Pensions Conference 2011. Review of Workshop E3: Pension schemes - are there lessons to be learned from insurers?

Are insurers really any the wiser and what can Solvency II really work for pensions?

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The first part of the session dealt with actuarial valuation issues which we are familiar with. Yield curves can be derived from gilt or swap curves, but there are issues in extrapolating long term yields.  Insurers’ liabilities are illiquid and so market-consistent valuations allow for illiquidity premiums - but how illiquid are pension liabilities?

Procyclicality is an important issue in the process and covers, for example, mean reversion in equity markets and higher liquidity premiums in distressed markets – the debate continues on some of these matters…

Capital requirements work to a 99.5th percentile one year Value at Risk. Regulatory supervision is layered: if a minimum solvency level is breached then the regulator can take over; if a secondary threshold is breached then corrective action must be taken. Risks modelled include market risk, insurance risk, and operational risk, although correlation can be allowed for.  Regulators are looking to significantly raise governance standards.

Time is running out to implement Solvency II for insurers.  On the plus-side it is principles based with an economic basis for assessing value, and will encourage development of risk management techniques.  On the down-side it still appears bogged down in detail and arguably flawed as it is incompatible with the procyclicality objective. It will cause a significant burden on firms and regulators.

One of the biggest challenges in implementing Solvency II for pension schemes is the valuation of sponsor covenant as a scheme asset – “it harbours the possibility of unfavourable financial and procyclical implication”.

Other significant challenges still remain if Solvency II is to be implemented for pension schemes across all its pillars: valuation and recovery, risk management and transparency and disclosure.