RESPONSE BY THE ASSOCIATION OF BRITISH INSURERS
TO THE EUROPEAN COMMISSION’S CONSULTATION ON THE HARMONISATION OF SOLVENCY RULES APPLICABLE TO INSTITUTIONS FOR OCCUPATIONAL RETIREMENT PROVISION (IORP) COVERED BY ARTICLE 17 OF THE IORP DIRECTIVE AND IORPs OPERATING ON A CROSS-BORDER BASIS
The Association of British Insurers (ABI) welcomes the opportunity to submit comments on the European Commission’s consultation paper on the application of Solvency II rules to IORPs covered by Article 17 of the IORP Directive and IORPs operating on a cross-border basis.
The ABI is the voice of the insurance and investment industry. Its members constitute over 90 per cent of the insurance market in the UK and 20 per cent across the EU. They control assets equivalent to a quarter of the UK’s capital. They are the risk managers of the UK’s economy and society. Through the ABI their voice is heard in Government and in public debate on insurance, savings, and investment matters.
The ABI's registration number on the European Commission's Register of Interest Representatives is: 730137075-36
Summary
The IORP Directive (2003/41/EC) was adopted in 2003. One of the key objectives of this Directive was to create “an internal market for occupational retirement provision organised on a European scale.”[1] It uses the idea of a “prudent person” to set qualitative rules on the investment and management of the assets and liabilities of these institutions and to allow them to operate across borders, so that savings into these financial entities would be encouraged. A provision of the IORP Directive is that Member States retain control of the structure of their pension system and determine how the three ‘pillars’ interact in order to provide occupational retirement benefits. This last characteristic is usually implemented by the Member States in the form of social and labour law requirements that are applicable in addition to those of the IORP Directive.
The IORP Directive has now been implemented by all Member States. Since implementation, there have been changes in the regulatory and financial environment that require a review of this legislation, particularly for those IORPs that are subject to Article 17 of the Directive and for IORPs operating on a cross-border basis. A review of the implementation of the IORP Directive has already been undertaken by the Commission and it may be an idea to update this in advance of any proposed extension of Solvency II to IORPs.
The introduction of a more risk-based approach to capital management has affected the entire financial system. This has led to a new approach to solvency for insurers that has resulted in a proposed new Directive for insurance - Solvency II – currently being considered by the European Parliament and the European Council. Those institutions covered by Article 17 in the IORP Directive i.e. IORPs that underwrite biometric risks, guarantee investment performance, or provide a specified level of benefits are dealt with currently under the Consolidated Life Directive (2002/83/EC) or Solvency I. When Solvency II is implemented, it is not clear what would replace this legislation.
The last consideration is the effect of differing social and labour laws on the cross-border activities of IORPs.
This consultation seeks to provide answers to some of these questions, and asks stakeholders for their views on a number of specific points.
ABI Response
The ABI believes that there are certain core principles that must be taken into account in any review of the IORP Directive. Whilst in the UK, there are no IORPs that are covered under Article 17 of the Directive, we can offer a wider perspective on the overall objective of this review.
It is important that there are no adverse effects on existing pension provision. Any changes need to be tested and implemented over a transitional period so that confidence in pension saving and other forms of long term savings is not damaged. The security of pension saving is important but must be balanced against encouraging growth of the funds by an amount that exceeds inflationary increases. As far as possible, the continued operation of schemes and employers as going concerns should be maintained in order to ensure this happens.
We believe that a hurried decision on the application of Solvency II to IORPs without a full impact assessment and before the details of Solvency II are fully decided, is imprudent. In fact, it may be necessary to find a method of assessing the solvency of all Pillar 2 pensions, i.e. all workplace pensions that include an employer contribution. Such a method, whilst is inspired by Solvency II in that it is a market consistent, principles-based approach, must take into account the particular characteristics of pension/ IORP provision as well as the various national environments (e.g. in the UK, the Pension Protection Fund (PPF)). As an additional example on different national characteristics, in the UK traditional defined benefit (DB) schemes have the additional protection of the employer’s promise to stand behind the obligation. This should be done in a way that fully reflects the essential distinctiveness of insurance and reinsurance undertakings.
The individual questions to this consultation and their answers are provided in the attached annex.
ANNEX TO RESPONSE BY THE ASSOCIATION OF BRITISH INSURERS
TO THE EUROPEAN COMMISSION’S CONSULTATION ON THE HARMONISATION OF SOLVENCY RULES APPLICABLE TO INSTITUTIONS FOR OCCUPATIONAL RETIREMENT PROVISION (IORP) COVERED BY ARTICLE 17 OF THE IORP DIRECTIVE AND IORPs OPERATING ON A CROSS-BORDER BASIS
The Association of British Insurers (ABI) welcomes the opportunity to submit comments on the European Commission’s consultation paper on the application of Solvency II rules to IORPs covered by Article 17 of the IORP Directive and IORPs operating on a cross-border basis.
The ABI is the voice of the insurance and investment industry. Its members constitute over 90 per cent of the insurance market in the UK and 20 per cent across the EU. They control assets equivalent to a quarter of the UK’s capital. They are the risk managers of the UK’s economy and society. Through the ABI their voice is heard in Government and in public debate on insurance, savings, and investment matters.
The ABI's registration number on the European Commission's Register of Interest Representatives is: 730137075-36
ANNEX - Consultation Paper Responses to Questions
A. IORPS SUBJECT TO ARTICLE 17 OF THE IORP DIRECTIVE
This section focuses on IORPs that are subject to Article 17 of the IORP Directive. These IORPs underwrite liabilities to cover against biometric risks, or provide guarantees of a given investment performance or a given level of benefits. They are therefore required to have regulatory own funds, i.e. "additional assets above the technical provisions to serve as a buffer". For these regulatory own funds, Article
17(2) of the IORP Directive refers to the Solvency I regime in the recast Life Directive. As the recast Life Directive will cease to exist after the adoption of Solvency II, the main question for IORPs subject to Article 17 is whether and to what extent the Solvency I regime should be replaced by solvency rules similar or equivalent to the Solvency II rules.
This main question is dealt with by looking first, in general terms, at the objectives and principles of the solvency rules and then, more specifically, at the rules relating to regulatory own funds and funding.
(i) Objectives and Principles
1. Solvency rules for IORPs subject to Article 17 should aim at guaranteeing a high degree of security for future pensioners, at a reasonable cost for the sponsoring undertakings, in the context of sustainable pension systems that are decided by the Member States.
Question Do you agree, or do you consider that the overall objective of solvency rules for these IORPs should be different?
The ABI supports the position adopted by the European Parliament in its amendments to the proposed Solvency II Directive that were approved on 7 October 2008. That is, that the existing legislative provisions for calculating solvency margins should be retained until such a time as the Commission, with the assistance of CEIOPS, develops a system of solvency rules for pensions which fully reflects all the characteristics of the assets and the liabilities that are associated with pension provision, whilst fully reflecting the essential distinctiveness of insurance and reinsurance undertakings.
2. Beneficiaries and sponsors seek to secure occupational pensions that maintain standards of living after retirement. Pension schemes, in particular those that provide life-long income such as annuities, are subject to risks related to future mortality rates, financial returns on assets, future inflation, future participation and contribution rates, which affect the overall solvency position of IORPs subject to Article 17. The CEIOPS survey shows that there are wide differences between Member States in their approach to these and other risks.
Question a) Do you believe that prevailing solvency rules for IORPs subject to Article 17 provide adequate protection relative to the objective of safeguarding pension beneficiaries’ claims at reasonable cost for the sponsoring undertakings?
In the UK there are no such institutions that are covered by Article 17, so it is difficult to make such an assessment in terms of the UK market. However, we believe that in principle, we need to fully investigate the effects of a blanket application of Solvency II to IORPs by performing Quantitative Impact Studies that would model the effect of these changes. Please see our answer to Question 1.
Question b) Have there been shortcomings or flaws identified in the prevailing solvency rules for IORPs subject to Article 17? If yes, please specify. What could constitute the main challenges lying ahead?
Please see our answer to Question 1. Any entity providing pension provision needs to have robust solvency rules applied to it. This must be balanced against the need for inflation-beating fund growth. An accurate assessment of the risks and risk management techniques that are relevant to this type of financial entity needs to be undertaken before a judgment is made that may not allow adequately for potential risks or even potential management actions or risk mitigating devices. There are also national considerations such as the Pension Protection Fund (PPF) in the UK, which is designed to protect members of eligible defined benefit schemes in the case of a qualifying insolvency event.
Question c) Which solvency rules could be viewed as proactively dealing with different risks and improving risk management techniques?
Please see our answers to Questions 1, 2a and 2b.
Question d) To what extent do compulsory versus voluntary membership in pension schemes have a different impact on the overall outcome of solvency rules and in which case(s) are problems likely to arise in the future?
Solvency rules are based on an evaluation of assets and liabilities. Assessing the likelihood of future cash flows would be an issue for both voluntary and compulsory membership. Even if membership is compulsory, it is possible that people may lose their jobs and so may not be able to contribute to their pensions.
Question e) To what extent do the solvency rules prevailing today in the different Member States need to differ for single-employer or multi-employer IORPs subject to Article 17?
The UK does not have IORPs covered under Article 17. However, in principle we believe that there needs to be an investigation into the solvency requirements for IORPs by conducting a quantitative impact assessment before this question can be answered. This would establish whether different types of IORPs need to be treated or assessed differently. It is important that any approach used works in practice as well as being theoretically justified. Please see our answer to Question 1.
3. The CEIOPS survey outlines four common overarching principles, as part of emerging best practices underpinning the supervisory framework which may be relevant to this consultation on IORPs subject to Article 17. First, a forward-looking risk-based approach to pension supervision, that weighs the potential risks faced by an IORP, as well as risk mitigants, and tailors the scope and intensity of supervision to this appraisal. Second, the principle of market-consistency in the valuation of an IORPs assets and liabilities for supervisory purposes. Third, the principle of transparency, which implies that an IORP is open on how its financial position is determined and that reserves (or shortages), as well as prudence embedded in technical provisions and adjustment instruments, are made explicit to the supervisor. Fourth, the principle of proportionality, implying that supervisory requirements are applied in a manner proportionate to the nature, complexity and scale of the IORPs inherent risks.[2]
Question a) Do you agree with these principles and which principles do you consider particularly relevant or not relevant to underpin the supervisory framework for IORPs subject to Article 17?
These four principles are key to any sound risk management and capital assessment project. We would also emphasise that transparency is not only important between the firm and its supervisor, but also between the firm and its customers as well as between an employer and its policyholders. There is a further requirement for supervisory transparency so that firms are aware of the criteria against which they are being assessed. These are all important but proportionality and transparency are ineffective if market-consistency and a risk-based assessment are not applied.
Question b) Are there any other overarching principles that you consider relevant for IORPs subject to Article 17?
Other considerations are that the security of pension provision must be balanced against the need to give returns on the funds that are above inflation. Furthermore, any rules must increase confidence in existing pension provision and encourage increases in pension savings, without being overly burdensome to IORP sponsors.
Question c) Do you see a case for a different supervisory approach for IORPs subject to Article 17 depending on their size or complexity?
The UK does not have IORPs covered by Article 17 of this Directive. However, our view in principle is that we are in favour of a harmonisation approach, provided that it is applied proportionately, and takes into account the differences in social and labour laws, and if appropriate, difference in issues such as mortality rates.
Question d) To what extent do you consider that the supervisory frameworks existing today for IORPs subject to Article 17 already meet the principles emerging out of international best practice, as described in the CEIOPS survey?