19 May 2015

IPE: Look at pension arrangements not IORPs

As part of the ongoing debate over which parameters to apply to calculate European IORPs’ solvency levels, the actuaries have compiled a discussion papercalling on regulator EIOPA to push for ‘Clarity before Solvency’. One major demand is for EIOPA to rule out the application of a single discount rate for all IORPs.

Falco Valkenburg, chair of the AAE’s pensions committee, said: “The discount rate is very important in EIOPA’s discussions on the holistic balance sheet (HBS), and two types of discount rates are debated – a risk-free rate or a rate based on the expected return on assets."

He noted that, for a fully guaranteed pension deal, the risk-free rate could be applied, and for a pure (collective) DC arrangement, the rate could be based on expected returns. “However, most pension deals in Europe are somewhere in between these two models,” he said. If EIOPA forces all IORPs to use the risk-free rate, “it is ignoring the specifics and conditions of a pensions deal and valuing them as though they were fully guaranteed”, Valkenburg said.

He said this happened in some countries with the first quantitative impact study (QIS), where a risk-free rate was applied. “The results exaggerated the funding deficits in some IORPs, but the truth is somewhere between national valuations and EIOPA’s approach,” Valkenburg said. He stressed the importance of getting a “true picture” of a pension arrangement’s liabilities and for plan members, as well as other stakeholders, to understand the implications of conditions attached to the deal. “Both DB and DC risks are currently often not fully understood and not communicated to members sufficiently,” he said.

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To achieve clarity on valuations, the AAE is proposing parameters be set on a national or European basis for ALM studies on liabilities by an independent committee “to prevent biased or too optimistic parameters being applied”. Valkenburg said: “An ALM allows you to make projections into the future development of members and assets of a fund. The HBS approach only shows you the situation at a certain point in time missing the wider point of how a fund can develop in the future.”

On a more technical note, Valkenburg argued that clarity on liabilities also meant no distorting parameters such as the application of a counter-cyclical or matching premium, used under Solvency II, to pension fund valuations. “Let’s not hide reality by using these premiums but rather have the ‘right’ value, an objective value – and if there is a large underfunding, the social partners could then decide to use something like a counter-cyclical premium to define parameters for when to start taking action,” he said.

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