Head to head: is Solvency II as bad for UK pension schemes and industry as its critics suggest?

Rob Gardner, co-chief executive, Redington

A tentative welcome

The response has been almost universally negative, yet virtually all of the comments relate to just one part – the discount rate used to value the liabilities. Although we recognise the discount rate is an important part of the debate, any assessment of the proposals needs to consider all aspects of the advice, which cover four areas: the scope of the directive and certain cross-border aspects; quantitative requirements and how they should be measured; qualitative requirements, particularly in respect of governance; and the information that should be provided to members and to supervisory authorities.

The quantitative requirements need to be considered in their entirety, in particular the impact of the holistic balance sheet (HBS) on the assets and liabilities, and that the third area covering governance is just as important as the second.

The HBS starts with the financial assets and liabilities as we would traditionally see from a typical actuarial valuation, but then makes various changes. Rather than looking at assets and liabilities separately, we will add them individually to the above, to try to illustrate the impact more explicitly:

• Recovery plans: the inclusion of a plan value is a key part of the HBS that seems to have been overlooked in most of the negative responses to EIOPA’s proposals. Even allowing for some sponsor default risk, this should broadly eliminate the deficit from the actuarial valuation.
• Discount rates: moving to a risk-free discount rate for liabilities has variously been estimated to add around £500bn-£600bn of liabilities. Although this is the main stumbling block for commentators, the inclusion of a recovery plan value will offset a substantial part of it.
• Other assets: sponsor covenant and any pension safety net such as the Pension Protection Fund (PPF) will need to cover the additional liabilities arising from the lower discount rate and the requirements for capital. There are challenges in putting values on these assets, but they add considerably to the security available to members.

Fourteen of the topics in the EIOPA advice come under the governance workstream and many of these items have already been addressed by the Pensions Regulator. We are encouraged EIOPA is drawing on the positive experience from Solvency II in the insurance industry by ensuring the risk and capital management inherent in the HBS are integrated into all aspects of pension scheme management.

The HBS embodies the approach to financial management of pension schemes that we advocate, ie that funding, investment, risk management and sponsor covenant are all intrinsically linked and therefore should be considered together holistically. We welcome the proposals while recognising there are a lot of details to be sorted out. We encourage the pensions industry to get involved to ensure we put in place a strong and robust foundation for the future provision of pensions.

Joanne Segars, chief executive, National Association of Pension Funds

An unnecessary danger

There cannot be many issues on which the Trades Union Congress, the Confederation of British Industry, National Association of Pension Funds (NAPF) and the government are united, but the European Commission’s proposals on pension scheme funding is certainly one.

Anyone following pensions will have noticed a long list of organisations queuing up to oppose importing the Solvency II system of extra capital requirements into the main EU pensions directive.

So it was quite a surprise to see the consultants at Redington arguing the holistic balance sheet (HBS) – the Solvency II-based pension funding system proposed by EIOPA in its advice to Brussels policymakers – would actually be good news.

Of course, being at odds with the vast majority doesn’t necessarily mean Redington is wrong – the crowd doesn’t always get it right, but on this occasion I am confident they have – and here is why.

The first point is simply this: if it ain’t broke, don’t fix it. The UK’s scheme-specific funding regime works. It ensures pensions are paid. It has been thoroughly stress-tested by the deepest recession in a generation. It is backed up by the work of the Pensions Regulator and by the Pension Protection Fund (PPF). So why swap it for an alternative that could be much worse?

The second point is Redington’s case depends on a series of unknowns coming up trumps. They are right the HBS would give schemes credit for the sponsor covenant, for PPF-style protection and for contingent assets, but we have no idea how these elements would be valued. If they were valued to maximum advantage then of course it is possible they might outweigh the extra capital requirements generated by other parts of the HBS. But that’s far too big an ‘if’. We would be staking the future of our pensions on a few strokes of the pen in Brussels.

The third point is to base our analysis on what we know. The one element of the HBS on which EIOPA has cast some light is technical provisions. Although its consultation paper last year provided some options, EIOPA’s central proposal is to value these with a risk-free discount rate. Figures from a sample of NAPF member schemes indicate an increase in liabilities to the order of £300bn. Furthermore, unknown amounts would be added for a ‘risk margin’ and ‘solvency capital requirement’. Would the new system really give enough credit to neutralise these massive increases in liabilities?

EIOPA’s final advice to the European Commission will be published in the next few days. We hope they will have listened to representations from the NAPF – and many others – warning a massive increase in funding requirements would lead to corporate insolvencies, further defined benefit scheme closures and an increased switch of investments from equities to gilts. The damage to pensions and to the wider economy would be significant.