European Buy Side Fearful Of ‘Solvency II For Pensions’ Plans

Terry Flanagan

Fears are growing that even a watered down ‘Solvency II for pensions’ could blow the pensions landscape apart in Europe.

The insurance industry is gearing up to adopt new capital adequacy rules, called Solvency II, from 2014 aimed at reducing the risk of insolvency, but many pension funds are fearful that the regulations may be used as a template by the European Commission in its plans for cutting down risk in occupational pension funds.

Pension funds are big institutional investors and critics of the proposed European Union reforms say the remaining defined benefit pension funds across Europe could be forced to close, paving the way for severe systemic consequences.

“To apply Solvency II to pension funds is just not the same thing,” one London-based buy-side executive told Markets Media.

“You’re dealing with a different client base. You are dealing with insurance claims rather than pensions. Pension funds have very different set-ups and operations than insurance companies. Many pension funds are underfunded whereas insurance companies are reasonably well funded by the nature of the business.

“Forcing pension funds to go into a Solvency II world would immediately impact solvency issues for a large number of pension funds. A lot of these guys would go into the Pension Protection Fund which would place huge strain on UK government coffers and probably destroy benefits for a lot of people.

“That said, Solvency II requires you to have an understanding of risk and a well balanced book, diversification and an ability to match your assets to your liabilities—so the principles are well applied but should probably be applied slightly differently given pension funds are in a slightly different situation.”

Under the planned proposals, the European Commission is looking to force pension funds to avoid risky investments and to hold larger cash buffers to guard against market volatility, while increasing cross-border competition and tightening supervision.

However, some economists have warned that the proposals will lead to the closure of many defined benefit schemes as they will become too expensive for employers to maintain.

The plans, which are likely to emerge as a legislative proposal at the end of this year, are most strongly opposed in the UK, Netherlands, Belgium and Ireland, where final salary pension schemes are most prevalent.

And one recent report by credit rating agency Fitch claims that even a diluted application of Solvency II to the European pension industry could negatively impact on corporate cash flows. It says the Commission’s plans for insurance-style funding requirements could negate the progress made by European companies in managing pension liabilities in recent years.

“The aim of putting occupational pensions on a level playing field with insurance companies makes it very hard to avoid making pension schemes compute liabilities in the same way as an insurance company, in which case liabilities will rise considerably,” the report said.

In March, Michel Barnier, the EU financial services commissioner responsible for guiding the pensions proposals through Brussels, posted on his Twitter account that Solvency II rules would not be “cut and pasted” from the insurance industry to the pensions sector, although many in the pensions sector are fearful at what the legislative proposals might bring.

“In the meantime, the approach taken by most lobbyists—assume the worst and lobby on that basis—may be prudent,” added Fitch.

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