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Solvency II rules could force pension plan closures

Applying Solvency II to occupational plans may lead to closures

Solvency II rules could force pension plan closures

FRANKFURT, Germany—Adoption of new rules for pensions based on Solvency II could dramatically increase funding requirements for employers that operate defined benefit pension plans across Europe, experts say.

Some groups argue that the stricter rules eventually could result in the closure of more pension plans.

The Frankfurt, Germany-based European Insurance and Occupational Pensions Authority, the regulator for insurance and pensions in the European Union, last week published its second consultation paper on harmonizing pension rules across the European Union. It includes adopting some articles of Solvency II, the risk-based capital regulatory regime for insurers and reinsurers that is slated for gradual introduction starting Jan. 1, 2013.

Among other things, EIOPA asked interested parties to give their views on whether the assets of pension providers should be valued on a market-consistent basis, and whether the solvency capital requirement and minimum capital requirement under Solvency II should be applied to European pension plans.

According to the consultation document, the risk-based approach to calculating the solvency capital requirement under Solvency II can be applied to pension funding.

“The promises made by Institutions for Occupational Retirement Provision and/or employers are comparable to those made by life insurance companies to policyholders,” EIOPA said in the document. “The same holds true for the risks IORPs are exposed to. IORPs invest in the same asset classes as insurance companies. The risks on the liability side resemble those of annuities offered by life insurers.”

However, because of the specific nature of pension providers, some amendments likely will be necessary, EIOPA added.

Interested parties have until Jan. 2, 2012, to comment on the plan.

The Brussels-based Comité Européen des Assurances, which represents insurers and reinsurers in Europe, supports a “level playing field” for occupational pension providers in the European Union, a spokeswoman said.

Experts say that the effects of any move to Solvency II-based regulation for pensions will be of particular relevance to Ireland, the Netherlands and the United Kingdom, where employer-sponsored pensions are the most common.

Any increase in funding requirements resulting from the regulation will be felt most in the United Kingdom, where employers are unable to cut benefits as a way to mitigate increased funding requirements due to U.K. law.

The London-based National Assn. of Pension Funds, which represents pension plans in the United Kingdom, has argued that applying Solvency II rules to pensions likely would increase the cost of providing pensions and may result in the closure of some of the defined benefit plans.

“We have now reached an extremely important stage in the E.U.'s review of the directive covering occupational pensions,” Darren Philp, director of policy at the NAPF, said in an email.

“The NAPF and its members will be playing a leading role in explaining why Solvency II is not appropriate for U.K. pension schemes and that its introduction would seriously undermine defined benefit pensions,” he said. “We hope that EIOPA will realize the unsuitability of these rules and that it will make this clear to the European Commission.”

A move to Solvency II-style regulation for pension plans could increase the liabilities of U.K.-based defined benefit plans by as much as £500 billion ($797.65 billion) and even drive some sponsoring employers to insolvency, Jonathan Camfield, a partner at actuarial firm Lane, Clark & Peacock L.L.P. in London, said in a statement.

While it is clear that EIOPA is set to introduce a Solvency II-like regime for pensions, the regulator has “recognized there are important differences between pension schemes and insurance companies, and has suggested that one way forward might be to have a two-tier approach to funding pension schemes across Europe,” Mr. Camfield said.

This implies that the United Kingdom might be able to continue using elements of its current approach for a limited period of time, though other countries may resist such an approach, he said.

Even if countries are allowed to continue their current funding requirements for pensions, EIOPA likely would require a “holistic balance sheet” to be produced for each plan showing the difference between the funding approach used and the Solvency II approach, Mr. Camfield said. For U.K. plans, this would require that a value be put on such things as the employers' covenant, which is seen as a guarantee of the plan's financial health.

It is complicated to put a value on that employer covenant and there is political pressure on EIOPA to find a consistent way of regulating pension plans in Europe, said Deborah Cooper, head of the retirement resource group at Mercer L.L.C. in London.

So while Solvency II may not be applied to pension plans “lock, stock and barrel,” there is likely to be a move to a more consistent funding approach for defined benefit pension plans across Europe, she said.

There is a plan-specific approach to pension funding in the United Kingdom, she said. If that were to change, the funding requirements for some employers could be dramatically increased.

Ms. Cooper said, however, that introduction of any Solvency II-type regime for pension funding may take so long that by the time it comes into force, many existing defined benefit plans may already be closed.