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IPE special report May 2018

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German call for flexible funding

Germany's Pensionsfonds are negotiating changes to the law governing the insurance industry, which would allow them to fall to a 90% funding level with a ten-year recovery period. A new study by the Organisation for Economic Co-Operation and Development (OECD) supports their calls for more flexibility in the funding requirements.

Currently, Pensionsfonds can only fall to 5% below full-funding and must be restored to full funding immediately, according to the regulations. Industry representatives argue these requirements are "too strict and unnecessary."

"Because Pensionsfonds are investing over the very long term, there is no need for a 100% funding level at all times," noted Klaus Stiefermann, managing director of German occupational pensions lobby aba.

As other EU member states were offering "far greater flexibility",
regulation in Germany should be similar to these frameworks, he adds.

"Looking towards Europe, this is a necessary step to boost the German Pensionsfonds sector," Stiefermann pointed out. "It would increase the vehicle's competitiveness with those from EU countries like Belgium."

Furthermore, Pensionsfonds investment opportunities would become more flexible as they could take more calculated risk in their portfolios, Stiefermann continued.

The suggestion, supported by insurance experts and other industry groups, failed to gain a majority at the most recent negotiations for an amendment of the relevant insurance law at the end of last year.

An expert commission had fully supported the call for a more flexible funding level and a longer recovery period. In turn, the commission suggested all recovery plans be made subject to agreement by the regulator.

A parliamentary hearing on the issue in late October was to bring the debate back to life and Stiefermann is convinced the changes will be agreed in time for the next amendment of the law early next year. The most difficult issue in the debate is the fact that Pensionsfonds are seen as a kind of insurance entity, says Juan Yermo, principal administrator for private pensions at the OECD.

"Although they have been created as a pension fund, these retirement vehicles are still under the general umbrella of life-insurance regulation and getting exemptions while you're in there is quite tough."

He pointed to EU-wide agreements on solvency margins and other minimum standards for insurance entities. "The goal of creating a vehicle that is competitive to those of other EU countries makes sense though," Yermo agreed.

In general he calls for a more "lenient" approach by regulators towards funding standards given the changed nature of calculating liabilities.

"Since valuation methods for funding purposes are likely to continue moving towards a market-based model, policymakers should be all the more cautious in setting funding regulations," he notes in his latest study on the subject entitled "Reforming the Valuation and Funding of Pension Promises - Are Occupational Pension Plans Safer?"

These regulations should provide sufficient flexibility in covering funding deficits while also providing incentives to establish funding buffers in good economic times.More flexibility in funding requirements was needed because market-based valuation is bringing greater volatility in to the valuation of liabilities.

"Regulators have to be more lenient in the way they approach funding situations because, as we have seen, discount rates can change overnight and market performance can also change rapidly," Yermo says. "The approach to funding has to be completely different to the one we had in the past," continues Yermo, noting that the OECD sees the trend towards higher levels of funding among pension funds "as a positive development".

"Over the cycle we think pension funds need to be better funded than they used to be in the past but at the same time we realise the volatility in the markets calls for a more flexible approach to how pension funds get there eventually rather than having ongoing full funding at all times."

However, he does not expect all EU countries to agree on funding requirements as the structure of pension funds itself is very different in the member states.

"In those countries where pension fund promises are backed by sponsors you are much more likely to have a situation where the regulator is not so concerned about constant full funding," said Yermo. "This is different in countries where the pension fund is a stand alone entity and looks a bit more like an insurance company. There you are likely to have much stricter funding rules."

What he could see happen is an agreement on funding rules for cross-border pension schemes. But even there a common denominator on the calculation of liabilities and the level constituting "full funding" needs to be determined.

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