Guest Editorial
Solvency II: Friend or foe?
Pensions (2011) 16, 137-139. doi:10.1057/pm.2011.18
There is never a shortage o f activity in the
world o f (international) pensions. This certainly
appHes to European pension schemes. Barely
has one European Directive on pensions been
issued, then another one comes along. A l l these
E U Directives have one thing i n common: they
intend to place the funding o f occupational pension
schemes on a sounder footing. O f course, as the
poet reniinds us, the best laid plans o f mice and
men often go awry. But this does not detract
f r o m the need for some f o r m o f funding-regime
to be i n place for occupational pension schemes.
The alternative would be for each pension
scheme to muddie along i n its o w n way, w i t h
the risk that a fair few o f them w o u l d go to
the wall.
However, even though sensible, effective
and targeted regulation is therefore welcome,
regulatory overkill is not. The European
Directive 2003/41/EC, the lORP-Directive,
laid d o w n some ground rules pertaining to
the f u n d i n g o f occupational pension schemes.
Essentially, pension schemes n o w have to meet
a requirement to be fully funded at all times,
w i t h undei-funded schemes having to put i n
place a recoveiy plan showing h o w scheme
solvency can be restored w i t h i n a set timeframe.
I n the U n i t e d Kangdom ( U K ) , the Pensions
Act 2004 incorporated much o f this Directive
by introducing the scheme-specifiic funding
regime. M u c h o f the terminology i n the
relevant parts o f that A c t is taken directly from
the Directive; for example, the requirement f o r
schemes to meet their technical provisions (that
is, to be 100 per cent funded).
Since the Pensions Act 2004 came into force
(early 2005), the Pensions Regulator has overseen
implementation o f the new E U requirements.
The old m i n i m u m funding requirement has
n o w been phased out, and almost all schemes
have moved onto the new scheme-specific
funding Standard, This, together w i t h the
presence o f a pro-active Pensions Regulator
equipped w i t h the dreaded moral hazard powers
o f contribution notices and financial support
directions, has led to a shift i n the balance o f
power between trustees and the employer. Where
previously trustees were less likely to insist on
additional f u n d i n g obHgations being imposed o n
employers, they are n o w actively encouraged by
the Pensions Regulator to treat their scheme as
effëctively being a creditor o f the employer. Like
every creditor, schemes should ensure that their
debtors pay them the money they owe. The basic
rules o f finance have been made to apply to the
pensions sector.
W i t h i n the U K , the impact o f the Directive
on pension schemes has been great. Certainly,
the usual f u n d i n g problems have not been solved
overnight — nor is i t likely that they ever w i l l
be. Pension schemes are struggling w i t h the t w i n
pressures o f ageing and excess regulation, making
it more and more difficult to finance their
members' benefits. B u t at least the new legal
framework has provided some structure and
homogeneity to what was until then a fairly
shapeless and toothless f u n d i n g regime.
Does this mean that a new Solvency Directive
is n o w really needed, and could i t improve things?
This is a big question. The E U has now passed
Directive 2009/138/EC, due to come into
force in October 2012, k n o w n i n the trade
as 'Solvency I I ' . Although i t does not directly
impinge on occupational pension schemes, as i t
is intended for insurance companies, i t is likely
to affect such schemes.
What does Solvency I I do? Basically, it sets out
stricter requirements on capital adequacy and risk
© 2011 Macmillan Publishers Ltd. 1478-5315 Pensions
www.palgrave-journals.com/pm/
Vol. 16, 3, 137-139
Guest Editorial
management for insurers, w i t h the aim o f
increasing protection for poHcyholders. The
n e w regime is intended to apply to all instrrance
firms w i t h gross premiuiai income exceeding
€5 million or gross technical provisions i n excess
o f €25 million. The Solvency I I Directive is
contained w i t h i n a pillared structure. Pillar 1
covers the financial requirements, setting out
h o w regulatory capital requirements should be
calculated. Pillar 2 deals w i t h standards o f risk
management and governance. Pillar 3 seeks to
improve levels o f transparency and introducés
new disclosure requirements for firms.
Solvency I I , therefore, introducés further
harmonisation and tighter regulation into the
insurance market. The question is whether
this wiU also have a knock-on effect on pensioia
schemes. After all, the new guidelines contained
i n Solvency I I should make litde direct difference
to most occupational pension schemes. Such
amendments as Solvency I I does make to the
l O R P - D i r e c t i v e only modify article 17, w h i c h
deals w i t h regulatoiy o w n funds. Most U K
occupational pension funds do not classify
themselves as such, and therefore one might be
tempted to think that for them Solvency I I is a
bit o f a red heriing. Funded occupational pension
schemes i n other countries, like the Netherlands,
might be more directly affected, but the bulk o f
the new provisions i n Solvency I I w i l l not be
aimed at them either.
Where, then, could occupational pension funds
face difficulties emanating f r o m Solvency II? Put
simply, the worry is that Solvency I I w ü l force
up the price o f annuities. The reason for this is
that Solvency I I requires insurers to hold more
capital to cover their annuity books. The cost
o f holding extra capital w i l l be passed on into
annuity pricing, making annuities more expensive.
This w i l l result i n buy-out exercises for defined
benefit schemes becoming dearer (and potentially
less likely). It wiü also have an impact on members
o f defined contribution schemes: they, after all,
use their accumulated pension pots on retirement
to purchase annuities. The more expensive these
annuities are, the more this w i l l eat into the
meniber's pot, leaving a smaller pension at the
end o f the day.
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©2011 Macmillan Publishers Ltd. 1478-5315
The impact this could have on the buy-out
market is therefore an issue w o r t h worrying
about. I n recent years, more and more pension
funds have attempted to provide benefit security
by means o f a buy-out exercise, whereby trustees
enter into an annuity contract w i t h an insurance
company. The insurance company effëctively
assumes the liability o f providing the stated
benefits (that is, the benefits are 'bought out'),
instead o f the tiaistees having to pay benefits
out o f general pension f u n d assets. The advantage
o f this is that members' accrued rights are better
protected against the vagaries o f underfunding.
O f course, there is a price tag attached to this:
after all, pension funds are effëctively purchasing
a benefit guarantee for their members, and this
does not come cheap. Trustees are always keen
to ensure that their members' benefit security is
enhanced, and buy-out exercises seem to make
this possible. B u y - o u t options have therefore
become more c o m m o n i n recent years.
Clearly, any change that drives up the price
o f annuities w i l l throw a spanner i n the works
i n this respect. I f trustees o f occupational pension
plans (or indeed, outside the U K , directors o f
boards o f pension schemes) find that the cost
o f securing a buy-out is becoming increasingly
expensive, they may well think twice before
going d o w n this road. This w o u l d mean that
the buy-out alternative might lose its lustre.
Members o f defined contribution pension plans
w o u l d feel the pinch even more direcdy i f
annuity prices go up, although the removal o f
compulsory annuitisation i n the U K might have
an ameliorating effect o n this point.
Defined benefit arrangements that are directly
insured w i t h an insurance company (common
in, for example, the Netherlands) could also
end up being squeezed through Solvency I I , as
their underlying insurance contracts could face
increasing costs. This could lead to a further
dismantling o f 'coUective' pension arrangements.
After all, employers may well f m d that the
most attractive option w o u l d be to do the bare
m i n i m u m f o r their employees i n future: simply
promising to pay m o n t U y contributions into
a personal pension plan might well be the way
foi-ward. The peifonnance o f the members
Pensions
Vol. 16, 3, 137-139
Guest Editorial
dc-pot (and the size o f the annuity) w i l l then
really be a matter for the members themselves.
Certainly, countries w i t h a collectivist tradidon
i n pension matters (like the Netherlands) would
have misgivings about such an outcome,
Is Solvency I I , then, a fiiend or a foe o f
occupational pension schemes? The answer seems
to be that, at the very least, further moves to
tighten the insurance market through additional
regulation could well make life more difficult for
pension schemes. Few w o u l d dispute the need to
have sensible and effective regulation i n this area —
but i t has to be done i n a thought-through way.
The concern has to be that, like the late, great
Eric Morecambe, Solvency I I is playing all the
right notes, but not necessarily i n the right order.
-^j^-
Occupational pension schemes have been
buffeted by the storms o f different regulatory
challenges i n recent years. N e w laws and regulations
have helped to impose a degree o f coherence
on what used to be a fairly ineffectual funding
framework — but now occupational pension
schemes need a breathing space to get on w i t h
what they should be doing: looking after the
accixied pension rights o f their members. Endless
new regulation, however well intentioned, w i l l
not necessarily improve things and may well
make matters worse.
© 2011 Macmillan Publishers Ltd, 1478-5315
Lorenz van der M e i j
Associate, H o u t h o f f Buruma
Pensions
Vol. 16, 3, 137-139
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