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4.3
Pension funds
4.3.1
Solvency II
The regulator is currently asking insurance undertakings to set aside regulatory capital at a level that
could discourage them to invest in the asset class. However, the possibility of having lower
regulatory capital is offered to insurance undertakings if they can prove that they understand the
risk they are taking and consequently have developed internal models to measure their risk. These
internal models need to be approved by regulators. The Guidelines are here to facilitate the dialogue
between insurance undertakings and their regulators when the former seek authorization to use
these internal models.
There are conceptual issues and misunderstanding in regulatory treatment beyond Solvency II. We
can expect that if we do not address these issues at a time when institutional investors have to cope
with re-regulation, we will be faced with a shrinking investor basis. The Guidelines aim at conveying
a different message on these points.
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Regulatory overview
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4.3.2
IORP Directive of 2003
The legislation is based on home country supervision of pension schemes, respect for national, social
and labour legislation, and the “prudent person” principle. The Directive provides for the home state
to lay down specific investment rules ensuring that the assets of the fund are invested in the best
interests of the members, that the institution is registered and that it draws up an annual report and
accounts. A limit of 70% of assets being invested in shares, negotiable securities treated as shares
and corporate bonds is laid down, with the provision for a lower limit for pensions guaranteeing a
long-term interest rate benefit.
Article 15: Technical provisions - (b) the maximum rates of interest used shall be chosen
prudently and determined in accordance with any relevant rules of the home Member
State. These prudent rates of interest shall be determined by taking into account: — the
yield on the corresponding assets held by the institution and the future investment returns
and/or — the market yields of high-quality or government bonds;
Article 16: Funding of technical provisions
1. The home Member State shall require every institution to have at all times
sufficient and appropriate assets to cover the technical provisions in respect of the
total range of pension schemes operated.
2. The home Member State may allow an institution, for a limited period of time, to
have insufficient assets to cover the technical provisions. In this case the competent
authorities shall require the institution to adopt a concrete and realisable recovery
plan in order to ensure that the requirements of paragraph 1 are met again.
Article 17: Regulatory own funds
1. The home Member State shall ensure that institutions operating pension
schemes, where the institution itself, and not the sponsoring undertaking,
underwrites the liability to cover against biometric risk, or guarantees a given
investment performance or a given level of benefits, hold on a permanent basis
additional assets above the technical provisions to serve as a buffer.
2. For the purposes of calculating the minimum amount of the additional assets, the
rules laid down in Articles 27 and 28 of Directive 2002/83/EC shall apply.
In practice, these rather vague rules only impact the investment behaviour of Defined Benefit
Schemes (DB) as they promise pensioners specified benefits (covering biometric risks), whereas
Defined Contribution Schemes (DC) leave the investment risk on the individual member rather than
the employer. The systemic implications flow particularly from the interest rate chosen to value the
liabilities as a sharp decline (or narrowing of the spread of high quality versus governments) can
balloon the liabilities. As the DB schemes are required to have sufficient assets to cover these
liabilities, they create powerful financial effects on the plan sponsors – as is happening in the UK at
present.
The interaction in recent years of IORPS and the pension accounting standard IAS19 has led to the
closure of many DB schemes so these systemic risks to the financial system are reducing
significantly. The rising social/political risk from the transfer to unsuspecting individuals of the
investment risk is outside the purview of this study.
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