EIOPA chairman Gabriel Bernardino tells Liam Kennedy and Susanna Rust why the recent stress tests of European occupational pension funds were a valuable exercise
IPE: Could you highlight any surprising aspects and the main risks and vulnerabilities that were identified in the stress-test exercise?
Bernardino: As you know, this is the first stress test exercise we are conducting on pensions at the European level. We have taken a number of conclusions from this exercise.
The main vulnerability we identified as a result of doing the exercise is definitely the one of a prolonged period of low interest rates. That is something that does not come as a surprise to any of us, especially when you’re talking about long-term benefits where the time value of money has a huge impact in terms of the calculation of the liabilities. If we continue to have a prolonged period of low interest rates, this will pose significant challenges to the resilience of IORPs. This should be in the attention and the scope of action of both IORPs and supervisors.
There are also some important results in relation to risks and vulnerabilities on the longevity side. The conclusions from the stress test analysis are that IORPs are relatively more resilient to an increase in longevity, which we calibrated as a permanent increase of 20%, than to market adverse scenarios.
Again the main results do not come as a surprise. But conducting this exercise is of added value. We now have the numbers confirming these vulnerabilities.
Speaking about other future challenges, key here are the differences between the national regimes that come to the fore.
There is a huge heterogeneity across the different regimes in the different countries. This is also the reason why, according to what is envisaged in our regulation, we have to develop a common methodology to have a basis for more comparable assessment and conclusions.
You haven’t referenced the holistic balance sheet (HBS) – what are the differences between the HBS and the common methodology?
That’s a good question. Basically, we don’t make reference to the HBS because it was developed for a completely different purpose. The HBS has elements related to the types of capital requirements for different assets. This is completely out of the remit of the stress test exercise. It was not the purpose of our stress test. When applying the common methodology, we aimed to address the differences in valuation of assets and, in particular, liabilities that exist between the national regimes.
With the common methodology, we are using a valuation that is market-consistent and thus more realistic. And let’s be clear that the biggest differences between the national balance sheet (NBS) and the common methodology come from the interest rate used to discount the liabilities. When we apply the common methodology, there is a 24% increase in liabilities versus the NBS numbers, and that is due to the risk-free interest rate. On the asset side, there isn’t such a big difference because many countries are already using the market value of assets in the NBS.
People have questioned the relevance of this exercise and are suspicious about why EIOPA has chosen a risk-free interest rate that is not dissimilar to that used in Solvency II.
Let me be very clear on this. We don’t work on the basis of these kinds of suspicion. Our agenda is transparent, and I’ve been always clear in my statements that in relation to solvency we view pension funds differently from insurance companies. We never said we are going to conduct copy-paste exercises from Solvency II.
What we’re talking about here is the stress test, which is for us fundamental, to ensure comparability at the EU level, to have an assessment of assets and liabilities that firstly is taking into account market reality and secondly is sensitive to changes in the most important variables, with interest rates being the main variable.
Mutatis mutandis, our valuation approach is applied commonly in all the countries, but there are differences across the national regimes, with some countries using values that are more market-based than others.
Again, it is important to ensure this more realistic basis of comparability. It is not a political approach, it is macro-prudential.
As per our founding regulation, EIOPA has the duty to perform stress tests. These are a fundamental risk management and supervisory tool, and the situation we are observing, both from a macro-economic and a financial system perspective, is sufficiently challenging and requires serious action, from the side of the supervisors and the industry.
Beyond the report itself, will you be giving any feedback or issuing any recommendations to the national regulators or any of the IORPS themselves? Can you give us a sense of how you will be taking this agenda forward?
The report itself is quite rich in information in a number of areas – we are very transparent. In the report, we already make a number of points that will be part of our conversations with the national supervisory authorities (NSAs). It is also important to note that the report was approved by our board of supervisors, so the national authorities have been fully involved and engaged in its preparation, conduct and analysis of the results.
We are now entering the next phase for EIOPA to determine possible recommendations to NSAs. In the coming months we will be working on it but final decisions as regards possible recommendations have yet not been taken.
Our financial stability team is leading the stress tests, thus we have a number of experts from EIOPA’s side but also a good number of experts from the national authorities that form the relevant working groups, as well as the stress test task force.
We have a two-year cycle of stress tests. Now we will follow up on this first one, together with our members (the NSAs) and stakeholders. We will further consider the issues of the linkages and the effects on financial stability and the economy. We will also monitor the macroeconomic and market situation to identify the factors we have to stress next time. But what is clear is that we are concentrating on the main elements and are not trying to capture everything. Such exercises – which imply resources from our side, the supervisors, but also are a burden for the industry – are supposed to be proportionate. And again these exercises are very important from the risk management and supervisory perspective, and we will continue to conduct them as is envisaged in our regulation.
What is going on with the HBS project?
Simultaneously to the stress tests, we made a quantitative assessment to finalise our work on the solvency side. This quantitative assessment will be added to the qualitative analysis already made by EIOPA during a consultation last year on the different possibilities of the use of the HBS in the supervisory framework. We are finalising this analysis and preparing an EIOPA opinion that we intend to send to the political institutions in Europe around April.
It is important to note this work is not linked to the IORP II discussion because there was a decision not to include solvency elements in this review. On the other hand, we promised to the different stakeholders to finalise our study on how the HBS concept could be used from a supervisory perspective. This will be the content of the opinion we are currently working on.
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