Brussels, 5 March Dear Colleagues,

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1 To: Life Insurance Committee Your reference: --- Our reference: VIE 8028 (03/08) Subject: Solvency II and pension funds - CEA s position proposal Brussels, 5 March Dear Colleagues, Referring to item 5 of the agenda of next LIC plenary meeting, please find attached the CEA s position proposal (annex 1) the Life Technical Sub Committee drafted and submits you for decision. For your information, please find also attached a background document with the answers of NAs to the questionnaire (annex 2) which helped the L/T S/C in its drafting work. This document is only meant for internal purpose and will not be annexed to the CEA s final position. Best regards, Signed by Caroline Bissegger Policy Advisor

2 Annex: 1 (CEA s position proposal) Dear Commissioners, The CEA 1 would like to express its view regarding the debate on the possible application of Solvency II rules to occupational pension funds. The CEA fully supports any plan to further examine how to apply solvency requirements to occupational pension funds on the basis of the proposed Solvency II framework for insurance. We understand that the European Commission will consider this issue when conducting its 2008 review of the IORP Directive (Institutions for Occupational Retirement Provision). The risks to which an insurance company may be exposed are varied and include the insurance risk, the catastrophe risks, the financial risk and the operational risk. The draft Solvency II proposal seeks to incorporate the latest risk management techniques, to provide all policyholders across the EU with same levels of protection, and to achieve a much greater level of harmonisation across the EU to help consumers realise the benefits of increased competition. Solvency II adopts a complementary three pillar approach: Pillar I a quantitative assessment of the risk using an economic risk-based approach where all risks are explicitly allowed for, ensuring earlier detection of new and emerging risks thereby, giving greater scope for preventative action; Pillar II a more qualitative assessment of the risks that a company is exposed to and the quality of its internal risk management processes and controls, etc. Pillar III enhanced transparency through supervisory and public disclosure, the latter seeking to use market forces to encourage best practice. The key benefits of the proposed Solvency II regime will be greater consumer confidence, enhanced policyholder protection, cost-effective protection and more innovative and competitive products. European insurers are collaborating fully with CEIOPS, the EU institutions and supervisors to ensure that the proposed Solvency II regime is successful in delivering a modern and effective regulatory framework. Occupational pension funds and life insurers are pension providers. However, a broad spectrum of pension fund arrangements exists across the EU, provided by both life insurers and occupational pension funds, even in the same member state. While individuals with pensions provided by life insurers will benefit from the high levels of protection 1 CEA is the European insurance and reinsurance federation. Through its 33 member bodies, the national insurance associations, CEA represents all types of insurance and reinsurance undertakings, e.g. pan-european companies, monoliners, mutuals and SMEs. CEA represents undertakings which account for approximately 94% of total European premium income. Insurance makes a major contribution to Europe s economic growth and development. European insurers generate premium income of 1,065bn, employ over one million people and invest more than 6,900bn in the economy. In 2007, European insurers generated premium income in pension savings in the 2 nd pillar of 105 bn whereas non-insurers generated 120 bn (estimated data).

3 to be delivered by Solvency II, those with pensions provided by occupational pension funds will not benefit from the same protections. The Solvency II regime is primarily being designed to deal with all forms of risk to which insurance companies, among which those providing occupational pensions are exposed. However, we believe the proposed framework is sufficiently flexible to enable it to take into account the specificities of different pension providers, of the schemes they offer and of member states. Occupational pension funds and life insurers are in competition across the EU. Pension funds in several Member States are offering the same products as insurance companies but without the same capital backing. There is no reason why beneficiaries of pension funds should have a lower security level than beneficiaries of pensions provided by life insurance companies. The application of the Solvency II regime to pension funds would be in the interest of consumers. In addition, the application of Solvency II to occupational pension funds would lead to efficient and consistent supervision of pensions across the EU, better overall risk management, improved mobility of workers and a level playing field for all pension providers (as also underlined in the European Parliaments Report on the Commission s White Paper Financial Services Policy ). A consequence of the IORP Directive is the cross-border extension of freedom of choice between different types and providers of pensions. According to a Towers Perrin study on Europe s Corporate Pensions Mix (2007), a quarter of European employers are already considering organizing occupational pensions on a cross-border basis. However, the current application of the IORP Directive has resulted in variations in national solvency standards, which has in turn lead to regulatory arbitrage between Member States. In addition, transferability of pension rights is made more difficult. This divergence is in marked contrast to the Solvency II proposal for insurance companies, which is intended to bring about consistent and harmonized supervision across the EU. In a single EU market for pensions, competition should be between providers and variations in scheme characteristics, rather than between supervisory regimes. The CEA is confident that the CEIOPS will conduct a thorough and effective fact finding exercise and analysis, leading to a well considered proposal. In conducting this work, it is important to recognise the need for appropriate transitional arrangements in some Member States, so as not to damage or destabilise pension saving. The CEA is of course keen to participate in any fact-finding or consultation exercise on this important issue, and to provide any additional contribution which CEIOPS or the Commission would require in the further steps. However, CEA must underline the importance for the insurance industry that the implementation of Solvency II for insurance companies is not delayed by the debate on pension funds. Best regards,

4 Annex: 2 (Background document for internal information) GDV : I. Preliminary remark Questionnaire (Belgium, Denmark, Germany, Italy, UK) From our perspective the CEA focus on this issue should be on the Single Market aspects. As to solvency requirements for pension funds it should be recognized that the IORP directive has established the possibility for cross border business in this area. Since occupational pensions are wholesale products it is highly probable that the paneuropean market will develop much faster in this area as in the field of private pensions. This hypothesis is backed by recent investigations: According to a 2007 Towers Perrin study a significant share of 25% of large European companies (N = 323) is already considering to organize occupational pensions on a cross-border base. The IORP directive is a minimum harmonization directive. Unfortunately, in practice this has led to heterogeneous implementation by the member states. There is a risk that interpretations could be influenced by industry policy considerations (Attachment 1: advisory report: Holland Pensions Champion ). However, different pension providers rather than different supervisory rules should compete in the Single Market for pensions. 2 It is not only necessary that harmonization of solvency rules for pension funds takes place, it is also necessary that this harmonization takes place at the level of solvency II rules. Otherwise the competition between different types of pension providers will be unfair, the more so as employers and/ or employees can freely choose not only between different types of occupational pension providers but also between private and occupational pension solutions. Moreover, the insurance industry should not only be concerned about their level playing field with pension funds but also with investment funds. The latter have recently stepped in the debate on the amendment of the IORP directive (see Attachment 2: Oxera-report: Defined-contribution pension schemes ). II. Need for immediate CEA action Apparently, there is a risk that the European Commission could delete the reference to the IORP directive in the new draft of the solvency II directive. Against this background, CEA should prepare a second letter to the European Commission asap which highlights the unfair competition issue in more detail. This letter should start with emphasizing the beneficial impacts of the solvency II regime for consumers and their overall confidence in the market (see the arguments brought forward in the CEA briefing note 4 Solvency II: Why it matters to consumers ). Furthermore, it should be pointed out that any specificity of occupational pensions (employers liability or employers option to unilaterally reduce benefits) can be integrated and priced in the framework of solvency II and can be taken into account when it comes to the calculation of own funds (apparently, EFRP agrees 2 A different position would not be consistent with the CEA position on social services of general interest in which the application of the same rules is required, independently of the ownership and legal form of the provider.

5 that transferring the solvency II framework to pension funds is possible otherwise they were not able to publish the additional costs 3 ). 1) Why are pension schemes currently provided on different bases / by different provider types in your Member States, and what factors influence employers decisions in choosing one over another? Are there current differences in solvency requirements that have an influence? ABI: The pensions system in the UK is made up of 3 levels or pillars. These are: Level one: State pension provision, provided on a pay as you go basis; Level two: Supplementary pensions provided via the workplace, of which there are two main types: Occupational pensions and employer sponsored Group Personal Pensions. Level three: Private Personal Pensions (including Stakeholder Pensions ). These may be offered on a group basis (as a form of level / pillar two pension) or purchased on an individual basis. Usually provided by insurance companies (so subject to solvency requirements). Pension types in pillars 2 and 3 can also be split into two basic types: Defined Contribution (DC): Income / benefits in retirement are dependent upon the value of the contributions made into the scheme for (or on behalf of, e.g. by the employer) the scheme member, and how successfully the scheme funds are invested to produce growth. Defined Benefit (DB): Income / benefits in retirement are usually determined by the length of time the individual has been in the employment of the sponsoring employer, and their final salary when they leave that employer (whether that is leaving to retire or to move to another employer). Key characteristics of the various types of pillar 2 pension scheme in the UK: (a) Occupational schemes: a. May be Defined Benefit or Defined Contribution. b. Established by an employer ( sponsoring employer ) exclusively for their employees. c. The purpose of scheme is limited to providing retirement income to scheme members. All funds in the scheme must be used for the benefit of the members. There is no profit to be made for any company. d. Only employees of the sponsoring employer can join the scheme, although an employee can remain a (non-active) member of the scheme after they leave that employer. 3 As far as it is not transparent what exactly has been calculated by EFRP, however, the correctness of the EFRP statement that the additional costs of a transfer of Solvency II to pension funds would amount to 40 to 60% of liabilities cannot be evaluated.

6 e. Because scheme membership is limited to employees of the sponsoring employer, the scheme is not in competition with any other pension scheme or provider to attract members into the scheme. f. Always Trust-based, which means independent trustees are appointed to manage the scheme on behalf of the employer and employees, for the benefit of the scheme members. g. Both employer and employees may contribute, depending on the rules of the scheme. h. In a DC scheme, at the point of the individual scheme member s retirement, the fund value accumulated for the individual member is usually used to purchase an annuity from an insurance company. At that point, all liability / risk moves to the insurance company that provides the annuity. i. In a DB scheme, if there are insufficient funds within the scheme to meet the cost of providing the benefits promised, the employer is required to provide additional funding (from company profits). This arrangement is referred to as the employer covenant. j. In a DB scheme, the scheme itself promises to pay that regular income in retirement, usually on the basis of how long they worked for the sponsoring employer and what their salary level was when they left that employer (final salary) or the average level of their salary during the time they worked for that employer. k. DB schemes makes a promise to pay income to scheme members at retirement, but this does not amount to a guarantee regarding the level of those benefits. If the sponsoring employer becomes insolvent, and the trustees find that they have insufficient funds to meet the promises made to scheme members, the trustees must use the funds available in the scheme to maximise the benefits they can provide to all scheme members. Scheme members may therefore find they receive less from the scheme than they had expected, based on the promises made. l. Insurance companies are not providers of occupational schemes, although they may provide administration or fund investment services for such schemes for a fee (i.e. they hold no liability for the scheme funds or benefits payable to members). (b) Group contract based personal pensions (GPPs) a. Established by an employer for their employees, into which the employer usually makes regular contributions for each employee in the scheme as long as they remain an employee of that company. b. Generally DC (no known examples of DB GPPs). c. Provided by insurance companies, therefore seeking to make a profit from the scheme. d. Employers may choose a GPP over an Occupational Scheme, because they are simpler to set up and administer than occupational schemes, and they involve no potential request from trustees for additional funds to top-up the scheme. (c) Self-Administered Pension Schemes: a. Established by an employer for their employees; b. Managed by the employer. c. Employer also directly provides income in retirement, rather than an annuity being purchased from an insurance company at retirement. d. Scheme provides a promise of income in retirement, not a guarantee. e. Those promises are unlikely to be met in full if the employer encounters financial difficulties. f. The question of profit does not arise, in that company other than the employer is involved. g. Such schemes can operate at a lower funding rate requirement than occupational and group personal pensions.

7 (d) Bulk (pension liability) Buyout companies: a. Companies that take over the full benefit liabilities of the scheme entirely, from the employer and trust, for a one-off fee. b. To date, all such transactions have related to DB schemes and have involved the scheme closing to new members and further contributions. c. The buy-out company may be an insurance company or a non-insurance financial services company. d. May occur when an employer becomes insolvent and the administrators pass responsibility for meeting existing promises to the buy-out company, with a one-of payment from the winding up settlement. e. May occur because the employer no longer wishes or is financially able to justify / afford the cost of running a DB scheme particularly the unpredictability of that cost. f. The transaction provides the employer with a fixed, one-off cost for transferring the liabilities, but removes all future liabilities to the buy-out company. g. The buy-out company charges a fee and takes control of the scheme assets, which it then invests with the objective of generating enough additional assets to meet all liabilities and provide it with a profit. Pillar 3 pensions are all Private Personal Pensions, involving a direct contract between the individual and the pension provider, which in most cases is an insurance company. Some level 3 pension schemes are referred to as mutuals and are run on a non-profit basis. Membership may be restricted to individuals employed in a particular sector or profession e.g. construction, the police. Competition between the different types of pillar 2 pension schemes that an employer might offer occurs only at the point at which the employer considers which type of scheme to use. Once established, there is no competition between providers of the different scheme types. The key factors for employers in choosing between different types of schemes to offer to their employees are: Risk / Liability. Certainty of cost. Administrative burden. Flexibility. Choice for employees (e.g. of investment funds) Portability of scheme benefits on departure from that employer. Occupational DB schemes have traditionally been popular in the UK. But given developments over the last few decades (e.g. increasing longevity, legislative changes removing tax benefits that supported scheme funding, poor financial management of fund assets in the past), they have become becoming increasingly unattractive to employers. They have become increasingly costly to run and expose the employer to unpredictable and potentially very large, open-ended liabilities. But there is great political and social pressure in the UK to support the continuing use of DB schemes. If an insurer wanted to provide a DB scheme, they would have to operate a much greater level of reserve scheme funding than would an occupational DB scheme, because there would exist no employer covenant i.e. additional external source of top-up funding.

8 Such a scheme has historically existed in the UK and some continue, in that there remain scheme members to which they must continue to pay retirement income - referred to as Deferred Annuities. But all such schemes closed to new members long ago, because they became too expensive / financially unpredictable for insurance companies to operate. ANIA: About why different pension schemes are provided in Italy, pension funds are offered on different bases or by different provider types because the legislation has determined a framework where the following pension schemes are allowed to be offered: collective schemes: closed-end pension funds (IORP), based on the collective labour agreement (on a company basis or on a job sector basis), promoted by employers and labour unions and addressed only to the employees of the company or of the job a certain (group contract) sector (e.g pension fund for chemical employees, engineering employees, etc). These pension funds delegate asset management to banks, insurers or asset managers through a mandate (this provision was set by the previous legislation, recently modified thanks to IORP transposition); collective and/or individual schemes: open-end pension funds, collective and/or individual pension funds, promoted by banks, insurers or asset managers, addressed to individuals (workers or not) or to the employees of a company (throughout a labour agreement at the company level) or both to individuals and a group of employees. Assets are managed by the promoters (banks, insurers, asset managers); only individual schemes: life insurance pension plans (PIP), life insurance individual contracts, promoted only by insurers, addressed to individuals (workers or not) and, under certain conditions, to a group of employees of a company through a multi-individual labour agreement signed with the employer. All pension funds are based on a DC scheme and workers can voluntarily choose to adhere or not, both to collective and/or individual schemes, having basically the legislative and fiscal framework. They can adhere even though the employer do not adhere and, after two year can transfer the position to a different pension fund (e.g. an open-end pension fund) even if they still work for the same company. About the factors influencing employers decision, it is mainly influenced by the following factors: a) if they consider the adhesion of their employees to a pension fund a lose of money (since if the employees adhere the employers have to pay a part of the contribution, even if hey have some fiscal benefit), they try to convince the employees not to adhere; b) if they prefer their employees having a supplementary pension because even if they have to pay some money the company will have some benefit (e.g. because employees will be happier), they can favour the adhesion to an open-end pension fund through a company agreement (easier way for small cap companies) or the adhesion to the closed-end (collective labour agreement) pension fund of their job sector (usual way for large companies where unions sponsor the closed-end pension fund) c) it has also to be stressed that the law sets a favouring arbitrage for closed-end (collective labour agreement) pension fund, because if the employee do not choose the collective scheme defined in the company (the closed-end pension fund of the job sector or the collective open-end pension fund to which the company has adhered), the employer is not obliged to pay his contribution for that employee.

9 Other factors deal with a normal market choice, based on costs, reliability of the intermediary or of the provider, etc. About any differences in solvency requirement, nowadays these differences exists but are not remarkable, since due to the previous legislation the closed-end pension fund promoted by labour unions (the proper competitor of insurers) had to delegate asset management, guarantee or mortality risk coverages offer, annuity payment to banks/insurers/asset managers. Now that the transposition of IORP directive has set that also closed-end pension fund can directly provide financial guarantees or annuity payment, even if such kind of offer is not still in place, there is a clear arbitrage since closed-ended pension funds do not have any solvency requirement, while open-end pension funds and life insurance pension plans have a solvency requirement (depending on the promoter: if it is an insurer, Solvency I and tomorrow Solvency II requirement). Assuralia: The employer s decision to choose one pension provider over another may, among other things, be driven by: - solvency requirements and fiscal rules; - specific concerns regarding the organisation of the pension scheme (in relation to the size of the company). The influence of solvency requirements on the employer s decision will be larger if Solvency II would only apply to life insurers. GDV: Since the 2001 reform, there is a strong tendency towards employee financed deferred compensation schemes (Entgeltumwandlung). In Germany, all occupational pension plans are of the DB type, as any plan must be at least capital protected at retirement (capital maintenance guarantee). By law, employers are ultimately responsible for any pension commitments. Pension plans may take the form of book reserves ( Direktzusage ), benefit funds ( Unterstützungskasse ), direct insurance ( Direktversicherung ), staff pension insurance ( Pensionskasse ) or pension funds ( Pensionsfonds ). Pension funds in Germany are called Pensionsfonds and are by law distinct from life insurance undertakings and regulated differently. They either take the form of public limited companies or mutual associations. Nevertheless, many insurance companies also own Pensionsfonds. Since the 2001 pension reform law many insurance companies have founded Pensionskassen, which offer their services to any employer. These Pensionskassen are a special kind of life insurance companies and are regulated as such. However, there are also Pensionskassen run by companies which are regulated differently. Corresponding to the German annuity paradigm occupational pension benefits must be largely paid in the form of annuities. Lump sums are partly possible but subject to a different tax treatment. Pensionsfonds do not allow lump sum payments. Underfunding of insurance-like pension vehicles is not permitted under German regulations. If the solvency margin is not met, it is the employer that will be required to make additional contributions. A funding ratio below 100% of the technical provision leads to insolvency of the pension institution (Pensionskasse or

10 Pensionsfonds). The pension institution underwrites the guarantee in the first place while there is a subsidiary guarantee by the employer. Ultimately, the employee has an enforceable claim against the employer. The internal occupational pension vehicles and Pensionsfonds are covered by an employer insolvency scheme (PSVaG). The PSVaG works on a partly funded basis. For occupational pensions, which become due, annuity contracts are bought with the life insurance industry. PSV premiums are calculated basing upon companies liabilities. For life insurance companies, a legal insolvency scheme has been established in All providers of Direktversicherung, moreover, are member of the voluntary insurance guarantee scheme Protektor AG, providers of Pensionskassen can become members of Protektor on a voluntary base. There is no legal requirement to index preserved benefits under a defined benefit scheme. With the insurance vehicles, usually, surpluses are used to increase benefits. The level of solvency requirements has, of course, a crucial influence on the employer s choice of the pension vehicle. F&P: In Denmark Pension Funds provide a very small part of total pensions and are subject to the same requirements to funding as multiemployer pension funds and life insurance companies. The position of the Danish Insurance Association is that solvency requirements should be the same for all providers of pensions - same risk, same requirements. However, we do not speak for Danish Pension Funds as they have their own organization. 2) How would the application of Solvency II rules to insurance companies - and any other relevant factors, such as different tax treatments, capital requirements, supervisory rules - create an un-level playing field between IORPs and insurance companies? ABI: It would have no real impact in the UK. There is no commercial competition between insurance companies providing pension schemes and IORPs. It is more expensive to operate DB schemes on an insurance basis than as an occupational scheme. Currently, therefore, there is no competition between insurance based DB schemes and DB IORPs, because the former does not exist. Even if IORPs were required to operate Solvency II rules, there are other factors that would make provision of DB schemes unattractive for insurers. For example, the level of benefits promised would be influenced by factors such as salary levels, over which the employer has control but the insurance company has no control. The liability would therefore be unpredictable and uncontrollable for the insurance company. There exists already an un-level playing field in the UK between IORPs and insurance companies offering pension schemes. An IORP offers a promise of benefits, which will not be met if the sponsoring employer company collapses. Whereas an insurer has to offer a guarantee of benefits. But from the point of view of consumers / individual scheme members, there is unlikely to be any awareness or understanding of the distinction. Employers must now make levy payments into the recently established national Pension Protection Fund (PPF). This was established by the Government to provide compensation for employees where the employer becomes insolvent and the scheme finds itself with insufficient assets to meet all benefits

11 promised. The PPF currently promises to provide individuals with 90% of the benefits promised by their pension scheme, but this compensation is capped at 26,000 per individual. ANIA: As above mentioned, now that the IORP directive allows closed-end pension fund to provide financial guarantees or annuity payment, there is a clear arbitrage, since closed-end pension funds do not have any solvency requirement, while open-end pension funds and life insurance pension plans have the solvency requirement asked to their promoter: if it is an insurer, Solvency I and tomorrow Solvency II requirement. Then, a possible scenario will be that closed-end pension funds and insurers will offer the same products, guarantees and services, assuming the same risk but not having to set different solvency capital. Tax treatments, supervisory rules and other factors are not an issue, with the exception (see answers to question 1) of the above mentioned point c). Assuralia: Different solvency requirements for life insurers on the one hand and pension funds on the other will lead to a distortion of competition, because of the impact of these requirements on: GDV: - the cost of capital; - the investment return which the pension provider can justify; - the asset liability management. Different regulations as to capital requirements and risk management create per se unlevel playing fields. The IORP directive is a minimum harmonisation directive. The concrete implementation by member states shows considerable differences. In order to prevent supervisory arbitrage a maximum harmonization of the European supervisory framework for pension funds is indispensable. Otherwise, different supervisory regimes rather than pension providers compete in the single European market for pensions. Whereas the Solvency I regulation covers only capital market risks Solvency II covers all types of risks insurance companies are exposed to (market risks, credit risks, operational risks). The solvency capital is calculated to be large enough to be able to compensate for all losses with a certain high probability within a given period, often a year (bankruptcy once in 200 years!). There is not reason why pension funds members should enjoy less security than life insurance clients. 3) What differences between IORPs and insurance companies would justify the non-application of Solvency II rules to IORPs? ABI: IORPs and insurance pension schemes are funded in different ways, and the risks borne in different ways. To place a requirement on UK occupational DB schemes to operate Solvency II requirements would require all employers offering such schemes to inject huge amounts from company profits we estimate 500 BILLION across the UK - into these schemes to meet the funding requirements, taking into account actuarial

12 calculations of potential liability based on rising longevity risks. This would effectively destroy most, if not all, such schemes as they would become too expensive to fund. We believe that the following characteristics of DB occupational schemes in particular justify nonapplication of Solvency II type requirements: Insurers are commercial, profit-seeking organisations. IORPs are non-commercial organisations which make no profit all assets must be used for the benefit of the scheme members. The sponsoring employer covenant (requirement to provide top-up funding to the scheme to meet benefit promises) ensures that the scheme has access to sufficient funding to meet benefit promises as long as the employer remains solvent. The PPF provides a Government-sponsored source of compensation in the case of the employer becoming insolvent. IORP Trustees are entirely independent of the sponsoring employer and have a legal responsibility to manage the scheme and its funds in the best interests of scheme members. UK occupational DB pension schemes are already facing major difficulties in trying to meet full funding requirements. Placing this additional pressure on them would, in practice, result in reduced pension saving rather than increased scheme funding, because these schemes would be forced to close. Any changes to IORP solvency requirements should take these factors into account. They must also take into account that the pensions market must be regulated in such a way that encourages rather than discourages innovative developments that could support greater pension saving and better meet both consumer and social needs regarding provision for retirement. For example, there is much discussion about the potential of developing hybrid pension schemes, that would involve some combination of DC and DB. Such possibilities offer the potential for insurance companies to offer pension schemes (as insurers, not scheme administrators) that could offer a realistic alternative to occupational DB schemes. Any changes to EU solvency requirements would need to take into account / allow the development of such new forms of pension saving. This would involve addressing key questions about where the risk is born (which may be split between insurer, employer and scheme member) and on whose accounts the required solvency reserves would have to be born. Changes also need to encourage and support greater consumer / scheme member understanding of the nature of scheme benefits and risks e.g. the difference between a promise and a guarantee. If any realistic consideration were to be given to requiring DB IORPs to operate Solvency II standards, we strongly believe this would need to be done in such a way and over such a timeframe that the impact could be minimised and responsibly managed. Options might include applying the new requirements only to schemes established after the rule changes are announced, allowing existing DB schemes to continue under existing requirements. ANIA: Basically none ( same risk, same capital ). At any rate, it depends on who bear the risk. If the pension fund assumes the commitment to offer a financial guarantee or to pay an annuity (so assuming the corresponding risk and competing with the analogous service offered by an insurer), the pension funds must have a solvency capital. The calculation of such capital should be in line with Solvency II principles, taking into account, in the same framework, any specific feature potentially different from insurers.

13 Assuralia: There are no fundamental reasons which justify the non-application of Solvency II rules to IORPs. The Solvency II framework offers sufficient flexibility to take account of the characteristics of pension funds. GDV: None (see response to question 6). 4) What similarities between IORPs and insurance companies would justify the application of Solvency II rules to IORPs? ABI: From a consumer / scheme member perspective, there is likely to be little awareness or understanding of a difference between an IORP and a pension scheme offered by an insurance company. Both are a form of saving for retirement which result in an income in retirement. Both IORP and insurance company DC pension schemes require the pension savings to be used to purchase an annuity (at retirement, or at least before age 75) to provide a guaranteed stable income in retirement. So consumer protection requirements are equally relevant. However, we believe it is not necessary that all types of pension scheme offer exactly the same consumer protection. Differences in consumer protection can be justified, but as long as key features: - the nature of the scheme and the associated risks, - the benefits that will accrue via the scheme i.e. promise vs. guarantee, - applicable consumer protection are communicated very clearly to consumers / scheme members. ANIA referred to its answer to question 3) with the remark that if the risk is the same, the capital would then be the same. Assuralia: Both life insurance companies and IORPs are active on the same market, i.e. the market of occupational pensions. Life insurance companies and IORPs (can) assume the same type of commitments: GDV: - On the one hand, there are pension funds which, just like insurers, guarantee a certain investment performance or a given level of benefits or cover biometric risks; - On the other, life insurers may offer pension schemes which are, from an economic perspective, similar to pension funds which do not provide guarantees (unit-linked life insurance). a. Solvency 2 is a risk-based method for determining the capital deemed to be required to meet losses resulting from running certain risks e.g. market risk, operational risk etc. The set up of Solvency 2 is, by its very nature, perfectly flexible and can be applied to all financial institutions and all types of risks which they may incur in their operations.

14 b. Basically, pension funds and life insurers are not different: Life insurance companies as well as pension funds offer long-term pension benefits including survivors and disability benefits. Corresponding to the rules in the single member states these pension benefits can be either guaranteed or not. With regard to the investment horizon there is no difference at all between life insurance as an occupational pension vehicle 4 on the one hand and pension funds on the other hand. Indeed, both life insurers and pension funds assume long-term obligations, i.e. for a period of 30 to 40 years. As far as employers have the contractual option to reduce the pension benefits according to the capital market development, their premises have to be considered as the economic equivalent to a unit linked life insurance policy. The latter will, of course, be subject to Solvency II rules. c. From a consumers perspective, there is no reason why pension fund beneficiaries should not take profit from the modern solvency II rules. If risks are run without sufficient extra capital being held then a pension fund can become underfunded. This undermines the whole idea behind the security of pensions, particularly if employees have contributed themselves. Also, it could lead to unfairness to members in how a pension fund deficiency, which would then arise, is dealt with. 5) If Solvency II rules were applied to IORPs, what would be the impact? For example on: a) insurance companies; b) IORPs; c) employers; d) employees/scheme members/consumers generally; e) the market for other saving and investment products; f) the equity market/bond market/wider economy. Following answers were given: a) insurance companies: ABI: There would be potentially significant impacts on insurance companies if the completion and application of the Solvency II Directive were to be delayed, or changed, due to issues concerning IORPs. In addition, the application of these solvency requirements could result in IORPs making sudden changes to the types of assets they hold, for example, moving from equities. This would have an impact on the stock market in general and therefore would impact on insurance companies. A widespread increase in closure of IORPs, during to changing funding requirements, would result in a loss in confidence in pension schemes., This could result in a loss of confidence in the entire industry, with an adverse effect on insurance companies. 4 Such as the Direktversicherung in Germany.

15 We must distinguish between the impact on (a) insurers acting as administrators of IORPs; (b) insurance companies acting as providers of pension schemes other than IORPs; (c) insurance companies buying-out the liabilities of IORPs; and (d) companies other than insurance companies buying-out IORP liabilities; (e) insurance companies that provide IORPs where the insurance company holds the risk / liability (currently theoretical in the UK no examples in practice; and (f) wider impacts on insurance companies, in terms of the assets available to them to manage their liabilities. Application of Solvency II rules to IORPs would impact as follows: (a) It would be financially impossible for DB IORPs to continue under such conditions, and they would therefore close. Insurance companies would lose the business of providing support services such as administration to such IORPs. (b) If those employers that are forced to close their IORPs were to look for another kind of pension scheme to replace the closed IORP, insurance companies would have an opportunity to market their non-iorp pension schemes as replacements. (c) It is likely many employers currently using IORPs particularly DB IORPs would seek an opportunity to close down their long-term liabilities associated with the IORP by passing those liabilities to a buy-out company. Insurers acting as buy-out companies would therefore have an opportunity to buy-out such closed IORP liabilities. But, due to the different funding requirements for insurance companies taking on such liabilities and non-insurance companies taking on such liabilities, insurance companies may find it difficult to compete with the noninsurance companies. (d) Non-insurance IORP buy-out companies are likely to have a good commercial opportunity to buy-out many of the IORPs that would be forced to close. (e) No impact they would have to operate Solvency II requirements regardless of any change for IORPs. (f) Forcing IORPs to close and thereby forcing their long-term liabilities to be managed in a much more risk-averse way would result in mass selling of the equities currently used to manage IORP funds to meet their long-term liabilities. The equities used in this way would have to be replaced with less risk assets, primarily bonds. These two needs wouod have a substantial and widespread impact on the equity and bond markets, pushing equity prices down, bond prices up and bond yields down. This would, in turn, make it mush more expensive for insurance companies to manage their won funds to meet their liabilities, not just for pension liabilities but for all insurance liabilities. The closure of IORPs would also have a negative impact on consumer the wide range of saving and investment products they sell in the UK. But and employer confidence in pensions as a general product and means of saving for the long-term. This loss of confidence in pensions would be likely to impact negatively on the willingness of consumers to save in pensions, resulting in less overall pension saving. This may be partially offset by a shift to other forms of saving and investment. This may offer positive opportunities for insurance companies, given the loss of confidence may extend beyond pure pensions. There is currently a trend in the UK to place more faith / investment in property than traditional savings products. This is contributing to the over-heating of the UK property market. It also fails to provide the kind of security that spreading of risks that is needed to maximise savings for retirement. However, this trend would be likely to be exacerbated by the widespread closure of IORPs. ANIA: no impact.

16 Assuralia: the application of Solvency II to IORPs would contribute to a level playing field between life insurers and pension funds. GDV: Level playing field within the second pillar and between second and third pillar. b) IORPs: ABI: At best / minimum: Force them to sell massive amounts of equities (currently held by them as investments to help them meet benefit promises) and replace those assets with low-risk, low-yield bonds. At worst: Make it financially impossible to meet the solvency requirements, and force them to close. If the employer is unable to provide additional funds to enable the IORP close with full funding, it is possible the employer would be forced into insolvency in the process. This would result in the scheme closing with insufficient funds/ assets to meet full benefit promises for all scheme members. The IORP members would then become dependent on the Pension Protection Fund for compensation, which would not deliver the same benefit levels as scheme members expected to receive under the IORP. ANIA: IORPs would have to set Solvency II capital, applying a charge on adherents or on the fund value. Assuralia: the application of Solvency II would improve the financial soundness of pension funds and would lead to an improvement of their risk assessment models. GDV: Harmonization creates a level playing field in Europe. In case that today s financial strength of occupational pension providers should not be sufficient for ensuring a security level of 99.5%, transition periods should be taken into consideration. c) employers: ABI: Employers using IORPs would be forced to divert substantial amounts of profits into IORPs that would suddenly find themselves in deficit. This could have a hugely damaging impact on the company s future profits and commercial viability. Many employers would, in these circumstances, close the IORP to new members. In extreme cases the impact may push the employer company into insolvency. ANIA: no impact. Assuralia: the application of Solvency II to IORPs would provide the employers with the guarantee that the capital level held by the pension fund, corresponds better to the risks to which the pension fund is exposed. GDV:

17 Benefit from the positive impacts of increased competition and confidence in occupational pensions. d) employees/scheme members/consumers generally: ANIA: possible increase in costs/charges for those adhering to closed-end (IORP) pension funds, initially due to capital to set from nil, and afterwards to cost of capital. Assuralia: the application of Solvency II to IORPs will provide a better protection of consumers interests. GDV: Benefit from the positive impacts of increased competition and confidence in occupational pensions. Enjoy in particular more security and develop more confidence in their pension providers. A consistent market based valuation of assets and liabilities of pension funds, moreover, may contribute to the transferability of pension funds. If different solvency rules applied for pension funds and for insurance companies the determination of transfer values became impossible. e) the market for other saving and investment products: ABI: The closure of pension schemes to new members (existing and future employees) would be likely to impact negatively on pension provision for employees. The worst case scenario would be employers not replacing closed IORPs with alternative pension provision. Alternatively, employers may replace the IORP with another form of pension scheme, but with lower contribution rates. Experience and research suggests that each time an employer is forced, by externally imposed changes, to reorganise their approach to pension provision, there is a risk that they level down their contributions to the new scheme. The greater the change imposed, the greater the risk (and extent) of levelling down. In an extreme case, increase pension funding requirements may tip the sponsoring employer into insolvency and leave employees with only a minimum level of pension provision. This would also lead to a loss of confidence in / reputation of pensions generally, which may discourage employees from saving at all. The impact of increasing numbers of IORP members requiring PPF compensation would be to make the PPF itself non-viable, as it would have insufficient assets to meet the liabilities it would have to meet under such circumstances. If the PPF were to continue, scheme levies to the PPF would have to be substantially increases, increasing scheme funding requirements. ANIA: benefit of level-playing field. Assuralia: It is difficult to assess the impact on the capital markets. GDV: too early to assess. f) the equity market/bond market/wider economy:

18 ABI: Market for other savings and investment products: Employees losing their IORP or more generally losing confidence in pensions may stop saving in a pension. They may use alternative products for long-term saving, or they may lose confidence in saving entirely. This would have a negative reputational and turnover/ profit impact on the pensions / savings / investment industry generally. May exacerbate the trend toward excessive reliance on property investments to secure income / wealth in retirement. Exacerbating that trend would be very risky, for the individuals concerned, for the property market, for public policy objectives on private saving for retirement, and in terms of the wider macro impact on the economy. Impact on equity and bond markets, and the wider economy: Would force sudden and widespread surge in selling of equities and purchase of bonds by IORPs, reflecting a need to move from relatively risky (but higher yielding) assets to low risk (and low yield) assets. Equity prices would drop significantly because of reduced demand for that asset class but also because the increased cost of funding pension schemes would reduce company valuations. Bond prices would rise significantly, and bond yields fall, further exacerbating supply/demand imbalances in that asset class for the long-dated maturities, which would need to be targeted by pension funds. ANIA: no impact on equity and bond market, benefit of level-playing field for the wider economy. Assuralia: It is difficult to assess the impact on the capital markets. GDV: too early to assess. 6) What adaptation of the Solvency II approach or other type of EU solvency requirement - would you consider appropriate for application to IORPs, and what do you anticipate would be its impact (for example, on (a) to (f) listed in question 5)? ABI: We do not believe it would be appropriate to apply Solvency II to IORPs. The Solvency II project must remain on track and must remain focused on meeting the current timetable for implementation to insurance. The focus of the forthcoming IORP Review should be on how the IORP Directive has been implemented across member states and what the Directive has achieved. Given how recently the IORP Directive has been implemented across the EU, and the fact that several Member States are not yet applying the Solvency I rules under the Directive, there is insufficient evidence to date on which to base an assessment of changes needed to solvency rules for IORPs. Any change to the solvency rules for IORPs must be based on evidence of what works and what does not work. It would also require a long adjustment process to enable the distribution of assets to be adjusted gradually.