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New capital requirements for pension funds - what liability arises with sponsors?
Comment on Norwegian pension fund regulations. Request for guidance from the Financial Services Authority of Norway, February 6th 2019.
New capital requirements for Norwegian pension funds came into effect on January 1st 2019, calculated under Solvency II principles. As discussed previously in these pages, http://www.corum.no/september-26th-2018-the-unknown-corporate-liability.html and http://www.corum.no/november-22nd-2018-pension-fund-board-responsibilities.html,, this potentially increases the capital requirements of the funds with a high multiple from the current funding situation. The pension funds will however be allowed to use transition rules, similar to those that apply to insurance companies for the implementation of Solvency II. Under those rules, the new requirements are phased in over 16 years.
It is in the nature of things that transition rules are temporary. In order to be allowed to use transition rules, pension funds (and insurance companies) are required to present to regulators plans for how a full capitalization is to be reached, and how any large negative market movements will be met and offset.
For insurance companies the capitalization plan is typically a version of their general business plan. Insurance companies have multiple source of revenues and profits, that range from product areas with high capital requirements (such as defined benefit pensions), to those with low capital requirements (such as unit linked life insurance). Many of those business areas have low correlation with each other, and some have low correlation with financial markets. An insurance company can thus reasonably expect to increase capitalization over time from retained profits.
Norwegian pension funds, however, have typically one dominant line of business - defined benefit pensions. Given the typical levels of defined benefits, and the current interest rate environment, meeting those benefit hurdles is more than challenging. Expecting significant investment returns above the guaranteed levels, that in turn can bolster capital, is then not really a plan. It is more in the nature of a prayer. That essentially leaves one potential source of additional capital, and that is the fund sponsor - through direct contributions and / or through higher premiums.
Under Norwegian law, sponsors are not directly legally responsible for "their" pension funds. A decision by a sponsors to provide additional capital to a pension fund is then a voluntary decision and not a legal requirement, even though sponsors may of course in any case assume a moral or commercial requirement to provide fund capital. What is clear is that the pension fund, i.e. the pension fund board, will not be in a position by itselg to commit a sponsor to provide capital. In the event that transition rules are used, and where the capitalization plan rests on sponsor willingness to pay up, it would seem to be necessary that the sponsor actually agrees.
Our discussions with the accounting and audit firms have not really yielded very satisfcatory results as to how this should be handled in information and accounting terms, neither at the fund nor at the sponsor level. This is of course a uniquely Norwegian issue, as other EU / EEA countries do not apply Solvency II requirements to pension funds. In order to clarify the issues, we have then requested guidance from the Financial Services Authority of Norway. A translation of our request is found below.
The Financial Supervisory Authority of Norway
Avdeling for bank- og forsikringstilsyn
Revierstredet 3
Postboks 1187 Sentrum
0107 Oslo
Oslo, 6th February 2019
New capital requirements for pension funds – information from pension funds and sponsors.
Reference is made to the new capital requirements for pension funds, which applies from January 1st 2019. In a letter to the pension funds of November 9th 2018, the FSAN points out that pension funds that will not meet the new requirements without using transition rules, are expected to prepare a plan for how the requirements will be met in the longer run.
Given the long time frame for transition rules, the actual financial position of pension funds in the near future will be very different, While some pension funds may already fully meet the new requirements, other funds may have a long way to go.
The pension funds are important participants in the financial markets, and there are thus many parties with a need to assess the counterparty risk represented by each pension fund. In a similar manner, beneficiaries and other stakeholders have a legitimate interest in understanding the counterparty risk. In order to make such assessments, correct and comprehensive information is key. As the requirements apply from January 1st 2019, it is particularly important that the information provided by pension funds and sponsors in connection with the current annual accounts meets these needs.
We thus request that the FSAN provides guidance on some issues regarding how the supervision of pension funds and sponsors will be performed, and on what information these will be expected to provide:
1, In the event that a pension fund does not meet the new simplified solvency capital requirement without using transition rules, will the pension fund be required to explain this in their public accounts? Will the pension funds also be required to report publicly what the full solvency capital requirement will be without using transition rules?
2. In the event that transtition rules are being used and there is a plan for increased capitalization, will the pension fund be required to provide information about this plan in their public accounts – or in any other manner be required to communicate the plan, or the major components of it, to the market?
3. In the event that a capitalization plan in whole or in part, implicitly or explicitly, rests on the sponsor being potentially required to give capital contributions, and given that that the pension fund itself presumably will not be able to make a commitment on behalf of the sponsor, will the FSAN expect that the sponsor has made a binding decision to provide such capital contributions if needed?
4. In the event that the sponsor has accepted a liability to provide capital as required, will the FSAN require that this is accounted for in the balance sheet of the sponsor?
5. In the event that the sponsor will be expected to account for such a liability, what is the guidance from the FSAN as to the calculation of the size of the liability? Given that such a liability will be derived from the pension fund’s calculation of capital requirements under a simplified Solvency II model, will the sponsor be required to perform a corresponding calculation?
With kind regards
Corum AS
Petter Berge
Chairman
Comment on Norwegian pension fund regulations. Request for guidance from the Financial Services Authority of Norway, February 6th 2019.
New capital requirements for Norwegian pension funds came into effect on January 1st 2019, calculated under Solvency II principles. As discussed previously in these pages, http://www.corum.no/september-26th-2018-the-unknown-corporate-liability.html and http://www.corum.no/november-22nd-2018-pension-fund-board-responsibilities.html,, this potentially increases the capital requirements of the funds with a high multiple from the current funding situation. The pension funds will however be allowed to use transition rules, similar to those that apply to insurance companies for the implementation of Solvency II. Under those rules, the new requirements are phased in over 16 years.
It is in the nature of things that transition rules are temporary. In order to be allowed to use transition rules, pension funds (and insurance companies) are required to present to regulators plans for how a full capitalization is to be reached, and how any large negative market movements will be met and offset.
For insurance companies the capitalization plan is typically a version of their general business plan. Insurance companies have multiple source of revenues and profits, that range from product areas with high capital requirements (such as defined benefit pensions), to those with low capital requirements (such as unit linked life insurance). Many of those business areas have low correlation with each other, and some have low correlation with financial markets. An insurance company can thus reasonably expect to increase capitalization over time from retained profits.
Norwegian pension funds, however, have typically one dominant line of business - defined benefit pensions. Given the typical levels of defined benefits, and the current interest rate environment, meeting those benefit hurdles is more than challenging. Expecting significant investment returns above the guaranteed levels, that in turn can bolster capital, is then not really a plan. It is more in the nature of a prayer. That essentially leaves one potential source of additional capital, and that is the fund sponsor - through direct contributions and / or through higher premiums.
Under Norwegian law, sponsors are not directly legally responsible for "their" pension funds. A decision by a sponsors to provide additional capital to a pension fund is then a voluntary decision and not a legal requirement, even though sponsors may of course in any case assume a moral or commercial requirement to provide fund capital. What is clear is that the pension fund, i.e. the pension fund board, will not be in a position by itselg to commit a sponsor to provide capital. In the event that transition rules are used, and where the capitalization plan rests on sponsor willingness to pay up, it would seem to be necessary that the sponsor actually agrees.
Our discussions with the accounting and audit firms have not really yielded very satisfcatory results as to how this should be handled in information and accounting terms, neither at the fund nor at the sponsor level. This is of course a uniquely Norwegian issue, as other EU / EEA countries do not apply Solvency II requirements to pension funds. In order to clarify the issues, we have then requested guidance from the Financial Services Authority of Norway. A translation of our request is found below.
The Financial Supervisory Authority of Norway
Avdeling for bank- og forsikringstilsyn
Revierstredet 3
Postboks 1187 Sentrum
0107 Oslo
Oslo, 6th February 2019
New capital requirements for pension funds – information from pension funds and sponsors.
Reference is made to the new capital requirements for pension funds, which applies from January 1st 2019. In a letter to the pension funds of November 9th 2018, the FSAN points out that pension funds that will not meet the new requirements without using transition rules, are expected to prepare a plan for how the requirements will be met in the longer run.
Given the long time frame for transition rules, the actual financial position of pension funds in the near future will be very different, While some pension funds may already fully meet the new requirements, other funds may have a long way to go.
The pension funds are important participants in the financial markets, and there are thus many parties with a need to assess the counterparty risk represented by each pension fund. In a similar manner, beneficiaries and other stakeholders have a legitimate interest in understanding the counterparty risk. In order to make such assessments, correct and comprehensive information is key. As the requirements apply from January 1st 2019, it is particularly important that the information provided by pension funds and sponsors in connection with the current annual accounts meets these needs.
We thus request that the FSAN provides guidance on some issues regarding how the supervision of pension funds and sponsors will be performed, and on what information these will be expected to provide:
1, In the event that a pension fund does not meet the new simplified solvency capital requirement without using transition rules, will the pension fund be required to explain this in their public accounts? Will the pension funds also be required to report publicly what the full solvency capital requirement will be without using transition rules?
2. In the event that transtition rules are being used and there is a plan for increased capitalization, will the pension fund be required to provide information about this plan in their public accounts – or in any other manner be required to communicate the plan, or the major components of it, to the market?
3. In the event that a capitalization plan in whole or in part, implicitly or explicitly, rests on the sponsor being potentially required to give capital contributions, and given that that the pension fund itself presumably will not be able to make a commitment on behalf of the sponsor, will the FSAN expect that the sponsor has made a binding decision to provide such capital contributions if needed?
4. In the event that the sponsor has accepted a liability to provide capital as required, will the FSAN require that this is accounted for in the balance sheet of the sponsor?
5. In the event that the sponsor will be expected to account for such a liability, what is the guidance from the FSAN as to the calculation of the size of the liability? Given that such a liability will be derived from the pension fund’s calculation of capital requirements under a simplified Solvency II model, will the sponsor be required to perform a corresponding calculation?
With kind regards
Corum AS
Petter Berge
Chairman