EU Pension Plans Show Massive Shortfalls in Stress Test

Pension plans in the European Union could lose as much as €270 billion ($298 billion), or 25% of their asset value, under adverse economic conditions, according to a recent stress test conducted by the European Insurance and Occupational Pensions Authority (EIOPA). EIOPA is the EU’s insurance and pension watchdog.

The biennial Institutions for Occupational Retirement Provision (IORPs) stress test assesses the resilience and potential vulnerabilities of European defined benefit and defined contribution pension plans. This year’s test was the first one that covered the analysis of environmental, social, and governance (ESG) factors.

“Long-term obligations and long investment horizons arguably require IORPs to consider ESG factors and enable IORPs to sustain short-term volatility and market downturns for longer periods than other financial institutions,” Gabriel Bernardino, chairman of EIOPA, said in a release. “The supervisory monitoring and the applied supervisory tools need to be capable of detecting adverse market trends and market developments that can have long-term negative effects.”

The EIOPA applied an adverse market scenario that was characterized by a sudden reassessment of risk premiums and shocks to interest rates on short maturities that resulted in increased yields and widening credit spreads. The adverse market scenario was applied to the end-2018 baseline balance sheet of a representative sample of European Economic Area (EEA) IORPs. In the baseline, the plans were underfunded by €41 billion on aggregate.

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“The adverse market scenario would have led to substantial aggregate shortfalls of €180 billion according to national methodologies and €216 billion following the stress test’s common methodology,” said the EIOPA in its stress test report. “Under the assumptions of the common methodology, the shortfalls in the adverse scenario would have triggered aggregate benefit reductions of €173 billion and sponsoring undertakings would have to provide financial support of €49 billion.”

Nineteen countries participated in the exercise, covering more than 60% of the national defined benefit and 50% of the national defined contribution sectors in terms of assets – in most countries. The report said 176 plans participated, 99 of which were defined benefit plans and 77 were defined contribution plans.

“The majority of IORPs in the sample indicated having taken appropriate steps to identify sustainability factors and ESG risks for their investment decisions, which is important for an effective implementation of the IORP II Directive,” said EIOPA. “Yet only 30% of them have processes in place to manage ESG risks. Further, only 19% of the IORPs in the sample assess the impact of ESG factors on investments’ risk and returns.”

EIOPA said it will follow the findings and analyze in more depth the investment behavior of EU pension plans, in particular in the “ultra-low” and negative interest rate environment.

“Going forward, EIOPA wants to further improve its analytical tool set for stress testing” the watchdog said, “extending the horizontal approach and with that assessing the common exposures and vulnerabilities of the DB and DC sectors together.”