14 December 2017

EIOPA’s stress test identifies spill-over risks into the real economy from shocks to the European occupational pensions sector

The exercise also assessed the potential transfer of shocks from IORPs to the real economy and financial stability through sponsor support and benefit reductions. The stress test is not a pass-or-fail exercise for the participating IORPs.

The stress test covered defined benefit (DB) and hybrid as well as defined contribution (DC) schemes. Overall, 195 IORPs from twenty member states of the European Economic Area (EEA) participated in the exercise, representing a coverage rate of 39% of total assets. EIOPA’s target coverage rate of 50% was not reached in some Member States due to the lack of power of the respective national competent authority to require participation in the exercise. Such inadequate supervisory powers constitute an additional risk because relevant authorities are not able to assess vulnerabilities during adverse market conditions. 

The European DB and hybrid occupational pension sector has, on average, insufficient assets to meet pension liabilities on the national balance sheet, both in the baseline and adverse market scenario. These vulnerabilities are even more pronounced on the common, market-consistent balance sheet, providing a more comparable and realistic view of the financial position of the IORPs. The shortfalls on the common balance sheet - EUR 349 billion in the baseline and EUR 702 billion in the adverse scenario - would need to be covered by increased sponsor support and/or by benefit reductions. The DC occupational pension sector would experience a drop of 15 % in the market value of investment assets in the adverse scenario, reducing the individual accounts of DC pension scheme members and, in case the scenario persists, leading to lower pension income when the members enter retirement.

More than a quarter of IORPs providing DB and hybrid schemes are covered by a sponsor that may not be able to (fully) support the pension promise following the adverse scenario. In addition, the stress test results show that pension obligations may exert substantial pressure on the solvency and future profitability of companies with a potential spill-over to the real economy. In particular, for 25% of participating IORPs the value of sponsor support on the common balance sheet exceeded 42% of the sponsors’ market value under the pre-stress and 66% under the adverse scenario. Benefit reductions have similar negative effects on the real economy by reducing household income and consumption, but also resulting in lack of trust in the pensions system. 

National recovery mechanisms do allow sponsor support and benefit reductions to be spread over substantial timeframes. IORPs in financial difficulties are usually subject to long-term recovery plans. Moreover, high discount rates – relative to risk-free interest rates – provide an optimistic view of the funding situation of IORPs and act to delay recovery plan measures. Such prudential mechanisms may contribute to mitigating the short-term spill-over effects to the real economy and financial stability. However, in case the necessary adjustments are postponed too far, restoring the sustainability of IORPs can only be achieved by putting a disproportionate burden on the younger generations.

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