Swedish Response to Consultation Ares (08) 14767

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Response to the Consultation Ref: Ares (08) 14767 by the Swedish Ministry of Finance and the Swedish Financial Supervisory Authority

A. IORPS SUBJECT TO ARTICLE 17 OF THE IORP DIRECTIVE

This section focuses on IORPs that are subject to Article 17 of the IORP Directive. These IORPs underwrite liabilities to cover against biometric risks, or provide guarantees of a given investment performance or a given level of benefits. They are therefore required to have regulatory own funds, i.e. "additional assets above the technical provisions to serve as a buffer". For these regulatory own funds, Article 17(2) of the IORP Directive refers to the Solvency I regime in the recast Life Directive. As the recast Life Directive will cease to exist after the adoption of Solvency II, the main question for IORPs subject to Article 17 is whether and to what extent the Solvency I regime should be replaced by solvency rules similar or equivalent to the Solvency II rules. This main question is dealt with by looking first, in general terms, at the objectives and principles of the solvency rules and then, more specifically, at the rules relating to regulatory own funds and funding.

i) Objectives and Principles

1. Solvency rules for IORPs subject to Article 17 should aim at guaranteeing a high degree of security for future pensioners, at a reasonable cost for the sponsoring undertakings, in the context of sustainable pension systems that are decided by the Member States.

Question Do you agree, or do you consider that the overall objective of solvency rules for these IORPs should be different?

Answer-Sweden: We agree. Another important aim is to ensure a level playing field with similar businesses.

2. Beneficiaries and sponsors seek to secure occupational pensions that maintain standards of living after retirement. Pension schemes, in particular those that provide life-long income such as annuities, are subject to risks related to future mortality rates, financial returns on assets, future inflation, future participation and contribution rates, which affect the overall solvency position of IORPs subject to Article 17. The CEIOPS survey shows that there are wide differences between Member States in their approach to these and other risks.

Question a) Do you believe that prevailing solvency rules for IORPs subject to Article 17 provide adequate protection relative to the objective of safeguarding pension beneficiaries’ claims at reasonable cost for the sponsoring undertakings?

Answer-Sweden: We prefer more riskbased rules in line with Solvency II. We do not see any reason why the same level of protection as is given by solvency II should not be given to beneficiaries of similar products in pension schemes. As is stated in the question, IORPs subject to Article 17 do business/bear risks which are comparable to the business/risks in life insurance undertakings. In Sweden it is the same kind of products. We strongly believe it is important that pensioners/beneficiaries in pension schemes safeguarded in IORPs have equally good protection as beneficiaries in similar products provided by life insurance undertakings. Also, it is of importance that the same rules are applied to IORP business in all countries. The aim should, in our opinion, be to apply solvency II for all IORP and life insurance business.

Question b) Have there been shortcomings or flaws identified in the prevailing solvency rules for IORPs subject to Article 17? If yes, please specify. What could constitute the main challenges lying ahead?

Answer-Sweden: Yes. In general, we see the same short-comings as are identified with solvency I for (re)insurance undertakings, i.e. the lack of a risk-based approach. To give an example, in the years 2001-2003 the life and pension industry had problems with the long decline in values of equities and long term bonds. But in principal, no companies became insolvent in Sweden. As the solvency I rules are not risk based, they did not measure the real risks for the companies at that time. The solvency II rules are risk based and have a better capacity to identify and foresee the risks in the companies. The overall problem is that if the IORPs or life companies have commitments which are based on a certain proportion of the salary and/or if they base their liabilities on forecasts of interest rates for a very long time ahead, it is almost impossible for them to hedge that risk at the time of giving these benefits.

Question c) Which solvency rules could be viewed as proactively dealing with different risks and improving risk management techniques?

Answer-Sweden: Solvency II could accomplish that much better than Solvency I. The main reasons for that are the risk-based capital requirements and supervision along with rules on governance and internal control. As a consequence, if risks are considered higher and/or if there are no acceptable internal control, the supervisor could require more own capital because of these risks.

Question d) To what extent do compulsory versus voluntary membership in pension schemes have a different impact on the overall outcome of solvency rules and in which case(s) are problems likely to arise in the future?

Answer-Sweden: For example, it could have some impact concerning biometric risks in respect of assumptions that people with better health tend to join pension schemes on a voluntary basis (risk selection). In that perspective, the longevity risks would be lower in a compulsory pension scheme, especially for lifelong pensions.

Question e) To what extent do the solvency rules prevailing today in the different Member States need to differ for single-employer or multi-employer IORPs subject to Article 17?

Answer-Sweden: In our opinion it should be the same rules irrespective of a single- or multiemployer IORP. There are no single-employer IORPs in Sweden, however.

3. The CEIOPS survey outlines four common overarching principles, as part of emerging best practices underpinning the supervisory framework which may be relevant to this consultation on IORPs subject to Article 17. First, a forward-looking risk-based approach to pension supervision, that weighs the potential risks faced by an IORP, as well as risk mitigants, and tailors the scope and intensity of supervision to this appraisal. Second, the principle of market-consistency in the valuation of an IORP’s assets and liabilities for supervisory purposes. Third, the principle of transparency, which implies that an IORP is open on how its financial position is determined and that reserves (or shortages), as well as prudence embedded in technical provisions and adjustment instruments, are made explicit to the supervisor. Fourth, the principle of proportionality, implying that supervisory requirements are applied in a manner proportionate to the nature, complexity and scale of the IORP’s inherent risks.[[7]]

Question a) Do you agree with these principles and which principles do you consider particularly relevant or not relevant to underpin the supervisory framework for IORPs subject to Article 17?

Answer-Sweden: We agree with all four principles and would like to refer to their compatibility with solvency II. Therefore, we are hesitant to highlight any of them. However, principles 1 and 2 may be mentioned as fundamental to create a risk-based solvency regime.

Question b) Are there any other overarching principles that you consider relevant for IORPs subject to Article 17?

Answer, Sweden: One issue we would like to mention specifically, eventhough it should be covered by the four principles, is the need of transparently stipulated rules for the valuation of different own funds items.

Question c) Do you see a case for a different supervisory approach for IORPs subject to Article 17 depending on their size or complexity?

Answer-Sweden, Fidep: In line with the proportionality principle in Solvency II we agree that this is needed. The bigger and more complex business in an IORP, the more time-consuming supervision will be needed.

Question d) To what extent do you consider that the supervisory frameworks existing today for IORPs subject to Article 17 already meet the principles emerging out of international best practice, as described in the CEIOPS survey?

Answer-Sweden: In our opinion it is not living up to best practise. Best practise would be in line with solvency II.

(ii) Regulatory own funds and funding rules

4. In cases where the IORP itself, and not the sponsoring undertaking, underwrites the liability to cover against biometric risk, or guarantees a given investment performance or a given level of benefits, the IORP is required to hold additional assets in the form of regulatory own funds according to the rules currently prevailing for life assurance undertakings (Solvency I). As from 2012, it is expected that new solvency rules will apply to life insurance undertakings (Solvency II). This would mean that from a solvency perspective, different rules will apply to IORPs subject to Article 17 and life insurance undertakings offering similar products.

Question a) Do you anticipate competitive distortions emanating from the application of different solvency regimes between insurance companies and IORPs subject to Article 17? Please specify.

Answer-Sweden: Yes. We are concerned that Solvency II may become a competitive disadvantage, meaning less protection to beneficiaries if employers chooses to safeguard occupational pensions cross-border, in MS with Solvency I regulation.

Practically, it is quite similar type of business in insurance companies (both life and non-life) and IORPs when considering long life business. We find no rationale for having different types of solvency regimes, although there may be reasons to regard certain additional protection rules in pensions. We are aware that there seem to be quite big differencies between the members states concerning their occupational pensions rules and frameworks. A goal to strive for, in our opinion, is to get a level playing field. A potential increase of cross-border selling must be based on fairness and equal rules between the member states.

On the other hand, Solvency II aim for strengthened protection to beneficiaries and a more effective capital allocation and internal market. This should create more competitive companies, meaning that Solvency II may be a comptetitive advantage. In our opinion this is a strong argument why Solvency II should be applicable to IORPs.

Question b) Do you have any evidence of such competitive distortions (as mentioned in the previous sub-question) existing already?

Answer-Sweden: So far we do not have any example of competitive distortions. One reason may be that, to avoid this situation on the Swedish market, we have implemented the option in Article 4 of the IORP Directive.

This issue is of great concern to us as we regard it a potential problem, both in relation to an effective internal market and the protection to beneficiaries. The problem we see is if one MS apply rules that permit the IORPs to be not fully funded during lengthy times whereas another country takes supervisory actions against an IORP who does not witout delay restore the lack of solvency capital, then you do not have the same level playing field. Pensions and long time savings in general is long business without any immediate liquidity problems. That is one reason why it is possible to run this type of business not fully funded during quite a long period of time.

Question c) What would be the likely impact of applying Solvency II (or similar solvency rules) to IORPs subject to Article 17?

Answer-Sweden: Better consumer protection and a level-playing field. Implementing Solvency II would mean risk based capital requirements, which means that IORPs would have to hold own funds reflecting the risk level of their business.

Question d) What would be the impact on the future provision of defined benefit schemes and the risk of closing down existing schemes?

Answer-Sweden: Necessary considerations have to be given the fact that pensions are long term business. Therefore, we think that there should be a long transition period.

Question e) What would be costs and benefits of this? Please provide quantitative information, where available.

Answer-Sweden: As is described previously we believe there are great advantages using Solvency II, of which the protection to beneficiaries and the level playing field on the internal market, are the most important benefits. Unfortunately, we have not been able to make any quantitative estimates of this effect. Concerning the costs, again we think that a transition period equivalent to the Article 22 in the IORP-directive may be an option.

Question f) In case a Solvency II-type regime were to be applied to IORPs subject to Article 17, which elements would need to be adjusted to take account of the specificities of the institutional set-up in which that IORP operates (e.g. recovery plans, additional contributionas, flexibility of benefits, etc.)?

Answer Sweden: Depending on features within the institutional set-up, there could be reasons to consider additions and adjustments to (preferably) the calculations of eligible own capital, but overall, the weight impact of this should be restrained. In Sweden, one example would be the mutual responsibility of all sponsors to collectively financially support the IORP, in a situation with financial difficulties. However, in principle we believe that any adjustment of this kind must be limited and used carefully.

5. The IORP Directive requires IORPs subject to Article 17 to hold assets to fund their technical provisions at all times. In the event of underfunding, the IORP is required to establish a recovery plan.

Question In case of overfunding can the excess assets be returned to the sponsoring employer or are there restrictions to this (thereby reducing the upside potential for employers)? Does this partly depend on whether occupational pension schemes are closed or open to new members?

Answer-Sweden: In Sweden this situation is usually regulated in the collective agreement between the employer and the employees. In practise the overfunding is primarily used to compensate pension payments for inflation. Adjustments for inflation are usually determined year by year. Secondly, the surplus could be paid out as bonus to employers. This is not dependant on whether the IORP are open or closed.

B. IORPs operating on a cross-border basis

This section focuses on IORPs that engage in cross-border business. These IORPs could be IORPs covered by Article 17 of the IORP Directive as well as other IORPs. The main question here is to what extent the differences in the solvency regimes for IORPs that operate on a cross-border basis are creating internal market problems. This main question is dealt with by looking first at the rules relating to technical provisions and then at the solvency rules for IORPs operating on a cross-border basis.

(i) Technical provisions

6. The CEIOPS survey shows that, in practice, Member States use different methods and assumptions to determine their technical provisions, partly reflecting historical and cultural differences. Current practices vary from applying best estimates to including extra safety margins in the underlying assumptions and incorporating prudence in different components of the technical provisions. Discount rates applied to the valuation of the technical provisions for example vary considerably. Moreover the treatment of mortality tables is rather diverse, as mortality rates, elements of prudence or incorporation of a trend component to reflect improvements in life expectancy are differently applied. This diversity can result in significant variations in the size of technical provisions across countries for comparable defined benefit commitments, and hence to differences in the level of liabilities to be funded.

Question a) To what extent do you consider greater harmonisation within the EU in this field or in individual elements of the valuation of technical provisions possible or necessary for IORPs operating on a cross-border basis?

Answer-Sweden: We should strive for harmonisation as far as possible. The easiest way must be to follow the solvency II regulation. You should pay attention to country-specific differences, e.g. differences in longevity among different population if there is clear evidence.

Question b) Should prudential requirements be considered separately from Social and Labour Law (SLL)? If yes, how could prudential requirements and SLL be distinguished?

Answer-Sweden: In Sweden the relative importance of collective agreements between the employer and the employees concerning occupational pensions, have led to a view that connections to SLL are quite minimal. The distinctions are already made.

7. The CEIOPS survey shows that in practice, Member States differ markedly in their approaches to inflation protection of the benefits promised. In some Member States they are conditional, in which case inflation risk is left with the beneficiaries, while in others they are unconditional.

Question a) How should differences in indexation promises (i.e. in nominal, conditionally indexed and real terms) be taken into account or included in a solvency framework for IORPs operating on a cross-border basis?

Answer-Sweden: The framework should reflect the conditions in the pension contracts between the employer and the employees. In Sweden, this is usually regulated in the collective agreement.

Question b) Do you foresee any difficulties arising from differences in the specific nature of pension promises in case of cross-border activity?

Answer-Sweden: The IORP must be very clear of the conditions concerning the pension contacts it will be dealing with. It is very important that the right information will be circulated between the involved parties when doing cross-border activities.

(ii) Solvency rules

8. The IORP Directive has created opportunities for the provision of cross-border pension services, as a first step towards an internal market for occupational pensions. Take-up so far has been rather slow, as full implementation of the Directive was achieved only in 2007. More time is therefore needed for the full effects of the Directive to unfold.

Question a) To what extent are the differences in solvency rules for IORPs operating on a cross-border basis acting as an obstacle towards cross border activity of occupational pensions?

Answer-Sweden: To some extent, particularly if companies in one country have to fulfil solvency requirements which ties up capital whereas companies in another country do not need to come up with additional corresponding capital. At "ceteris paribus", companies in the country without solvency rules would have a better possibility to offer a lower premium. We regard this as one of the obstacles but have difficulties to grade its importance in relation to other obstacles. With Solvency II in place we believe this problem will have a greater importance. In Sweden, Solvency II will apply to occupational pension schemes safeguarded by life insurance undertakings.