Germany: We have a few questions
As far as the IORP II quantitative impact study is concerned, the German occupational pension sector does not know what it is good for. Barbara Ottawa reports
Despite what commentators or critics in Brussels think, the German pension fund industry is not anti-EU and is open to suggestions from the Commission – if they make sense.
German pension funds would like to know why they should calculate certain scenarios that, according to the critics, are far-removed from their world of occupational pension schemes. Helmut Aden, managing director of the BVV banking pension fund and chairman of the company pension fund association VFPK, puts its succinctly: “We do not believe in the methods used for calculations, and Solvency II is flawed in principle and is particularly unsuitable for our business model.”
However, the German pension fund industry is already considering some of Brussels’ suggestions – albeit only in principle.
The occupational pension fund association, AbA, welcomes the idea of a holistic approach to calculating liabilities and assessing assets for pension funds, but not in the form of the holistic balance sheet (HBS), as suggested by the commission.
“The HBS for calculating capital requirements might have a theoretical appeal but in practice it would burden funds with unnecessary, complex and inappropriate quantitative requirements,” AbA stated. It fears that this would “counteract the aim of strengthening and expansion of occupational pensions”.
In principle, consultants, including Alfred Gohdes at Towers Watson Germany, do “not have a problem with solvency-based capital requirements as such,” he says. “We already have solvency capital requirements in Germany for certain types of pension benefits amounting to, in most instances, approximately 4.5% of the accrued liabilities.
“The problem is that even before applying stress tests to determine the solvency capital requirements as foreseen in the quantitative impact study (QIS), German pension funds would have to substantially hike their liabilities. My estimates are 35% to 40% in the base scenario of the QIS. That equates to approximately €50bn.”
Gohdes warns that a “sudden sea-change” of that degree would be devastating for German pension funds, some of which have been around for 100 years. “Perhaps of greater concern is that the Commission has not indicated what action it will take to bridge any gap between the pension fund’s assets and these liabilities,” he says.
Pension funds are not against increasing buffers and reporting requirements, but only according to local parameters adjusted to the pension system. Aden says: “In principle, pillars two and three of Solvency II make sense and should be applied even though they require a lot of additional reporting.”
But capital requirements do not need to be reformed, Aden believes. German pension funds are already increasing their reserves to meet longevity, market and other risks. “A capital quota is not the only figure that tells you something about the risk-bearing capacity of a pension fund,” he says. Furthermore, the debate on lowering the discount rate used in Germany has been on-going since before Solvency II, but “every cut in the discount rate has to be earned”.
The German discount rate based on the interest curve has been described as “hopeful” since the financial crisis, and is still between 3% and 4%. In 2012, the drop in the discount rate by 140bps to 3.35% led to a hike in liabilities for companies listed on the DAX from €259bn to €317bn by year-end, although by the beginning of 2013 the discount rate had increased to 3.7%. These calculations show the volatility that is already embedded in the pension system.
“We have a problem with the capital requirements under Solvency II, which introduce a lot of volatility to the system,” says Aden. He is convinced these “requirements do not increase security in the system but they are bringing all the possible losses forward realising a risk that has not even occurred yet”.
The occupational pension sector is also offering suggestions for improvement.
The most pressing issue is the mark-to-market approach, which, according to Aden, is already being watered down by the introduction of additional features, such as the illiquidity premium and the counter-cyclical premium. “It should be questioned whether it might not make sense to do away with it entirely,” Aden says.
“Mark-to-market valuations assume the current rate of return over the next 60 years – but if I can only generate a 1-2% return of my assets over the next decades then I might just as well shut down,” he continues.
And Aden says the approach is currently failing. “In the past, mark-to-market was synonymous with fair value. At the moment fair value cannot be calculated using a mark-to-market approach in the current market environment of distorted interest rate developments.” He adds that if “ECB continues to flood the market with money, any kind of saving is superfluous”.
Together with Georg Thurnes of Aon Hewitt in Germany, Gohdes has submitted a paper to the Commission suggesting dropping the market approach for determining the discount rate altogether.
On the question of reporting requirements Aden says local authorities, and federal ones like the German BaFin, already have much data from pension funds and they know our business. He suggests making use of this data and expertise rather than demanding new figures and reports.
Gohdes says: “Local supervisory authorities know the local systems, including the interaction of state pension and supplementary provision in depth and Brussels should make better use of that knowledge.”
In general, the German occupational pensions sector wants a more tailored and local approach to supervision and other issues.
AbA is demanding a “stand-alone, appropriate and affordable supervisory regime” for pension funds “taking into account the specific characteristics” of occupational pensions.
Last year, Towers Watson suggested to the Commission that local supervisors should be allowed to determine how quickly they converge their regulatory regimes.
Stakeholders have also demanded that local supervisory authorities should be better integrated into the debate on the future of pensions.
Pension representatives want the Commission to consider cross-border pensions. “Apart from the European Commission, I do not really see anybody wanting to go down that road – almost everybody is operating locally,” says Aden. AbA confirms this and points out that it might be enough to create a level-playing field where local authorities recognise foreign pension benefits like they do domestic ones.
However, the industry is divided on the eventual goal. Gohdes welcomes moves towards a consistent supervisory regime, but he warns: “Without a very long transition period it would be like asking a one-year old to recite Shakespeare by tomorrow”.
He concedes: “It might indeed make sense to aim for a risk-based supervisory regime but the question is how?”
Aden does not agree with having a unified supervisory regime and finds it “worrying that there should be only one benchmark for all pension funds in Europe”.
He also criticised the fact that the insurance industry was asked to do a sixth QIS on the effects of long-term guarantees shortly after pension funds had to do their QIS, even though it is actually the pension industry that works with long-term guarantees.
Gohdes says Germany does not want any special treatment. “We are realistic enough not to want any special treatment for German pensions. The Netherlands and the UK are facing very similar problems under the QIS, indeed to a much greater degree as they have much larger absolute amounts of defined benefit assets.”
Greater transparency is also demanded. “The Commission keeps stressing transparency for pension funds but is itself leaving a lot in the dark. It is amazing that the Commission has not disclosed its entire model, including not mentioning how it wishes to implement its proposals,” Gohdes says.
One omission by Brussels was even tantamount to “wilfully damaging occupational pensions”, Gohdes and Thurnes stated in their paper. The EC and EIOPA failed to mention that the holistic balance sheet (HBS) was not a balance sheet as such, but a “tool to facilitate prudential supervision”, as EIOPA chairman Gabriel Bernadino explained last year.
“If HBS were a balance sheet in the traditional sense, the sponsoring employers would probably have to recognise corresponding liabilities on their balance sheet where the IORP recognised corresponding assets,” say Gohdes and Thurnes.
They said the “many issues arising from the quantification” of subjects like sponsor support, pension protection schemes, the level of risk margin and the classification of differing benefit types “became very evident from the QIS” and needed further development, as well as a “significant amount of additional understanding of the legal environments by the EC and EIOPA”.