A controversial EU proposal to apply insurance industry capitalization standards to workplace pension funds has been shelved — for now. Michel Barnier, European Commissioner for Internal Market and Services, warns that the European Union’s executive agency could revive the plan in the fall.
The proposed regulation, known as Solvency II, calls for the adoption of consistent valuation criteria for the assets and liabilities of Europe’s workplace pensions, making it possible to directly compare the financial health of pension funds across Europe. The Commission regards the establishment of common valuation standards as the first step in creating a harmonized European pensions market and, eventually, a level playing field between the pensions and insurance industries.
The idea has drawn strong opposition from numerous EU member states and pensions industry bodies. The criticism intensified in April when the European Insurance and Occupational Pensions Authority released a quantitative impact study that found pension schemes in a number of member states would be dramatically underfunded under the Solvency II standards.
The study found that although Swedish and Norwegian pension funds would remain relatively healthy under the new calculations, Irish pension funds would show deficits of between 81 and 93 percent under different stress testing scenarios. In the U.K., home to the biggest pension fund industry in the EU, plans would have a deficit of 45 percent of liabilities, or €963 billion ($1.3 billion), according to one scenario. In the same scenario, Dutch pension plans, which have already undertaken some of the most rigorous pension reforms designed to bolster funding levels, would be underfunded by an estimated €193 billion.
“From one angle, it is understandable from a European level that [the Commission] would come up with a coverage requirement for pensions,” says Harmeen Geers, spokesperson for Dutch pension giant APG. “But the problem is that European pension schemes vary so much — and in the Netherlands we already have a lot of capital set aside, which is why we feel that we shouldn’t fall under Solvency II.”
Patrick Burke, a director at Irish Life Investment Managers and the former chairman of the European Federation for Retirement Provision, points out that as well as leaving pension plans underfunded by hundreds of billions of euros across Europe, Solvency II would have a major impact on how pension funds invest. The rules “would strongly encourage further shifts to bond investment over equity investment,” he tells Institutional Investor. By forcing pension funds to chase bonds that already carry historically high valuations, the application of Solvency II would mean that the “price of bonds would be influenced by the resulting increased demand and become even more expensive” while equities would likely face selling pressure. “Even a 5 percent shift is a significant shift in equity markets,” says Burke.
Another problem, according to Burke, is the introduction of greater systemic risk into the system. Solvency II effectively applies a similar logic to the insurance industry as Basel III does to the banking industry. If common capital rules are applied to banks, insurers and pension funds, “something is going to happen when one of those pillars faces a problem,” Burke says. “We may not know what that event is, but once we’re driven by the same framework, whatever has a risk on one of those pillars has a risk for all three.”
That lumping together of very different sectors of the financial industry into a one-size-fits-all regulatory framework is a major part of the problem, according to Philip Whyte, a senior research fellow at the Centre for European Reform, a Brussels-based think tank. Whyte says the Commission sees little difference among financial institutions when it comes to making regulations. “It seems to be true to say that when you listen to legislators and political leaders and policymakers in continental Europe, they see the financial services industry as an undifferentiated sector — they don’t always think of banks as fundamentally different to hedge funds and hedge funds as fundamentally different to pensions.”
And since the European Parliament — the main source of European legislation — is directly elected, it increasingly reflects the biases of the general electorate, which is “not terribly sympathetic towards the financial sector in general,” Whyte points out. “The financial sector is the financial sector — it doesn’t matter if you’re an investment trust, a hedge fund, a pension fund or a bank,” he says. All are believed to “pose a systemic threat,” he adds.
While pension funds are likely breathing a sigh of relief that Solvency II has been shelved for now, Barnier pointed out that the Commission may revisit the proposals in the fall. As the EU executive agency focuses its energies on ensuring that pan-EU regulations on governance and transparency cover the pension fund industry, Barnier insists that solvency rules “will for the time being remain an open issue.”
