Allianz Global Investors

Transcription

1 Consultation of the European Commission on the Harmonisation of Solvency Rules applicable to Institutions for Occupational Retirement Provision (IORPs) covered by Article 17 of the IORP Directive and IORPs operating on a cross-border basis Allianz Global Investors

2 2 A. IORPs SUBJECT TO ARTICLE 17 OF THE IORP DIRECTIVE EXECUTIVE SUMMARY Main question in section A Should the current Solvency I regime applicable to IORPs who underwrite liabilities to cover against biometric risk, or provide guarantees of a given investment performance or a given level of benefits (IORPs subject to Article 17), be replaced by solvency rules similar or equivalent to the Solvency II rules in their version discussed currently? Allianz Global Investors does agree to the overall objective of solvency rules for IORPs, that is the rules should essentially be derived from the Solvency II framework for insurance undertakings, but should take into account all the specific factors of IORPs mitigating risks by sharing some risks with the sponsoring undertaking and plan members. Allianz Global Investors does not welcome an application of solvency rules similar or equivalent to the Solvency II rules in their current specification. The current specification as used in the QIS 3 and QIS 4 framework is not eligible to provide an adequate manner of ensuring an appropriate level of security for the plan members without jeopardizing the overall attractiveness of IORPs. IORPs and life insurers basically offer similar long-term pension benefits including survivors and disability benefits. In addition there is little difference with regard to the investment horizon and the risks the IORP is faced with compared to life insurers. From Allianz Global Investors point of view there is a clear need for the development of a separate framework for IORPs which should incorporate the overarching principles of Solvency II but may also reflect the specifics of IORPs (e.g. possibility of benefit cuts). Allianz Global Investors recommends to perform an additional Quantitative Impact Study to analyse the impact of an application of a Solvency II-like regime to IORPs. Beside the discussion of the range of application, there is still an ongoing discussion about the underlying principles of Full Fair Value and the one year horizon of Solvency II. Are these principles in line with the long term nature of life insurance business and IORPs? Do these principles have a negative impact on the overall stability of the financial system? This discussion goes far beyond the scope of this consultation, so we just mention it in this context. We believe that from a macroeconomic perspective, the European Insurance Sector should be recognized as a strong and stable institutional investor even after implementing the Solvency II framework. If Solvency II becomes reality for IORPs, pension funds may be forced to make significant changes to their asset allocation in order to reduce short-term risk, thus jeopardizing their long term investment goals. This may include decreasing exposure to equities and forces pension funds asset allocation to stray away from efficient and well diversified portfolio structures. Given that IORPs take on comparable types of liabilities compared to most insurance companies, but profit from a more advantageous structure of the beneficiaries (often compulsory membership) and hence are not faced with adverse selection and the risk of cancellation, pension

3 3 funds should be allowed to rely on long-term investment strategies with sufficiently high expected returns. Changes in asset allocation arising from a Solvency II-like regime for IORPs may also introduce unfavorable systemic risks. The potential reallocation of assets may distort financial markets and may lead to declining equity markets while interest rates were forced down by increasing demand for fixed income investments, leading to a spiralling effect. There is some evidence that the low level of long term interest rates during the last years was caused by increasing demand for long term bonds by insurance companies. A recent report from OECD (performed by ifa and risklab) highlighted that introducing a Solvency II-like regime on pension funds may lead to capital intensive products such as guarantees becoming more expensive to provide, as additional capital must be provided by the sponsoring company. This in turn could reduce the range of solutions offered to scheme members and may have severe socio-economic consequences for employees in certain Member States. As a consequence, Allianz Global Investors recommends to discuss the treatment of equity risk within the Solvency II framework for insurance companies again and examine different approaches to model equity risk. Allianz Global Investors would like to stress the importance of drawing lessons from the current financial crisis when building an adequate framework for assessing solvency requirements of insurance companies and IORPs. It s obvious that basing solvency funding requirements upon mark-to-market accounting principles enhances the sensitivity of financial markets. This was also recognized by the International Accounting Standards Board: An amendment to the Standard IAS 39, issued on October 2008, permits an entity to reclassify non-derivative financial assets out of the fair value through profit and loss category in particular circumstances. The amendment also permits an entity to transfer from the available-for-sale category to the loans and receivables category a financial asset that would have met the definition of loans and receivables, if the entity has the intention and ability to hold that financial asset for the foreseeable future. From Allianz Global Investors point of view, the mixed valuation approach used in the IFRS-Framework should be extended to the Solvency II-rules to ensure a harmonized method of asset valuation within accounting and solvency assessment rules. In addition, Allianz Global Investors supports to have an equity stress determined in relation with the duration of the insurance liabilities (or the holding period of assets) and the position of the financial cycle. A risk-based prudential solvency regime will require companies investing in risky assets to hold capital in order to be able to face their liabilities even in bad times. This prudent person principle is a key feature of a system based on the full responsibility of companies.

4 4 There are two main reasons why investing an adequate share in equities is appropriate for e.g. life insurance companies and their nature of the business, which is characterized by long term liabilities and increasing need for high returns which lead to a higher level of benefits. Hence, investment in equities should result in a capital charge that is adapted to the economic logic of the insurers investment. First, investment in equity contributes to a correct diversification of assets, by avoiding overexposure to bonds alone. Second, investment in equity provides a better return for policyholders over the long term. In addition, it guarantees a better coverage of inflation risk. Within the QIS 4 framework an alternative dampener approach is being tested for the equity risk, which has two components: one linked to the relative level of equity prices over the previous 10 trading days compared to the average level for the previous year; and another linked to the duration of the liabilities. The theoretical basis of the dampener approach is based on the fact that the probability that the value of equity raises is smaller when this value is high than when it is low. Allianz Global Investors welcomes the idea behind the dampener approach. While being consistent with the solvency one-year horizon, the dampener effect should be all the more taken into account than the time horizon of the insurance company is long. Main question in section B To what extent are the differences in the solvency regimes for IORPs that operate on a cross-border basis creating internal market problems? It is Allianz Global Investors opinion that a greater harmonisation of solvency rules for IORPs subject to Article 17 and appropriate minimum standards concerning methods and assumptions for determining technical provisions are in general desirable, as regulatory minimum standards foster the acceptance of a basic internal market principle: the mutual recognition of sole supervision by the authorities of an IORPs home country. Hence, the realisation of these objectives may provide some impetus to the development of an internal market for occupational pensions. However, the harmonisation process has to be conducted with sound judgement, that is the specific legal and economic frameworks of pension systems in the Member States have to be considered with due diligence. Even a comprehensive standardisation of solvency rules or the calculation methods regarding technical provisions would be insufficient to remove all obstacles towards cross-border pension services. These obstacles are the result of a highly heterogeneous structure of pensions systems across Member States, especially concerning social and labour law provisions, and cannot be dealt with solely by harmonisation of solvency rules or supervisory regulations. For IORPs operating on a cross-border basis, intimate knowledge of the tax and legal framework for occupational pensions in the host state is essential. Otherwise the market entrance of these IORPs will hardly be successful.

5 5 Allianz Global Investors does not recommend different solvency rules for IORPs operating on a cross-border basis and IORPs solely operating on a national basis. Rules that have been agreed upon as being sound and reasonable should apply to all IORPs independent of cross-border activities. From Allianz Global Investors point of view a level playing field within the European Single Market for pension services will be particularly promoted by market transparency: The sponsoring undertaking must be enabled to evaluate the products and services offered by an IORP based in another Member State in comparison to the services of domestic IORPs. Hence the sponsoring undertaking will be able to assess the costs, benefits and risks of either solution.

6 6 A. IORPs SUBJECT TO ARTICLE 17 OF THE IORP DIRECTIVE (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 undertaking, 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? Allianz Global Investors does agree to this overall objective of solvency rules for IORPs, that is the rules should essentially be derived from the Solvency II framework for insurance undertakings, but should take into account all the specific factors of IORPs mitigating risks by sharing some risks with the sponsoring undertaking and plan members. Pension funds and life insurers basically offer similar long-term pension benefits including survivors and disability benefits. In addition there is no difference with regard to the investment horizon and the risks the IORP is faced with compared to life insurers. Hence, the financial principle same risk, same capital and especially the qualitative requirements serve the interest of the plan members and thus should be applied to IORPs as well as to life insurers. The key question is how to reflect the specific features of IORPs with risk sharing elements. Some possible modifications are discussed below (see Question 4 f). Allianz Global Investors does not recommend an application of Solvency II framework in the specification as discussed today, because the specifics of IORPs are not taken into account adequately. 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? The IORP Directive provides an adequate framework for European IORPs and sets out some principles for the calculation of the technical provisions and the necessary surplus funds (regulatory own funds) in excess of these but does not mention specific rules or parameter values to be used. So the first step to assess adequacy is to be aware of the fact that the level of technical provisions varies significantly from country

7 7 to country. Article 17 requires IORPs to hold additional assets in excess of the technical provisions. Hence, in order to compare the quality of the different security mechanisms you have to take into account the different starting point for the calculation of the required amount of regulatory own funds. Beside the amount of regulatory own funds there are other security mechanisms that provide further protection to the full funding requirement regarding technical provisions, e.g. guarantee funds, mechanisms to reduce benefits and the obligation of the sponsoring undertaking to pay an additional premium. The assessment of the overall level of security of a country s pension system requires a detailed comparison of the combination of the prevailing security mechanisms and the way of calculating the technical provisions respectively the resulting level of the provisions. Hence a ranking of the different pension systems with regard to the level of security is very challenging and quite tricky. The mentioned CEIOPS survey provides a broad overview of the different rules established in Europe (based on the IORP Directive). Allianz Global Investors opinion is that the minimum level of requirements implied by the prevailing solvency rules is adequate (its provisions have been exceeded in some Member States), but the way it is being calculated should be harmonized using a modified Solvency II-Framework or a Solvency II-like regime by taking into account the specifics of IORPs (see Question 1). Therefore the calculation rules (including the value of options representing the risk mitigating mechanisms (as explained in question 4 f)) should lead to no substantial increase in the overall required regulatory own funds of IORPs respectively the cost for the sponsoring undertakings. 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? One of the major weaknesses of the current system is certainly that it fails to incentivize companies to use sound and adequate modern risk management practices. The current system only focuses on certain risks using implicit risk margins to protect policyholders respectively plan members. In addition, recognizing the weaknesses in the current framework, certain member states have developed additional requirements which have resulted in the establishment of a patchwork of regulations across Europe. Solvency II now seeks to incorporate the requirement of an adequate risk management framework which handles all relevant types of risk the life insurer is faced with. For the first time a direct link between the risks of the asset management strategy, operational risks, asset-liability-mismatch-risk and the required regulatory own funds will be established. Using an option framework as described in question 4 f would allow for calculating the required funds the same way insurers do, but charge the options value against the required capital which reduces the effective amount of regulatory own funds needed. As described in the CEIOPS survey there is a variety of different security mechanisms applied in the member states (see Question a). To establish a consistent and widely accepted method of valuation for the implied options of these mechanisms could constitute the main challenge for following this approach proposed by Allianz Global Investors. Question c) Which solvency rules could be viewed as proactively dealing with different risks and improving risk management techniques?

8 8 While the first pillar of Solvency II points out which risks have to be included in the calculation of the Solvency Capital Requirement (amount of regulatory own funds needed), the second pillar includes qualitative requirements related to risk management and operational organisation. The extension of the range of risks included in the first pillar is a big step forward but contains no elements of proactively dealing with risks. Elements that can be viewed as proactively dealing have to be implemented by fulfilling the requirements of the second pillar e.g. by implementing a sound risk management system. Risk management is a structured approach to managing uncertainty related to a threat, a sequence of human and corporate activities including: risk assessment, strategies development to manage it, and mitigation of risk using managerial resources. A sound and adequate risk management (in the sense of Solvency II) must necessarily deal proactively with risks because it must identify possible risks arising in the future. This is a substantial part in the risk management process as a whole. 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? Given that IORPs take on similar types of liabilities compared to most insurance companies, but profit from a more advantageous structure of the beneficiaries (often compulsory membership) and hence are not faced with adverse selection and the risk of cancellation, an appropriate solvency regime should take this into account. 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? From Allianz Global Investors point of view there is no need for solvency rules to differ for single-employer or multi-employer IORPs. Both kinds of IORPs are faced with the same risk (e.g. market risk) and so there is no reason to treat them differently (assuming that the specifics mentioned in Question 1 are incorporated in revised solvency rules). Applying the principle of proportionality (see Question 3 c) may lead to easements depending on the size or complexity of the IORP and this will likely affect more single-employer than multi-employer IORPs, indirectly leading to different rules for both groups. 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 forwardlooking 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 marketconsistency 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

9 9 principle of proportionality, implying that supervisory requirements are applied in a manner proportionate to the nature, complexity and the scale of the IORP s inherent risks. 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? Allianz Global Investors fully agrees with the four overarching principles outlined in the CEIOPS survey. A proactively dealing and forward looking approach to risk management is crucial for an adequate system of identifying and handling the risks an IORP is faced with. Supervision based on market-consistent valuation emphasizes the actual financial position and allows for realistic solvency monitoring. However, some exceptions of this principle should be discussed to avoid suffering from full market volatility on the asset side (e.g. Namenspapiere in Germany) respectively because a market value for pension liabilities is usually not available (see question 9 d). This was also recognized by the International Accounting Standards Board: An amendment to the Standard IAS 39, issued on October 2008, permits an entity to reclassify non-derivative financial assets out of the fair value through profit and loss category in particular circumstances. The amendment also permits an entity to transfer from the available-for-sale category to the loans and receivables category a financial asset that would have met the definition of loans and receivables, if the entity has the intention and ability to hold that financial asset for the foreseeable future. There is an ongoing discussion about the eventual negative impact of market consistent valuation on the overall stability of the financial system. This discussion goes far beyond the scope of this consultation, so we just mention it in this context. Concerning the principle of transparency: Disclosure of the methods and calculations of how the IORP determines its financial position is imperative for an efficient supervision. Finally, the principle of proportionality implies that supervisory requirements are applied in a manner proportionate to the nature, complexity and scale of the IORP s inherent risks. From our point of view the modifications described in Question 4 f are one side of the coin related to the principle of proportionality, because they reflect the specifics of IORPs in an adequate manner. The other side of the coin is the question whether there should be a different supervisory approach for IORPs depending on their size or complexity or not (see Question c). Question b) Are there any other overarching principles that you consider relevant for IORPs subject to Article 17? Allianz Global Investors has not identified any other principle of overarching character. Question c) Do you see a case for a different supervisory approach for IORPs subject to Article 17 depending on their size or complexity? One of the principle goals of a solvency framework is to protect the customer or plan member and determine an appropriate level of security applied to providers of pension benefits or life insurance. Because of the fact that in a majority of cases the

10 10 plan member has no choice which IORP to join, the level of protection should not depend on the size of the IORP. The interest and need of protection of the plan member is equal irrespective of size and complexity of the IORP. Despite of this, the overarching principle of proportionality implies that supervisory requirements are applied in a manner appropriate to the nature, complexity and scale of the IORP s inherent risk, a principle Allianz Global Investors agrees on. If some easements in the solvency framework depending on the size of the IORP are to be applied, the overall level of security (99,5%) should nevertheless be the same compared to the application of the full range of solvency rules. In general, Allianz Global Investors supports the application of uniform solvency rules to all types of IORPs irrespective of size. This requires the consideration of the IORPspecifics mentioned above to avoid a negative impact on the attractiveness of IORPs. 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? According to the CEIOPS survey the common principles outlined above are viewed as appropriate and fundamental by all Member States. Despite of this they have not yet been incorporated in all aspects of supervisory practices in all countries. Member States currently use (sometimes completely) different valuation methods and different security mechanisms, resulting in a wide range of different implementations of the IORP Directive. This makes it difficult to compare the different pension systems with regard to the level of security implied. Beyond the agreed principles there seems to be no real best practice across Europe. Based on the CEIOPS survey Allianz Global Investors point of view is that the supervisory frameworks existing today do not meet the overarching principles described in the survey. The extent to which they meet them varies from Member State to Member State, impeding the same level of security for plan members across Europe. (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. Allianz Global Investors point of view is that there is some probability that competitive distortions arise from the application of different solvency rules or that

11 11 market participants use supervisory arbitrage to set up an optimised vehicle for providing long term pension benefits to customers or plan members. As mentioned above, the products offered by IORPs and life insurers are basically not different. Life insurers as well as IORPs offer long term pension benefits including survivors and disability benefits. The reference in the current IORP Directive to the Life Insurance Directive clearly illustrates that the legislator believes that it is reasonable to have similar capital requirements for life insurers and IORPs. But as mentioned above, it is crucial to take all specifics of IORPs into account when determining solvency requirements. This may lead to different solvency requirements, even when products are similar. Question b) Do you have any evidence of such competitive distortions (as mentioned in the previous sub-question) existing already? Allianz Global Investors does not have any evidence of such competitive distortions yet. Because of the reference in the current IORP Directive to the Life Insurance Directive a similar or equal treatment of life insurers and IORPs is assured in the current framework, even if there are some differences between the Member States supervisory rules (see question 3 d). Question c) What would be the likely impact of applying Solvency II (or similar solvency rules) to IORPs subject to Article 17? The likely impact of applying Solvency II to IORPs has been examined in a recent survey of the OECD performed by risklab Germany and IFA. The target of the survey was to analyse what the quantitative funding requirements would be, if Solvency II would be applied to IORPs with defined benefit plans (based on QIS 3 model). Compared to an initial funding level of 100% based on IAS 19, the survey finds that Solvency II may potentially require a dramatic increase in funding level for IORPs depending on the security level and the allowance for risk sharing with the plan sponsor. Significant changes in asset allocation may arise if schemes seek to reduce the SCR as an alternative to holding additional capital. The survey does not focus on IORPs in specific countries. Instead, a generic analysis is performed (based on certain assumptions regarding type of pension plan, mix of plan members, asset allocation and initial funding level). The various plan types represent a broad range of pension plan designs found throughout the Member States. It is important to understand that the effects may vary significantly between countries and different types of IORPs, albeit the results provide an excellent indication of what might happen if Solvency II or a Solvency II-like regime would be applied without modifications. Allianz Global Investors recommends to perform an additional Quantitative Impact Study to analyse the impact of an application of a Solvency II-like regime to IORPs. Question d) What would be the impact on the future provision of defined benefit schemes and the risk of closing down existing schemes? As mentioned in the last question the results may vary significantly between countries and different types of IORPs. By applying the Solvency II framework without any modification allowing for the specific features of IORPs, in some cases the funding requirements could increase in a way that would seriously threaten the existence of

12 12 defined benefit schemes. The dramatic increase in regulatory own funds implies idle funds, which are not acceptable for the plan sponsor. Thus in some Member States the future provision of defined benefit schemes would be questionable and there would be a substantial risk of closing down existing schemes. Question e) What would be the costs and benefits of this? Please provide quantitative information, where available. Not applying Solvency II or Solvency II-like rules to IORPs would mean that from a solvency perspective different rules would apply to IORPs subject to Article 17 and life insurers. The benefits of not applying Solvency II to IORPs respectively applying different rules to IORPs and life insurers are resulting from leaving the current framework for IORPs unchanged, which means no need for additional regulatory own funds (if necessary within the Solvency II framework), no costs of implementation of risk management systems will arise and the overall attractiveness of IORPs remains unchanged. The costs of applying different rules for companies offering similar products are inconsistency, higher complexity of supervision, competitive distortions between IORPs and life insurers and different levels of security for plan members within the group of IORPs depending on the particular vehicle they choose (or not choose in the case of compulsory membership) for retirement provisions. 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 contributions, flexibility of benefits, etc.)? As mentioned above, Allianz Global Investors does not welcome an application of solvency rules similar or equivalent to the Solvency II rules in their current specification. The following specifities should be taken into account when adjusting the Solvency II-Framework or developing an own framework for IORPs. In addition a calculation of technical provisions similar or equal to IAS 19 should be discussed. In general all specifics which have material impact on the level of security of the IORP should be taken into account for the calculation of the regulatory own funds required. There are two essential mechanisms to reduce the risk of a risk sharing IORP (in addition there could be guarantee funds and allowance for recovery plans) which should therefore be reflected adequately in the Solvency II-Framework: The obligation of the sponsoring undertaking to pay an additional premium and the option of benefit cuts. While benefit cuts can be seen as a put option that the plan members have sold to the IORP, the obligation to pay an additional premium is comparable to a call option for additional own funds sold to the IORP by the sponsoring undertaking. As a result the IORP holds a long position for two options which represent a significant value to the IORP and thus should be accepted as a specific form of own funds. Of course, using the options-framework allows for reflecting credit risk of the sponsoring undertaking. Assuming that the calculation of technical provisions will not be harmonized across Europe, the different levels of technical provisions must be taken into account in an adequate manner to reflect the different levels of security implied by the calculation methodology. This can be done by comparing the country s level of technical provisions with those calculated using the Solvency II-framework and treat the

13 13 difference as equity or capital requirement (dependent on whether they exceed or do not exceed the technical provisions under the Solvency II-regime). With regard to qualitative requirements and the rules for disclosure of information (the second and third pillar of Solvency II) there should be no modification for IORPs. They should be fully applied because even if some specific components of own funds are accepted within the first pillar of Solvency II, all the risks including the value of the options described above should be identified and managed within an adequate risk management framework. Beside of the position with regard to the range of application of Solvency II Allianz Global Investors recommends to discuss the treatment of equity risk within the Solvency II framework for insurance companies again and examine different approaches to model equity risk. A risk-based prudential solvency regime will require companies investing in risky assets to hold capital in order to be able to face their liabilities even in bad times. This prudent person principle is a key feature of a system based on the full responsibility of companies. There are two main reasons why investing an adequate share in equities is appropriate for life insurance companies and their nature of the business, which is characterized by long term liabilities and increasing need for high returns which lead to a higher level of benefits. Hence, investment in equity should result in a capital charge that is adapted to the economic logic of the insurers investment. First, investment in equity contributes to a correct diversification of assets, by avoiding overexposure to bonds alone. Second, investment in equity provides a better return for policyholders over the long term. In addition, it guarantees a better coverage of inflation risk. Within the QIS 4 framework an alternative dampener approach is being tested for the equity risk, which has two components: one linked to the relative level of equity prices over the previous 10 trading days compared to the average level for the previous year; and another linked to the duration of the liabilities. The theoretical basis of the dampener approach is based on the fact that the probability that the value of equity raises is smaller when this value is high than when it is low. Allianz Global Investors welcomes the idea behind the dampener approach. While being consistent with the solvency one-year horizon, the dampener effect should be all the more taken into account than the time horizon of the insurance company is long. 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? Allowance for distribution of excess funds could be interpreted as the opposite mechanism of recovery plans. The duty to provide additional contributions in the event of underfunding should be accompanied by the possibility of returning excess or idle funds to the sponsor. A pension system including both mechanisms could be

14 14 viewed as a symmetric approach and should be incorporated into a revised IORP Directive. From Allianz Global Investors point of view the possibility of returning excess assets should partly depend on the nature of the pension scheme (closed or open to new members). In the case of a pension scheme including future service the excess funds could be offset against future contributions and thus benefit the collective as a whole.

15 15 B. 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? While current practices in the calculation of technical provisions differ significantly between Member States in terms of the applied methods and assumptions, all of these different practices are inside the scope set by the IORP Directive, that is IORPs in all Member States have to adhere to the principles set out in the IORP Directive (recognised actuarial methods, prudence, reference points for interest rates and biometric tables). As pointed out in the CEIOPS survey, national rules for the calculation of technical provisions should not be seen isolated when assessing the overall level of security of a system of occupational pensions provision. Specific rules or parameter values to be used in one country, which seem less prudent regarding security for the beneficiaries at first glance, might for example be offset by social or labour legislation. Of course significant differences in the level of the required technical provisions for the same pension promise between countries could lead to severe competitive distortions when an IORP from a country with low requirements regarding technical provisions offers its services to employers in a country where the correspondent requirements for the local IORPs are higher. But it is Allianz Global Investors point of view that it would be a wrong approach to set up different regulatory and solvency frameworks for IORPs operating on a cross-border basis on the one hand and IORPs solely operating nationally on the other hand. A solvency framework based upon the principles described in question 3 is reasonable for all IORPs regardless of cross-border activities. To prevent severe competitive distortions the principle of transparency has to be emphasized and not just in the form of disclosures to the supervisory institution but in the sense of market transparency. Take for example an IORP from one country which applies a best estimate discount rate for calculating technical provisions in combination with the employer s obligation to pay additional premiums when the return on the IORP s assets does not meet the expectations. When this IORP offers its products to an employer in another Member State where technical provisions have to be calculated using a risk-free interest rate and where obligations to pay additional

16 16 premiums are uncommon it is essential that the employer in the second Member State is aware of the additional risk he is taking by using the IORP with the less prudent calculation of technical provisions. The promotion and improvement of market transparency is one of the crucial points in cross-border activity of IORPs. Question b) Should prudential requirements be considered separately from Social and Labour Law (SLL)? If yes, how could prudential requirements and SLL be distinguished? As the CEIOPS survey points out, the security level of the pension system of a particular Member State depends on prudential requirements as well as on security mechanism originating from social or labour law provisions. Therefore an isolated approach to achieving and maintaining a high security level of national occupational pension systems by just focussing on prudential requirements does not seem adequate. A revised regulatory and solvency framework for IORPs must provide the necessary flexibility and provide space for taking the specific security package of every Member State into account. 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? From Allianz Global Investors point of view there is a relatively simple answer to the question of different indexation promises: The particular indexation promise that is included in a pension promise is part of the liabilities of an IORP and has to be reflected in the calculation of technical provisions and the corresponding funding requirements for the IORP. However, a differentiation is necessary between cases where the indexation promise is or must be given by the IORP itself and cases where the sponsoring undertaking has the obligation to protect pension benefits against inflation and might or might not transfer this obligation to the IORP: Indexation promises that constitute an obligation for the sponsoring undertaking only need not necessarily be reflected in the IORPs technical provisions. Question b) Do you foresee any difficulties arising from differences in the specific nature of pension promises in case of cross-border activity? Allianz Global Investors sees no material difficulties concerning the calculation of technical provisions arising from differences in the specific nature of pension promises between the Member States. Basically, the promised benefits are of the same nature: retirement, survivors and disability benefits. In the case of material differences between the typical pension promises of two (or more) communities of pension beneficiaries it could be reasonable to separate the liabilities and the corresponding assets and apply a group-balance concept only within one community of beneficiaries.

17 17 Apart from that it will certainly be a challenge for an IORP starting or planning crossborder activities to acquire the intimate knowledge of the occupational pension system of another Member State in order to be able to develop compatible products for this new market. (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 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? The requirement to provide regulatory own funds is one factor in the cost calculation of an IORP or the sponsoring undertaking respectively. Like requirements for the calculation and funding of technical provisions this affects the product design and can therefore lead to competitive distortions when IORPs from Member States with lower solvency requirements offer their products in Member States who impose stricter solvency requirements on their local IORPs. However, from our point of view there are other and more important reasons that complicate the conduct of cross-border activity (see next question). Question b) Do you think that there may be other, and potentially more important, reasons beyond the scope of prudential regulation that complicate the conduct of cross-border activity? Please specify. According to Article 20 of the IORP Directive, which outlines the basic framework for cross-border activities of IORPs, the supervisory authority of the host Member State has to supply information about the requirements of social and labour law relevant to the field of occupational pensions under which the pension scheme sponsored by an undertaking in the host Member State must be operated, as well as any specific funding rules applicable to cross-border activities of IORPs and information requirements. However, receiving a pile of paper (if real or virtual in electronic form) is not the same as being able to deal with all the specific features of a pension system and the particular needs of potential sponsoring undertakings in the host Member State. Acquiring the necessary detailed knowledge of the pension market environment to be encountered in the host country is the major challenge for IORPs operating on a cross-border basis. 9. The IORP Directive lays down only minimum solvency requirements for IORPs. The CEIOPS survey suggest that material variations in regulatory requirements may spur regulatory arbitrage by IORPs operating on a crossborder basis and supervisory competition between Member States. Question a) Is there any evidence of i) regulatory arbitrage by IORPs

18 18 operating on a cross-border basis, and/or ii) supervisory competition between Member States? If so, please give examples. From Allianz Global Investors point of view there are already indications of regulatory arbitrage as well as supervisory competition. Representatives of several insurance companies and pension funds have been praising the smooth cooperation with the supervisory authorities in Liechtenstein on several conferences and symposia and the FMA (Finanzmarktaufsicht Liechtenstein) itself has been emphasizing the scope for implementing the IORP Directive in national legislation with the predominant aim of creating an attractive location for insurance companies and IORPs. Similarly, Belgium is for example publishing brochures advertising the country as an attractive home country for IORPs and emphasizing the supervisory flexibility. Question b) Do you expect regulatory arbitrage by IORPs operating on a cross-border basis, and/or supervisory competition between Member States to occur in the future, and what evidence do you have to support your belief? As outlined above regulatory arbitrage and supervisory competition can already be observed and are from our point of view likely to increase in the future. Question c) Do you think that regulatory arbitrage and/or supervisory competition due to differences in the treatment of IORPs operating on a crossborder basis could ultimately be in the interest of pension beneficiaries or sponsoring undertakings or do you think that this may ultimately be harmful? If so, in what way? First, it should be emphasized that competition is a vital element of a market economy leading to efficient market results. In this sense supervisory competition can be in the interest of pension beneficiaries and sponsoring undertakings as far as it leads to lean and efficient regulatory frameworks and best supervisory practices throughout Europe. Less strict regulatory requirements would lead to lower costs for IORPs and could lower the cost for the sponsoring undertakings and/or increase the benefits for the beneficiaries. The other side of the coin is the security level of the national systems of occupational pensions and the system as a whole. Supervisory competition and regulatory arbitrage must not lead to significantly lowering the security level as occupational retirement provisions are increasingly important for maintaining the standard of living in old age while the usual pay-as-you-go systems of statutory pension funds become difficult to sustain. Question d) Do you think that the EU solvency rules for IORPs operating on a cross-border basis should be risk-oriented, and based on a market-consistent valuation of assets and liabilities? As outlined above (see question 6 e) Allianz Global Investors does not recommend different solvency rules for IORPs operating on a cross-border basis and IORPs solely operating on a national basis. Rules that have been agreed upon as being sound and reasonable should apply to all IORPs independent of cross-border activities. Risk-orientation should be a basic principle of solvency rules because adequate regulatory own funds must be at hand when risks turn to losses. Since one of the major risk categories faced by IORPs (and insurance undertakings) is market risk, a market-consistent valuation of assets and liabilities is a crucial