Pension Groups: Solvency II to Hurt Markets

Solvency II would hurt equity markets as well as force the closure of remaining defined benefit pension funds, a pan-European employers and retirement industry group has claimed.

(March 1, 2012) — Equity markets could be hit and systemic risk would spread through the pension fund investment sector if European Commission enforce insurance regulation, Solvency II, on retirement schemes, trade bodies have said.

A group of pension fund, employer and investment organisations today called on European Commissioner Michel Barnier to drop the ‘illicit assumption’ that Solvency II capital rules are the best way of safeguarding pension provision across the continent.

Barnier today launched a review of pension fund regulation across Europe. Over the past year, stakeholders have been responding with their views on how to improve the system and raise concerns that the Solvency II regulation, which was initially designed for insurance companies, was the wrong fit for pension funds.

A statement from the group today said: “We believe that it is dangerous to apply legislation made for insurance companies to institutions for occupational retirement provision (IORPs). There are fundamental differences between them. Any effort to harmonise the regulatory regime is based on flawed logic and could have unintended consequences on pension plan members, IORPs and the economy as a whole by impeding growth and job creation.”

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Along with claiming stricter capital rules on defined benefit pension funds would make them unaffordable for most employers, the group said applying Solvency II to this sector would have massive unintended consequences on the wider financial and business communities.

The regulation would see pension fund investors move away from risk assets, such as equities, and buy lower-risk securities, such as bonds. The group said this would take huge pots of money away from businesses that listed on global stock exchanges in search of capital for growth.

“Under the new rules pension funds would likely de-risk their asset allocation, making available less capital to companies to create growth and jobs. Businesses are already experiencing difficulties getting access to credit during this period of economic turmoil,” the statement said.

Jerry Moriarty, Director of Policy at the Irish Association of Pension Funds, told aiCIO: “If pension funds all start pulling out of equities and moving into bonds, yields will be driven down even further and they are already fairly expensive.

“Additionally, the rules would push all pension funds in the same direction, with similar asset allocations. Pension funds have been forced to diversify for years, to help spread their risk, and now they may be about to be forced back into one asset class, with the rest of their peers.”

Moriarty said the situation would be even more worrying should there be a problem with an asset class that had become crowded with institutional investors.

Dörte Höppner, Secretary General at the European Private Equity and Venture Capital Association (EVCA), said: “Pension schemes that guarantee a secure income for millions of Europe’s pensioners are also an important source of capital for long term investors such as venture capital and private equity, which in turn generate income for pensioners by investing in innovation and growth. Applying Solvency II to pension schemes would severely jeopardise this virtuous circle of value creation.”

This morning, Barnier said on his Twitter feed that Solvency II could not be ‘cut and pasted’ from the insurance to the pensions sector, however, in the speech delivered at the launch, Barenier said: “In so far as insurance products and pension schemes are comparable, the regulatory framework should be similar.”

Liabilities have outpaced the growth in assets for the sixteen publicly listed US corporations with pension liabilities over $20 billion, research by Russell Investments has shown.

(February 29, 2012) — While asset returns were positive in 2011, liabilities still outpaced the growth in assets for the publicly listed corporations in the United States with pension liabilities over $20 billion, according to an analysis by Russell Investments.

According to the firm, the “$20 billion club” — a group that represents nearly 40% of the pension assets and liabilities of all US-listed corporations — now has a combined shortfall of worldwide pension assets below liabilities of $173 billion on their balance sheets, up from $121 billion last year. In other words, the analysis showed that pension liabilities grew faster than assets in 2011, and cash contributions have continued to rise.

“When combined, the $20 billion club represents more than three quarters of a trillion dollars in pension liabilities, so it is a good guide to what is happening in the system as a whole. Even though corporations are taking steps to close their pension deficits, falling interest rates in 2011 meant that just about everyone’s position deteriorated,” said Bob Collie, chief research strategist at Russell Investments, in a statement.

He added: “Pension risk matters a great deal. Both interest rates and asset values can change quickly, so it’s a very fluid situation. But unless market conditions prove exceptionally favorable, we are likely to see sponsoring corporations continuing to make significant contributions for several years to come.”

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The solution to rising shortfalls for pensions worldwide, according to Russell: De-risking, diversifying, and focusing on total portfolio outcomes via multi-asset portfolios.

To help ameliorate the shortfall, the firm foresees rising cash contributions in the years ahead — with the total contributions made by these 16 corporations over the next seven years expected to be close to $250 billion.

Expecting higher contributions by plan sponsors in the years ahead, Collie warned investors earlier this month to beware of ‘crowded trades.’ As a result of institutional investors putting more and more money into the market at the same time, investors should be aware of the danger of such trades distorting the market as investors try to buy and sell simultaneously, Collie told aiCIO. “Overall, the general need for higher contributions among plan sponsors is not surprising as many factors have aligned,” he said, citing falling interest rates, higher liabilities, and the Pension Protection Act’s (PPA) redefinition of shortfall requirements.

“Perhaps the single most important factor is the way that the PPA has redefined how plan sponsors must make up a shortfall. When there’s a shortfall, the PPA now says plan sponsors have seven years to make it up. Previously it was roughly double that. So it means contributions are now much more responsive to changes in the market situation,” Collie said.

Russell’s research follows a report released in December by Mercer that showed the outlook for 2012 pension plan contributions and expense is bleak. “Even though discount rates moved somewhat higher during November, they are likely to be in excess of 40 basis points lower at the end of this year than they were at the end of 2010,” said Kevin Armant, Principal in Mercer’s Financial Strategy Group. “Because equities have also underperformed expectations, corporations who use a December 31 measurement date will likely see larger pension liabilities on their balance sheet, as well as higher 2012 pension expense.”