Stephanie Baxter looks at what UK schemes should expect from European stress tests over the coming months.
At a glance
- The European regulator has gone ahead with pension stress tests despite huge backlash
- The tests that will be run this year are another pressure on UK schemes coping with the pension reforms
The pensions industry has been highly critical of the European regulator's determination to impose continent-wide solvency standards on schemes. Proposals to develop a holistic balance sheet (HBS) to measure solvency levels have also attracted suspicion.
The latest controversial move by the European Insurance and Occupational Pensions Authority (EIOPA) is to launch stress tests for defined benefit (DB) and defined contribution (DC) schemes in 17 member states including the UK.
The aim of the exercise is to test the resilience of DB schemes against adverse market scenarios or an increase in life expectancy on a common, holistic balance sheet (HBS) and on their national balance sheet. DC schemes will have to identify the effects of potential shocks on the future retirement income of members who will receive benefits in five, 20 and 35 years' time.
To add to the burden, a quantitative assessment will be run at the same time to gather data on how the HBS could be used by European regulators.
EIOPA believes stress tests are an "important supervisory tool" to examine the sensitivity of pensions to adverse market developments, to "reach conclusions for stability of the financial system" and enhance consumer protection.
National Association of Pension Funds (NAPF) policy lead for EU and International James Walsh calls the tests "extensive and complex" and warns they will need "careful scrutiny" from regulators.
He says the responses to EIOPA's previous round of consultations does not support any of this work.
The UK is not the only country to question the tests. The chairman of Germany's pension association has lambasted EIOPA as exceeding its legal mandate and said it should be challenged.
While the NAPF continues to argue the HBS project should be pushed aside - not least because the European Commission has no plan to take it forward - Walsh says it is it is important the UK gives an "accurate response".
How will schemes be chosen?
The European regulator wants the tests to cover more than half of total assets under management in DB schemes in the UK and either half of assets or half of members in DC schemes.
The Pensions Regulator (TPR) has already contacted a sample of the largest schemes to urge them to take part on a voluntary basis. A spokesperson says it will shortly provide details of how it will help collect the data.
TPR's director of policy Nigel Peaple says: "It is vital that the impacts of a possible future solvency regime on the UK are clearly shown and that the advice EIOPA gives to the commission completely recognises the UK position. It is important therefore that the conclusions reached following the exercise accurately reflect the UK pension system."
LCP head of corporate consulting Alex Waite agrees that schemes must participate. He says "It's much easier for us to have credibility and sway in Europe if we do the calculations for a good proportion of the top 250 schemes."
That being said, the amount of extra work should not be underestimated. The NAPF is working with TPR to gather the data without overburdening schemes which are already busy with a slew of UK reforms.
"We understand that this is a very busy time for schemes and we will ensure that this exercise is run as simply and efficiently as possible," says Peaple.
The UK watchdog says it is developing options for schemes to take part as simply and efficiently as possible.
What do the tests involve?
The test for DC is quite straightforward. It analyses the effects of instantaneous shocks to asset prices and different assumptions for long-term yields on expected retirement incomes. Waite says we are not going to learn anything useful from this, however.
It will be more complex for DB schemes. They will be tested against a scenario where equities fall by 45%, and bond yields fall, coupled with increases in liabilities due to higher longevity.
"When you add that all together a scheme's deficit will increase multiple times," warns LCP's Waite.
While EIOPA has said these are just tests to assess the vulnerability of schemes to shocks, there are concerns it could take regulatory action if the results are not favourable.
Such a dramatic fall in equities would impact UK schemes more than those in various other countries. "Germany tends not to have funded plans like the UK so a fall in equities doesn't impact them," says Waite.
The calculations are likely to be carried out by schemes' actuaries rather than TPR or the pension managers. While the maths is not that hard for an actuary to do, Waite points out that companies will have to pick up the added cost. "This is yet another cost for sponsors of pension funds," he says.
Participating schemes will not have much time to prepare; data must be submitted to TPR by 10 August. But schemes will have to be thorough given the potential consequences.
What happens next?
19 May: Workshop (in Frankfurt) with participating schemes
May - August: Q&A procedure for participating schemes
10 August: Deadline for submitting data to national regulators
End August - September: Centralised quality assurance of all submissions by EIOPA
December: Disclosure of results
Schemes that have not been contacted by TPR but are interested in taking part should contact them via: [email protected]
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