Written by Marek Handzel
The IORP II impact study was supposed to provide a platform that would allay fears surrounding its introduction. But it has failed to reassure its most important participants, finds Marek Handzel
For once, the snarling Euro-sceptic British Bulldog is not alone.
Joined by the Dutch Wetterhoun and the German Alsatian, their collective bark may yet turn into a nasty bite as they threaten to tear chunks out of the European Insurance and Occupational Pensions Authority’s (EIOPA) latest investigation into Europe’s most sophisticated pension systems.
EIOPA’s launch, back in October, of a quantitative impact study (QIS) on the revised institutions for occupational retirement provision, commonly referred to as IORP II, has been met with more resistance than perhaps the authority was expecting.
Recently, organisations as diverse as the European Trade Union Confederation, the European Fund & Asset Management Association, and the European Association of Craft, Small and Medium-sized Enterprises, along with a number of other business, employee and industry bodies, joined forces to question IORP II and the QIS.
Speaking for representatives from all nine countries involved in the QIS, they expressed reservations over both whether IORP II could be enforced across Europe, given the region’s diverse defined benefit (DB) landscape, and its lingering similarity to Solvency II.
“At the moment, “ a joint statement from the bodies read, “it feels as if the potential new rules push for short-term security at the expense of long-term investments and pensions adequacy.”
Off the shelf
The consultancy firm Mercer has also lambasted the QIS, describing it as “not fit for purpose”.
Commenting shortly after the study’s launch, Deborah Cooper, who is head of Mercer’s regulatory group and based in the UK, outlined a number of flaws that the company believes exist within its structure.
“The QIS will only consider a balance sheet calculation, ignoring what is most fundamental to IORPs and their sponsors, which is how liabilities are financed,” she said.
Cooper also complained that the importance of DB pension funds to the capital markets was ignored; the evaluation of sponsor covenants was superficial as well as too general in its lack of differentiation between legal and corporate structures; and that the study’s approach had been “picked off an insurance market shelf”. This meant that pension funds would be treated in too similar a fashion to insurance companies, giving EIOPA an incomplete picture of IORP II’s likely effect.
Another consultant, Aon Hewitt’s Kevin Wesbroom, is also critical of IORP II and the QIS, but says that the directive is backed by logical reasoning.
“If you step back and look at the HBS (Holistic Balance Sheet) concept, it’s a very clever idea on a variety of levels,” says the firm’s principal consultant.
“Technically, it’s dealt with pension funds and insurance companies on the same level, assuming you place the sponsor covenant as playing the same role as capital funding for insurance companies.”
He suggests that sets the scene in the longer term for comparing, for example, a book of annuities held by an insurance company like Legal & General, and a pension fund with promises to pay out to members – and treating the two in the same way.
“At another level,” he says, “what’s clever about it is that you can make the whole thing work across a wide range of benefit structures that you have in Europe.”
By keeping the QIS as close to the insurance model as possible he says, it makes it easier for EIOPA to impose its directive on member states. So, for example, Germany and France (where insurance companies and pension funds are in closer competition with each other than elsewhere) as well as the Netherlands and the UK, despite their different pension payment models in relation to guaranteed increases, can better fit under its umbrella.
The problem with this, however, says Wesbroom, is that the impact on individual pension systems is massively different.
He points to the two different alternative valuation approaches that could be used for determining the amount of financial assets a pension fund is required to hold.
Level A technical provisions are based on a risk-free interest rate, while Level B ones can be calculated using an interest rate based on expected asset returns.
“If (EIOPA) says you can initially cover Level B but then says move to Level A at some point, then you’ve just added half a trillion pounds to UK pension liabilities,” he says.
The highly technical document disclosure required by the QIS has also caused concerns.
A number of German employers are worried about confidentiality in regards to revealing market-sensitive covenant funding levels, while UK firms are anxious about the internal political wrangling that may emerge for the QIS. They could find themselves in a quandary if with one hand they are waving away their pension fund trustees’ demands to increase contributions, while with the other they are signing off a confirmation to EIOPA that shows how many millions they have in cash reserves.
But there’s more to it than keeping cards close to chests. There is no consistent methodology at the moment of valuing an employer covenant, while added complications arise from today’s global economic market, dominated as it is by multi-nationals who publish figures in a variety of manners and jurisdictions for tax purposes and shareholder interest.
“I’m not even sure if they will be able to get their hands on the infor-mation they need,” says Wesbroom.
Don’t get emotional
Those close to, and within EIOPA, of course, disagree with much of the criticism levelled at the QIS.
A lot of the fear surrounding IORP II is based on the heart ruling the head, argues Robeco director, European pensions, Jacqueline Lommen, a former member of EIOPA who was closely involved in the drafting of the original IORP directive back in 2003.
“What I also hear from people in certain countries is that they call IORP II ‘Solvency II’. Pension trusts are different animals from insurance companies and EIOPA knows this fundamental difference,” she says.
IORP II accepts the three main principles of Solvency II; solvency requirement, governance and risk management, and reporting and transparency rules, says Lommen. But it then adopts the HBS approach, which offers far more flexibility for pension funds than it does for insurance companies.
“The HBS approach means that if there are auto-security mechanisms to secure pensions, you may deduct these from the solvency buffers (funding requirements),” she explains.
These include the sponsor’s covenant level, a country’s security net, such as the UK’s Pension Protection Fund, and the fact that some countries offer conditional indexation or can lower pension rights if needed when a fund is struggling, as in the Netherlands.
“EIOPA has no agenda to destroy relatively well-functioning pension systems,” she says. “The aim is to create transparency for the funding of pension systems to see if you are able to pay out pension promises.”
Short on time
EIOPA will analyse the data it receives from the QIS and publish its report in the early spring of 2013. Whether the information it compiles will provide the authority with enough knowledge to proceed with IORP II is, given the various possible complications stemming from lukewarm participation, debatable.
“In my view it’s a challenge to base calibration on just one impact exercise,” says Lommen.
“On the other hand, we have the five QIS reports from Solvency II so we can re-use elements of those on pension funds. But it would be better to have at least two studies and maybe a further quick third one.”
But EIOPA may feel rushed to put something in place sooner rather than later, before the European Commission changes composition again and further delays implementation.
Rushing the process might be counter-productive however. In order to compromise over apparently irreconcilable differences between member states, EIOPA may decide to allow legislation to be interpreted at a local level.
“That will just leave us spending years wasting time and energy on interpretation instead of looking at achieving better member incomes,” warns Wesbroom.
Then the growling really would begin.
Written by Marek Handzel, a freelance journalist