The European Insurance and Occupational Pensions Authority (EIOPA) has launched a stress test to model what the impact of controversial funding rules would be on pension schemes. What does this mean for trustees?


European commission

Source: Sébastien Bertrand

Credit: Sébastien Bertrand

What happened?

The European Insurance and Occupational Pensions Authority (EIOPA) has launched a stress test to model what the impact the adoption of a controversial new framework would have on pension schemes across Europe.

The Institutions for Occupational Retirement Provision (IORPs) Directive contains stringent rules on capital requirements which could require scheme sponsors to pay off their pension scheme deficits.

One of the most controversial provisions contained within the IORPs directive is the holistic balance sheet. This forms part of the new rules which govern the valuation of scheme assets and liabilities, and their capital requirements.

By creating a holistic balance sheet, EIOPA is trying to establish a common valuation framework for pension schemes across Europe. EIOPA promises that it will “[take] into account the diversity in national occupational pension systems” – but UK experts warn that EIOPA’s proposals will create a one size fits all framework which will cause UK pension scheme deficits to soar.

The stress tests are designed to demonstrate the impact on pension funds. The scenarios they are testing are deliberately extreme and designed to demonstrate what would happen to pension schemes in a crisis situation where equities have fallen 45% and life expectancy has increased by two years.

What does that mean for trustees?

The stress tests will show the impact the IORPs directive could have on pension schemes in the UK. Trustees will be interested because this stands to have a significant impact on the way their assets and liabilities are calculated.

“The results are likely to be truly shocking for most trustees and will be a vivid demonstration of the risk involved in running a pension scheme,” says Rowan Harris, an actuary at Barnett Waddingham. “While the scenarios given are highly unlikely to materialise in a particular year, we live in interesting times and it could be a useful exercise for trustees to consider how they might prepare for and respond to a future crisis”.

“An EIOPA consultation last year showed the European pensions industry was overwhelmingly against proposed EU solvency rules based on a complex ‘holistic balance sheet’, and pension scheme solvency rules have explicitly been removed from the EU’s current legislative agenda,” says James Atherton, a partner at LCP. “We all hoped the holistic balance sheet would be kicked into the long grass, but the new assessment exercise suggests that EIOPA is taking it upon itself to plough on regardless with developing complex potential rules, which appears to be a complete waste of time and money”.

“It is important the stress tests are not used to strengthen the case for a holistic balance sheet, which no one wants outside EIOPA,” says Graham Vidler, director of external affairs at the National Association of Pension Funds (NAPF).

Several of the NAPF’s members are involved in these stress tests, which Vidler says makes them “good corporate citizens”. It is also likely to be useful for the schemes themselves because it will give them a clearer idea of the potential challenges presented by an EU-wide valuation framework.

The stress tests should be viewed in the wider European context. The European Commission has recently appointed a new set of commissioners who are “looking at everything through the prism of jobs and growth,” says Vidler.

Given this stated priority it is “hard to see why something like the holistic balance sheet is necessary – it gets in the way of jobs and growth rather than promoting them,” he says. So the new commissioners may be more sympathetic to the needs of companies across Europe than their predecessors.

“At a time when the European Commission is focusing on making EU law simpler and reducing regulatory costs, it is hard to see how they would feel able to take a proposal such as the holistic balance sheet forward,” Harris adds. “EIOPA’s own initiative work on this is imposing additional costs on schemes without any clear benefit.”

What next?

EIOPA has launched a consultation on this issue which will run until 10 August. Trustees and their advisers will be able to contribute their views to the consultation if they wish to do so. EIOPA’s intention is to deliver their advice to the European Commission in March 2016.

Trustees and national regulators will then need to wait to hear the outcome of the stress test and quantitative assessment and keep up to date on what this means for the adoption of the directive.