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Watson Wyatt queries PVK solvency proposals

NETHERLANDS – Consulting firm Watson Wyatt has criticised solvency testing proposals by the PVK, the Dutch pension fund and insurance watchdog.

The Pensioen- & Verzekeringskamer has produced a white paper on the annual solvency test for pension funds and insurance companies. To meet the minimum solvency position, pension funds must comply with a 100% funding ratio and meet a minimum solvency cushion.

The minimum solvency cushion corresponds to value-at-risk buffers used in the banking industry. At the beginning of each year, market volatility would be predicted and a cushion or buffer in line with the forecasts would be set.

“This is a terrible idea as pension funds are not similar to banks, and it is a practical necessity for pension funds to be able to have a substantial mismatch between their assets and liabilities,” says Roland van Gaalen, head of research at Watson Wyatt Netherlands in Amsterdam.

Such a rigid buffer would be impossible to maintain unless there is a good match between assets and liabilities – which is an impracticality for pension funds, according to van Gaalen.

“Assets cannot match liabilities exactly. To do so a fund would need to be indexed against inflation and the supply of index-linked bonds is too small in the euro zone, so funds have to invest in bonds and equities. Banks can get round this by using balance sheet strategies, but pension funds cannot.”

Watson Wyatt is proposing that this minimum solvency cushion should instead be variable, between a floor of zero and an upper boundary. This is also referred to as a “mismatch cushion” as it arises from the mismatch between assets and liabilities.

Says van Gaalen: “Pension funds need flexibility. When the market is high, then this cushion should be high, but in bad years, the built-up cushion should be able to be used, and not have to be replenished immediately, unless the market recovers.”

The solvency test forms part of the annual capital adequacy test that is applied to Dutch pension funds and insurers and is in the process of being reformed. It seeks to ensure that each institution has sufficient capital to meet its pensions and insurance liabilities. Pensions experts are currently being invited to give their opinion on the white paper. The final ‘financial adequacy framework’ should be implemented by 2006.

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