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Top 1000 Pension Funds: Ongoing review plots changes with Solvency II in mind

The temporary discount rate floor is to continue until a new method of calculating the discount rate under Solvency II is ready, according to Rachel Fixsen

How best to bridge the gap between the current regime for discounting pension liabilities and the upcoming measures contained in the EU’s Solvency II directive has been occupying minds at Sweden’s financial regulator.

The old system, whereby pension funds calculated their liabilities using a discount rate based on government bond yields, became untenable in the first half of 2012, when yields on government bonds fell to historic lows as a result of the euro crisis, and insurers and occupational pension funds came under pressure. So the regulator, Finansinspektionen, decided last June to introduce a temporary floor for the discount rate.

Official solvency ratios at pension funds were falling due to the low discount rate, and the regulator feared this would lead to pension companies short-selling equities and shifting allocations to interest-bearing assets. This could have created a negative spiral of continued falling share prices and interest rates, the regulator believed.

The introduction of the discount floor, which was initially set for just one year, was generally welcomed by the industry. However, pension fund AMF, which manages SEK335bn (€38.6bn), said its solvency ratio was still high enough that it could continue with its current investment strategy.

It acknowledged the floor might help strengthen companies that had been weakened, but warned the measure could encourage funds to hide problems, allowing them to get worse.

In May 2013, Finansinspektionen extended the temporary interest rate floor until the new methodology that had been adapted to Solvency II was in place. The plan is for the methodology to take effect from 31 December 2013.

The regulator then outlined details of the new Solvency II discount rate, describing it as more stable and predictable, because it is less dependent on market valuation.

Market valuation of the discount rate was problematic, according to Finansinspektionen, because the Swedish government bond market was not liquid enough or deep enough to give reliable estimates of long-term interest rates.

The new method will involve companies using market data to calculate the discount rate of up to 10 years. After the 10-year point, which is the last liquid point, the curve will move towards the ultimate forward rate.

Advantages of the new methodology include that the discount rate is less sensitive to market swings, because it is based on market and model assumptions, the regulator said.

The traffic-light model, the measure Finansinspektionen uses to assess insurance companies’ exposure to risk, is also coming into line with new Solvency II. The regulator has said it would announce these alterations after the summer, with the preliminary start date happening in the last quarter of 2013.

The Swedish government also launched an inquiry this year into how occupational pension schemes should be regulated. The inquiry’s official mission is to consider how suitable solvency rules for pension institutions should be designed, as well as to look at the law governing occupational pension institutions.

It will also assess whether accounting rules for pension funds are appropriate. An important point for the inquiry is to ensure that Swedish legislation complies with the IORP.

Last autumn, the Life Insurance inquiry called for transfer rights for all defined contribution (DC) pensions. It said transfer rights should be applied to individual pensions, as well as to those agreed through collective bargaining.

The inquiry stated the rules should be applied retroactively for private pensions, and occupational DC pensions where contributions had ended because the scheme member had changed jobs or where the beneficiary had died.

An inquiry last year into Sweden’s national buffer funds received largely negative responses from the funds themselves, although they agreed that some improvements were necessary.

The inquiry, headed by Mats Langensjö, recommended abolishing the current quantitative investment regulations and replacing them with the prudent-person principle to improve performance, governance and flexibility of the fund system.

It also suggested creating a new authority with responsibility for the buffer funds’ total assets of around €100bn. This new pensions reserve board, or Pensionsreservstyrelsen, would be the asset owner and set targets for the fund.

The number of funds should be reduced from five to three, the review concluded, reflecting the government’s brief to slim the system down to at least three funds.

While AP4 said the report argued for a one-fund solution, AP1 said the number of funds was less important than how asset management was governed and organised. Investment rules should be flexible enough to let the funds adapt to changing market conditions, it said.

Many of the funds cautioned that the creation of a pensions reserve board could reduce diversification, as it would be the only body setting performance and investment targets.


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