banks and insurance companies - market risk is a secondary risk to IORPs," the association said. "The primary risk of changing asset prices is the effect on the portfolio return of reinvestments."
The same applied to interest rate risk. According to AbA, such risk was present only because the QIS required assets to be marked to market and liabilities to be discounted with a 'market-consistent' discount rate.
"It is the absolute level of interest rates or market returns over time which matter, not inter-temporal changes to these variables," it added.
In its response, the German association also took into account all other types of risk occupational pensions were confronted with, such as longevity and disability-morbidity.
AbA also predicted that mortality would be counted twice, arguing that there was no need for a 20% discount on mortality rates, which would be allowed under the SCR, when there were already automatic processes in place to address increasing longevity.
AbA also said that the capital charge for pension disability-morbidity risk could be lower for IORPs compared to insurers, since IORPs do not have the disadvantage of adverse selection due to mandatory participation.
According to AbA, the calculation of the different risks for the solvency capital requirements also relied heavily on credit ratings, a fact it found surprising.
"This is remarkable," it said in its response, "given that the European Commission is reviewing the Credit Ratings Directive, which will reduce the reliance on ratings in financial regulation.
"Relying heavily on credit ratings will introduce pro-cyclicality into the solvency assessment of IORPs, thereby amplifying risk."
Finally, the European Association of Paritarian Institutions (AEIP) argued against the calculation of solvency capital requirements in the operational risk module.
"We find the formula proposed too difficult, complex and burdensome for small IORPs to follow," the association said.
Instead, the AEIP suggested that operational risk might be ignored in this first QIS, especially where good governance models are already in place.
"It seems also questionable if there is actually a need for a very complex calculation of the operational risk when pillars II and III of a Solvency II-like approach, which aim at good governance and transparency, might be implemented by IORP II," the AEIP concluded.