Solvency II debate continues
16 June 2008

Written by Sophie Baker

Solvency II, the regulation aimed at establishing a solvency system that is better matched to the true risks of insurers, has been met with both support and opposition at conferences in the last week.

Talk that the new rule should be applied to pension funds as well as insurance companies to keep things safer for scheme members has faced criticism from some parties saying that it would make things unnecessarily onerous on pension funds that already have an employer as a back-up, unlike insurance companies, while others have favoured the new EU framework, due to be introduced around the end of 2009.

Jane Beverley, principal at consultancy firm Punter Southall, expressed her doubt at the suitability of Solvency II for pension funds. “Despite this apparent show of hands in support of Solvency II, the case against such a move remains strong. As we set out in our research paper last year, pensions and insurance are fundamentally different vehicles and should be treated as such. Safety mechanisms already exist for pensions, especially in the UK, such as the backing of the sponsoring employer and the Pension Protection Fund, which make a solvency regime unnecessary.

“A Solvency II regime could increase required funding levels for UK defined benefit pension schemes dramatically, and there could be a wider negative impact on pension provision across the EU, as higher funding costs deter other states from providing defined benefit schemes.”

In the past week, the Dutch made a U-turn in its opinion of Solvency II, when Falco Valkenburg, chairman of the investment and financial risk committee at the Groupe Consultatief Actuariel Europeen and partner at consultancy firm Towers Perrin, told delegates at the Pensioen Forum 2008 that Solvency II constitutes a “good basis” for a framework for risk.

“If we have the same risk, then [we should] have the same buffer. But if you do not have the same risk – and I think that Dutch pension funds are in many cases different from an insurance product because they can steer with, for instance, indexation and contribution rates - then you do not have the same risks, which should be combined with a lower buffer,” said Valkenburg.

Similarly, Danish ATP pension fund chief executive Lars Rohde said that Solvency II would be a way of making it clear “risk is in short supply.” He believes it is necessary to have strict and explicit solvency rules explaining what would happen “if and when the perfect storm arises and forces the pension fund to act.”

Beverley told European Pensions that the sudden support for Solvency II from French, Dutch and Danish representatives is perhaps due to the fact that “In two of these countries, private sector defined benefit provision is uncommon: in France, pensions are generally provided by the state and so the application of Solvency II would have little impact on French pension schemes. In Denmark, there is extensive private sector provision, but it is mainly on a defined contribution basis and so again Solvency II would not have a significant impact.”

So what is the attraction of Solvency II? Beverley sees one factor being that Solvency II would improve member protection by requiring pension schemes to hold a high level of reserves.

“The counter argument is that member protection can be achieved by means other than requiring pension schemes to hold reserves – for example, by having an obligation imposed on the sponsoring employer to back the pension scheme, and having a guarantee of last resort such as the Pension Protection Fund to provide a safety net in the even that the employer fails,” she added.

Another positive point for Solvency II is that it would ensure a level playing field across Europe, although Beverley is sceptical about this, as it would only work if applied to all retirement provisions across all countries, both state and private sector.

Beverley’s views on Solvency II stem from a Punter Southall research paper, issued in December 2007, which found that applying Solvency II to UK defined benefit schemes “would have disastrous effects, possibly increasing the cost of UK defined benefit pension schemes by up to 90 per cent. We would anticipate that this would lead to increased numbers of pension scheme closures and even employer insolvencies.

“Furthermore, we believe that insurance and pensions are fundamentally different and have different economic and social objectives,” she commented.