Sweden’s financial supervisory authority warns of negative interest rate risk

The director general of Sweden’s financial supervisory authority, Finansinspektionen, has highlighted the risks of the current negative interest rate environment on occupational pension providers.

Delivering a speech to the country’s Finance Committee, 5 November, Erik Thedéen, also spoke of introducing a phased period for the new regulatory framework for occupational pensions.

“Sweden is about to introduce a new regulatory framework for occupational pensions. As the supervisory authority for the occupational pension market, Finansinspektionen wants to give the Riksdag the best possible basis to make its decision,” he said.

On the low and negative interest rate environment, he said Finansinspektionen has a responsibility to mitigate the risks presented by a low interest rate situation and ensure that occupational pension companies handle the problems that the low interest rates can cause.

He highlighted the big figures in the industry, with the occupational pension market having around SEK 2,600bn in assets under management. In addition, life insurance companies have a little more than SEK 1,800bn in invested assets.

“The consequences if the risks are not managed could be huge for both Sweden's employees and pensioners,” he stated.

He spoke of the capital requirements regulation for occupational pension companies: “The purpose of capital requirements for occupational pension companies is that the companies must have sufficient capacity to generate long-term sustainable returns. This requires companies to have the financial strength to cope with the temporary decline in value of assets.”

He highlighted a “clear flaw” in the current traffic light model, which has been used for a decade, in that it assumes that market rates can never be negative. Therefore, no capital requirement is calculated for interest rate risk for negative interest rates.

“When the model was developed, no one could imagine that today - 10 years later - we would have ten-year interest rates of zero and even below that. The design of the traffic light model has the paradoxical effect that the lower the market rates fall to zero, the more the capital that occupational pension companies need to hold for interest rate risk also decreases.

“Some companies today have no interest rate risk according to the traffic light model, that is, these companies do not need to hold any capital at all to cover their interest rate risk. During the last year's interest rate decline, the total capital requirement for interest rate risk for occupational pension companies according to the traffic light model has gone from just over SEK 75bn to SEK 5bn. Of course, this does not mean that the interest rate risk in these companies has disappeared,” he said.

On the confidence level for capital requirements, he highlighted that the bill suggests a level of 97 per cent for occupational pension companies. He said in the current system, as interest rates have fallen, the level of traffic light protection has also fallen.

“The capital requirement in the traffic light system is therefore no longer equal to the capital requirement proposed in the bill. The lower the level of protection is set, the less capital the companies need to hold to cope with larger declines in the values of the assets.

“Disregarding the risks in this way is problematic…however, the problems that this can cause will not be visible until it is too late to adapt the business to new market conditions in orderly form,” he said.

In addition, Thedéen stated that the proposed regulation means that occupational pension companies have to adapt to new rules in a market situation we have not previously experienced.

“To create the best possible conditions for future pensions, companies need to be given the opportunity to adapt to both the market situation and the new regulation over a longer period. New regulation and new market conditions are good reasons for recommending phase-in and adaptation rules over a period of several years,” he said.

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