Initial response of OPSG Solvency Subgroup 15 October 2014

Solvency Sub Group Alberto Floreani Ruth Goldman Thomas Keller Michaela Koller Niels Kortleve Joachim Schwind Philip Shier (Lead) Martine Van Peer Neil Walsh Allan Whalley

Activity to date Received CONFIDENTIAL draft from EIOPA on 23 September : thank you 2 conference calls of sub group to discuss initial reaction and work plan Slides prepared to aid discussion and serve as starting point for detailed consideration Need to plan future activity to enable an OPSG response to be drafted, approved by OPSG and submitted by 13 January

Previous OPSG comment on holistic balance sheet (HBS) Previous OPSG opinion on the Call for Advice, Technical Specifications for QIS, and the results of the QIS highlighted concerns : “expressed doubts about the practicability of the approach” “seems to offer possibilities to take the specific characteristics of IORPs into account, although it is very complex” “QIS does not include very important elements of the prudential framework: like recovery periods, tiering of assets and liabilities and the required policy action if the IORP hits a supervisory trigger point, nor indeed the trigger points themselves” “after the QIS, there are much more doubts if it will be possible to use the HBS as a supervisory tool” “OPSG suggested that alternatives to the HBS could be considered not targeting full harmonisation but still using a holistic framework..[taking] into account the steering and adjustment mechanisms but [leaving] freedom to NSAs to calibrate the system with a view on the national practices”

Content (based on draft) Introduction etc (p 1-10) contract boundaries (p 11-27) [Qs ] discretionary benefits (p 27-37) [Qs ] benefit reductions (p37-39) [Q 35] sponsor support (p39-78) [Qs ] pension protection schemes (p79-81) [Qs ] supervisory responses (p82-155) [Qs 72 – 110] possible simplifications [Q 111]

General reaction EIOPA own initiative work in response to concerns raised (by OPSG and others) about HBS in QIS. Will the (new) Commission wish to continue to pursue the HBS approach? We welcome the additional work which has been done and the discussion on some of the more difficult issues Pleased to see detailed consideration of the use of the HBS including the broader approach (3.13) not conditional on “harmonisation” which provides 3 options for use of the HBS: To set solvency capital requirements To establish minimum technical provisions To assess sustainability of the IORP (pillar 2 provisions)

Supervisory responses – use of HBS Helpful to see detail and examples Consideration of options for HBS Include non-legally enforceable sponsor support? Include pension protection schemes? Include discretionary/mixed benefits? Include benefit reductions? Include off balance sheet items/surplus funds/subordinated loans? Options for tiering of assets Additional national requirements? Recovery periods (technical provisions, SCR) Transitional measures

Initial comment on supervisory responses Concept of HBS requires inclusion of all steering instruments → no further instruments available for recovery (if too low funding) → recovery plan impossible because steering instruments are already included in HBS (section 5.2.5) If funding level < SCR → no additional steering instruments are available (already included, see above) → no recovery possible → what is added value of SCR (except notion of too low funding)? If HBS has to be fully based on market value → inclusion of all elements that have market value logical → many options EIOPA proposes (partially) exclude some of these elements → exclusion only sensible when not marked-to- market?

(Legally enforceable) sponsor support Recognise complexity Difficulty getting data Arbitrary assumptions? Multi-employer IORPs and multi-IORP employers “EIOPA recognises that it may not be possible to devise a one-size-fits- all methodology” “EIOPA therefore supports an EU wide principle based approach to the valuation of sponsor support” “The valuation of sponsor support should be market consistent. The specifics of the calculation should then be left to members states, NSAs or IORPs to implement as appropriate to their own circumstances” “EIOPA recommends a proportionality principle” Comment: Legally enforceable may be theoretical if not actually enforceable e.g. how much is recoverable in the first place, secured v unsecured support, assuming unsecured creditor where pension fund sits in priorities ( if anywhere), enforceability across jurisdictions…

Initial comment on proportionality The 3 approaches set out for applying proportionality (i.e. to determine sponsor support as the balancing item in the HBS) seem valuable and lead to a simplification of the calculations. Wider group and/or non legally enforceable support is excluded, so there is a trade off between invoking the simplification for proportionality and recognising the full scope of potential sponsor support The first approach (default rate of the sponsor) presents the advantage that the information is available. The second approach (strength of the sponsor) seems to take into account more specific information of the sponsor but at the same time seems to bring in some subjectivity. The third approach (existence of pension protection scheme) is simple. However, for very small IORPs it should be possible to consider the sponsor support as the balancing item on the HBS without any calculation and without SCR, provided some simple conditions are fulfilled. For example: sponsor support <10% of total salary charge.

Modelling approaches Probabilistic (stochastic). Generally more appropriate for larger IORPs / sponsors. QIS simplification 1. Take current level of underfunding, assume a Gaussian distribution allowing for standard deviation of assets / liabilities / correlation between them. This approach requires data than can be difficult to obtain. QIS simplification 2. Used by most IORPs in QIS. Requires a probability weighted average of future cashflows where only uncertainty is default risk of sponsor. Simplified stochastic approach (“Barrie & Hibbert”). Use forward yield curve for interest rates. Use average default rates of sponsor. Alternative simplified approach. Use accounting ratios (income cover / asset cover) to assess sponsor strength. EIOPA provides series of standardised tables to calculate sponsor support.

Other issues discussed Maximum sponsor support. QIS used arbitrary parameters (50% of sponsor worth and 33% of future cashflows). Proposes principles-based approach building on principle 2 for assessing proportionality. Probability of default market data (credit rating /cds) financial reporting data (similar to alternative simplified approach) PPF approach in UK (credit rating assessment based on financial factors shown to be statistically relevant to experience of sponsors). Timing of sponsor support what regulatory regime permits; duration of liabilities and / or strength of employer. Cases of more complex IORP structures. sponsor with multiple IORPS; IORP with multiple sponsors; parental guarantees; not-for-profits. Could also consider access to additional funds in certain circumstances additional sponsor support in the form of IORP access to escrow accounts jointly held with sponsor access to additional funds in the event of certain triggers

OPSG response Three high level areas where the OPSG may want to form views: Is the principles based approach appropriate? Are the specified methodologies appropriate, which are best, are others needed? Are the solutions for specific issues appropriate?

Benefit reductions May arise in 15 Member States Benefit reduction mechanism Option 1: Allow for ex-ante benefit reductions in the holistic balance sheet but make no allowance for ex post reductions or reductions as a result of sponsor default/insolvency Option 2: Allow for ex-ante benefit reductions in the holistic balance sheet, but make allowance for ex post benefit reductions or reductions in case of sponsor default on a country by country basis Option 3: Include all benefit reductions on the holistic balance sheet Is distinction between ex-ante and ex-post benefit cuts relevant? For member no difference in outcome and in PBS same expectation and scenarios no difference in communication

Contract boundaries Solvency II approach for insurance contracts. Unilateral rights (or obligations) of an IORP to terminate the contract/agreement/promise or reject additional contributions to the contract/agreement/promise or modify the promise in a way that contributions fully reflect the risk is the basis for a definition of contract boundaries for IORPs. What if right is vested in sponsoring employer? For an IORP, contract boundaries are defined on accrual of future benefit entitlements rather than contributions or premiums Contributions. Incoming cash-flows (contributions) should be recognised in technical provisions if they are meant to finance the (accrual of) benefits. Incoming cash-flows whose amount is determined based on the funding position of the IORP and/or are not meant to directly finance the (accrual of) benefits should qualify as sponsor support and should not be recognised in technical provisions, but separately (for instance as an asset on the holistic balance sheet).

Proposed action plan Initial discussion at OPSG today Further consideration by subgroup [Pre-meeting this morning] Drafting of more detailed responses on issues/answers to questions (allocated to sub-group members) Meeting /conference call in mid-November to consolidate into first draft for issue to OPSG Discussion at OPSG on 26 November? Further discussion/redraft by subgroup Issue for further comment and then written approval in December Submit response by 13 January 2015