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Behind the headlines: The impact of Solvency II on pension schemes

The European Commission’s apparent intent to force pension schemes to hold more capital by introducing insurance-type Solvency II requirements has led to a comical bout of one-upmanship over the impact it will have on the UK.

The Department for Work and Pensions says proposals put forward by the European Insurance and Occupational Pensions Authority (Eiopa) to introduce a “holistic balance sheet” for occupational pension schemes would increase scheme liabilities by 20 to 30 per cent at a cost likely to be “at least £100bn”.

Incredibly, this is the most conservative estimate of the impact the new regime could have. A report from JP by JP Morgan, published last week, estimates that pension schemes or their sponsors would need to pay an extra £600bn to make up the difference between liabilities (estimated at £1.6trn) and financial assets (estimated at £1trn).

JLT Pension Capital Strategies says the final bill for UK companies could reach £1trn, although managing director Charles Cowling concedes this depends on how the new rules are introduced.

The National Association of Pension Funds says that the proposed rules would “threaten the UK economy and jobs”, with businesses forced to pump “at least £300bn” into defined-benefit pension schemes.

What is the Eiopa proposal?

Eiopa’s aim – and the aim of the European Commission – is to ensure members’ benefits are safe and guaranteed in all circumstances.

Eiopa proposes to do this by introducing the “holistic balance sheet” for European pension schemes. Under this approach, pension schemes could be required to increase funding levels and introduce a risk margin and solvency capital requirements to reduce the likelihood of members losing out if the company goes bust.

The risk margin is the difference between the amount it would cost to transfer liabilities to another provider and the “best estimate” of the total liabilities. The SCR represents the additional capital that must be held to protect against uncertainty. Under Solvency II, insurers are required to hold enough capital so that there is less than a 0.5 per cent probability of insolvency in 12 months.

To put it another way, insolvency should be a one-in-200-year event.
Eiopa’s call for advice discusses a number of confidence levels, including differentiating between one-in-200-year events and one-in-40-year events.

Representatives from Government and the pension industry have argued that these measures are unnecessary for the UK because the Pension Protection Fund and The Pensions Regulator already act as a safety net for scheme members.

Why so many different impact estimates?

Despite the initial European Commission green paper being published in July 2010, the proposals remain at a very early stage. A DWP spokeswoman describes the Eiopa call for advice as “nebulous” and, importantly, says no impact assessment has been conducted.

As a result, the pension industry – which is incredibly keen to put pressure on European officials to rethink the proposals – has produced its own impact assessments based on the limited evidence available.

The NAPF’s minimum estimate of a £300bn increase in liabilities, for example, is based on a survey of a sample of its membership. However, the trade body has been unable to factor in costs linked to the risk margin and SCR outlined in the Eiopa call for advice because there is insufficient detail available.

JP Morgan’s analysis, on the other hand, is based on the figures provided by the Pension Protection Fund’s Purple Book in 2010. The PPF is widely considered to be the most accurate source of information on the funding status of UK pension schemes but the information used by JP Morgan is already out of date.

Industry figures suggest the proposals would not need to be implemented in the UK until 2016 at the earliest, so the actual impact of any reforms will depend on how the schemes are funded if and when the new rules are brought in.

There also remains significant uncertainty about the impact the risk margin and SCR would have and the discount rate that would be used to calculate liabilities. In its analysis, JP Morgan points out that a 1 per cent increase in the discount rate would lower the UK’s aggregate deficit by around £200bn.

More fundamentally, because the Eiopa call for advice is at a very early stage there is no guarantee that the Solvency II regime set to be imposed on insurers will actually be replicated for pension schemes.


The figures put forward by pension industry representatives are not necessarily fanciful as numbers will inevitably be astronomical when talking about defined-benefit pension funds.

However, there is more than of a whiff of finger-in-the air maths here. That is not to say the figures calculated are too large – they could be too low – but there are some huge leaps being made, particularly when estimating the UK’s total assets and liabilities.

Furthermore, as Standard Life head of pensions policy John Lawson points out, if employers are forced to fund pension schemes to full insurance buyout level (referred to by JP Morgan as “best estimate”) and make a commitment for the solvency capital requirements on top of that, they may simply choose to buy out their liabilities with an insurance company in order to avoid the additional SCR payment.


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