Low rates and falling asset prices have hit pension schemes hard, the first stress test by the European Insurance and Occupational Pensions Authority has shown, and experts warn the holistic balance sheet could still rear its head.
Eiopa this week released the results of its first stress test for occupational pension schemes, aimed at testing the resilience of defined benefit and hybrid schemes.
The tests comprised two situations: one looking at negative demand shock from a drop in equity markets affecting other asset classes and another looking at a general, though less severe, drop in prices across a wide range of asset classes, combined with negative supply shock to oil and other commodities.
Source: EIOPA
Eiopa’s report on the tests shows schemes are vulnerable in both situations to a drop in asset prices and an increase in technical provisions liabilities caused by persistently low interest rates.
The report states: “Due to the corresponding spread widening [caused by either scenario], interest rate sensitive assets would not offset this increase and hence the position of DB IORP schemes would be impaired further.”
However, the report also showed schemes were less vulnerable to increases in member life expectancy, which has long been a cause of increasing liabilities, than they were to market falls.
The report revealed an instantaneous permanent 20 per cent decrease in mortality rates would only decrease schemes’ excess of assets over liabilities by six percentage points.
Jon Hatchett, partner at consultancy Hymans Robertson, said that while the threat from low interest rates and low investment returns appear more pronounced, schemes should bear all of the highlighted issues in mind.
“I think they’ve identified the right risks, [and] they’re all important,” he said.
Holistic balance sheet fears
Hatchett added that schemes should not be worried about the introduction of the holistic balance sheet, which would apply funding requirements similar to those of insurance companies to pension schemes.
“I wouldn’t place it high on the list of things for schemes to worry about,” he said. “Eiopa seem to be keen on it, but politicians [are not].”
[From] conversations we’ve had with Eiopa it’s very much not dead in their eyes. In Europe, people say, things never die. They are just pushed further away
The introduction of the holistic balance sheet would add £350bn to Europe’s occupational pension deficit “overnight” if introduced, hitting the UK, Ireland, Belgium and the Netherlands particularly hard, according to law firm Eversheds.
Tim Smith, senior associate at Eversheds, disagreed that the holistic balance sheet was nothing to worry about.
“[From] conversations we’ve had with Eiopa it’s very much not dead in their eyes,” he said. “In Europe, people say, things never die. They are just pushed further away.”
The Pensions and Lifetime Savings Association also released a statement saying it was “very disappointing to see Eiopa pressing ahead with its holistic balance sheet concept”.
Rowan Harris, consulting actuary at consultancy Barnett Waddingham, said the balance sheet concept would be used, and the impact of its use measured, in the authority’s quantitative assessment, due out in March.
“They’ve sort of rebranded it as a common methodology,” she said.
However, Harris welcomed the report, saying: “All the way through the report Eiopa recognises the way pension schemes operate, [that] investing for the long term... is beneficial for the wider economy.”
