EIOPA has already conducted stress tests of insurance undertakings in 2011 and 2014 and on the 11th of May 2015 launched its first stress test for IORPS (Institutions for Occupational Retirement Provisions) along with a Quantitative Assessment on further work on solvency for IORPS.
It’s worthy to notice that both exercises have different objectives and will be reported on separately, but, given the considerable overlap in the evaluations, will be conducted in parallel to reduce the burden on both participants and supervisory authorities.
As recalled by EIOPA’s chair Gabriel Bernardino, Pension funds are already experiencing a challenging environment with low interest rates and rising life expectancy and the Stress Test is meant to assess the resilience of IORPs to adverse market developments and to raise awareness of the sector’s risks and vulnerabilities. The exercise will be conducted in 17 European countries with material IORP sector (> 500 million euro in assets), covering at least 50% of their national market. IORPs participants will run the Stress Test till the 10th of August and the NSA (National Supervisory Authorities) will submit the results to EIOPA on the 24th of August. There will be a first validation meeting in the period 31st of August – 4th of September, then a follow up between NSAs and IORPs and a second validation meeting in the period 28th of September – 2nd of October. Results will be reported in December 2015.
The IORP Stress Test 2015 consist of a core module for IORPs providing Defined Benefits (DB) or hybrid schemes and a satellite module for IORPs providing Defined Contribution (DC) schemes. The reference date for input data and calculation is 31/12/2014. IORPs have long-term obligations and in many cases cannot become insolvent, as they do not bear the full risk of commitments to members and beneficiaries; the Stress Test takes into account the nature of their obligations and all security and benefit adjustment mechanisms in order to achieve a proper view.
The core module assesses the impact of two adverse market scenarios and one longevity scenario on the value of assets and liabilities on both IORPs’ national prudential balance sheets and the common Holistic Balance Sheet (HBS) – which provides a comparable view in different member states. No calculation of the SCR is required and the evaluation must be market consistent and conducted in accordance with the technical specifications for the quantitative assessment of the further work on solvency of IORPs, using simplifications if needed. The two adverse scenarios are calibrated to be occurring instantaneously and simultaneously (no correlation matrix) and the longevity scenario represents a separate permanent decrease in mortality rates of -20%. The balance sheet provides a transparent view of the extent to which pension obligations can be supported by financial assets, sponsor support and pension protection schemes and the extent to which benefits adjustments are expected in the adverse scenarios.
The satellite module, instead, does not assess the resilience of the IORP, but rather the potential outcomes for members under various defined scenarios. In DC schemes risks are borne by the plan members, so IORPs’ balance sheets are in equilibrium by definition; the satellite module provides an overview of the design characteristics of DC plans and their robustness are compared by assessing the effects of adverse scenarios on future retirement incomes of three representative plan members which start to receive pension benefits respectively in 5, 20 and 35 years from now. Five adverse scenarios are assessed: two with an instantaneous fall in asset prices, two with lower future investment returns and one with an increase in life expectancy.
Both modules test a prolonged period of low interest rates combined with a fall in asset prices due to a re-appraisal of risk on financial markets, which is indeed a key vulnerability for the occupational pension sector.
The Quantitative Assessment, which will be run till the 10th of August 2015, constitutes the next step in EIOPA developing its advice to the European Commission on EU solvency rules for IORPs. The first step was the publication on the 13th of October 2014 of the “Consultation Paper on Further Work on Solvency of IORPs”, for which EIOPA has received 77 responses. The Authority will provide feedback and will publish its advice on March 2016.
The aim of the assessment is to collect data from IORPs on the possible implementation of various supervisory frameworks. IORPs have to evaluate the HBS including all securities and benefit adjustment mechanisms and the calculation of the SCR under two baseline scenarios where the elements of the HBS have to be evaluated respectively using the basic risk free interest rate or the expected return on assets. The first baseline scenario corresponds to the baseline scenario of the core module of the Stress Test.