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Impact Investing

IPE special report May 2018

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Taking the time to assess the risk

The latest consultation paper for the holistic balance sheet (HBS) within the revised IORP Directive has aroused great interest across Europe. The European Insurance and Occupational Pensions Authority (EIOPA) gave the pensions industry until 1 August to submit its input on the controversial first quantitative impact study (QIS) for the implementation of the HBS.

Three main issues arose from the responses sent to EIOPA. First, participants complained - once again - about the timetable set by the authority and Brussels. According to them, the current time frame remains "too short" to come up with a "proper" impact analysis for the HBS.

Second, the industry has decried the lack of clarity over the valuation of pension funds' liabilities, while arguing that both the prudential and holistic frameworks for the revision of the IORP Directive are poorly adapted.

And third, pension representatives expressed concerns over the similarity between Solvency II and some elements found in the consultation paper for the Directive on occupational pensions.

For the European Federation for Retirement Provision (EFRP), a large part of the QIS consultation document seems to have been "copy-pasted" from the Solvency II Directive.

"Those sections in the consultation document that are pension-specific appear somewhat simplistic and require more consideration and a more sophisticated approach," it says. "For instance, the concept of risk margin that must be calculated according to the cost-of-capital formula and that is included in the calculation of the technical provisions, does not make sense for IORPs."

Some pension representatives therefore recommend the examination of existing practice already implemented by a number of member states. The Dutch Pension Federation, for instance, has called for the FTK model. "It could be worth studying in-depth the experiences of the current reforms of the FTK - a risk-based supervisory framework with market-consistent valuation - which is under reconstruction," it says.

Many in the pension industry have supported this approach. However, it could be argued that the FTK has not been without fault in recent years, due to its valuation of nominal liabilities and use of the euro swap curve to derive a market discount rate at a time when interest rates are at record low levels.

The valuation of liabilities is an urgent matter for the pensions industry. In the UK, Towers Watson argues that EIOPA's proposals would, at some point, mean that making higher contributions to a scheme could also lead to higher deficit.

"In this framework [HBS], paying money into the pension scheme does not necessarily make things better, because a pound leaving the sponsor can weaken its ability to provide further support to the scheme," argues Huw Evans, senior consultant. "The only thing that could then be done to improve the security of members' benefits would be to strengthen the business, which is not something regulators can simply command."

The consultancy, discussing a UK-specific example, said this would be the result of the physical assets increasing, resulting in a lower claim to the Pension Protection Fund were the sponsor to go insolvent, combined with a decrease in the value of the sponsor support.

This puts the whole balance-sheet concept under question and suggests that the HBS might not be such a useful means of assessing the solvency of a fund.

For the EIOPA Occupational Pensions Stakeholder Group, if the pension contract is complete and all security mechanisms are included in the HBS, the funding ratio will always be 100%. "This is because of changes in market conditions, which will have an impact on the value of the HBS items," it explains. "Changes in markets, longevity, et cetera, will impact upon the balance-sheet items, causing the (holistic) funding ratio to stay unchanged."

An alternative to the HBS could then be a holistic framework, leaving aside the balance-sheet concept. Unlike the balance-sheet approach - which, according to some, "unrealistically" suggests that all of the elements can be quantified precisely - the holistic model would give more freedom to member states to calibrate that framework to the local pension system.

All those issues bring us back to the question of the timetable. So far, nobody knows how EIOPA and Brussels will proceed, or whether they will amend their current proposals for the revised IORP Directive. If they do, several other impact studies will be necessary to value the different adjustment mechanisms to be made. This would take months, even years. Given that Brussels has already agreed to postpone the introduction of the draft revised IORP until the summer of 2013, a further delay is not inconceivable.

 

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