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Top 1000 Pension Funds: Final phase of reform aims to take account of all risks

Finland’s financial regulator wants risks faced by pension providers to be assessed using the same principles as in the rest of the financial industry, according to Rachel Fixsen

The final phase in Finland’s new national solvency regime for the statutory earnings-related pension scheme is now being laid out, with the amendment scheduled to come into force in January 2015.

The first two phases of the legal framework are now in place. The first introduced a more accurate risk classification for bonds and loans in the application of the national risk-based solvency requirement formula.

The second phase, which came into force on 1 January 2013, replaced a set of temporary regulations introduced in 2008 during the financial crisis. Those rules sought to prevent pension insurance companies from making short-term asset sales, and ran until the end of 2012.

The new, permanent, law is meant to retain the pensions sector’s risk-bearing capacity at the same level as the temporary law, and also aims to improve the use of risk buffers, says Finnish pensions alliance TELA.

During the first quarter of this year, the alliance noted, solvency was strong, and getting stronger for almost all companies under the rules.

However, the financial regulator (FIN-FSA) said that the transition from the temporary legislation to the permanent law had the effect of slightly reducing solvency in the pension insurance sector, with the solvency ratio estimated to fall by about 0.6 percentage points.

In effect, the law combines the investment and insurance risk buffers that pension providers already have, strengthening their solvency reserves. While not joined, these two buffers count as one in assessments of a company’s financial strength.

The new law also allows company and industry-wide pension funds to include a separate item in their solvency capital based on the employer’s obligation to make additional contributions.

Before the law was passed, there was resistance from some politicians. It was argued that insurance buffers had grown too large and that contributions should therefore be reduced.

Also included is a new procedure to be put in place in the event of unusual financial market conditions. This involves FIN-FSA monitoring financial market developments in future and informing the ministry of social affairs and health if the average solvency of pension providers is seen to have deteriorated, or if it looks like it could deteriorate rapidly.
In such instances, measures can be taken case by case, according to the new law.

The third and final phase of the solvency regulation reform is still being hammered out.
The working group set up by the government to prepare concrete proposals is still sitting, with its term due to end on 31 March 2014.

The group is proposing measures to strengthen the pension funds’ risk-taking ability, making proposals on the transition to fair value for employment pension schemes accounts, and assessing what is needed in order to extend Solvency II to Finnish occupational pensions.

This third phase is to be a comprehensive reform which, according to  the regulator, aims to take all material investment and insurance risks of pension providers more comprehensively and more precisely into account.

It also aims to include elements to reduce the pro-cyclicality of the financial markets.
FIN-FSA has also proposed a new solvency mechanism, where the capital requirement is based on the stress-testing of various risk factors.

It has said that the risks faced by pension providers should be assessed and managed using the same principles as in the rest of the financial industry, albeit taking the pension sector’s particular features into account.

Last autumn, the Finnish regulator made a recommendation on sound internal governance in pension insurance companies.

FIN-FSA said boards had to include adequate investment and risk-management skills, which related to both the nature and scale of a company’s investment business.

The regulator made clear that it was important that steering and control operations were led adequately – for example, using a well-designed and appropriate limit system to ensure the board would operate with set objectives.

If internal control was to be effective, it said, changes in the risk position had to be reported regularly to the board.

A debate continues on the rules of pensionable age. At present, the statutory retirement age is flexible, ranging from 63 to 68 years.

But some minor changes in the age limits came into force on 1 January 2013, preventing part-time pensions from being taken before the age of 61. Previously, part-time pensions could be taken a year  earlier  at 60.

Also, people retiring at 62 were no longer allowed to take an actuarially reduced pension.
Looking ahead, the rules on pensionable age will be changed again as part of the next pension reform, which is expected to take effect in 2017, perhaps earlier.

An expert group chaired by the director general of the finance ministry is working on alternative policies for this forthcoming pension reform, which is due to report at the end of this year.

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