The outcomes of the stress test show that European IORPs offering defined benefit schemes have, in aggregate, insufficient assets to cover their liabilities. Closing this gap could place a heavy strain on some of the employers that use an IORP for providing retirement benefits to their employees. This could have a negative impact on the real economy.

The objective of the stress test was to assess the resilience of the European IORP sector to potential negative developments on the capital markets. The scenario of the stress test combined a fall in risk-free interest rates, resulting in an increased economic value of the liabilities, with a drop in the price of assets held by IORPs. EIOPA also addressed the possible indirect effects such developments could have on employers that use an IORP for the provision of retirement benefits to their employees.

Design of the stress test

The stress test covered both defined benefit schemes in which benefits are guaranteed to the beneficiaries by the IORP and/or the employer and pure defined contribution (DC) schemes. In the case of the latter, the employer merely promises to pay a certain contribution towards the employee's pension; no benefits are guaranteed to the beneficiary. However, pure DC schemes have only been permissible in Germany from 1 January 2018 and were therefore not yet relevant for the stress test.

The stress test for defined benefit schemes was conducted both on the basis of the relevant national accounting and regulatory standards (i.e. in Germany, the German Commercial Code (Handelsgesetzbuch – HGB – only available in German) and solvency regulations in accordance with Solvency I), as well as a uniform European valuation standard developed by EIOPA. For the first time, EIOPA included in its stress test an ascertainment of the future cash flows of IORPs from contributions and benefits.

Using the uniform valuation standard, assets and liabilities were valued on a market-consistent basis with risk-free interest rates being applied for the calculation of the technical provisions. Security mechanisms, such as the commitment of employers to provide additional payments to secure benefits and protection by the Pensions-Sicherungs-Verein VVaG (PSVaG), were valued as assets. If the liabilities exceeded the available assets, including the relevant security mechanisms, under the uniform valuation standard, the value of the technical provisions was reduced such that the value of the liabilities corresponded to the value of the assets.

The amount by which the liabilities were reduced is an indication of the reduction of benefits that might be expected in the future. However, such an indication does not mean that benefits will eventually actually be reduced, since such a step depends on many factors, not the least of which are any counter-measures taken.

EIOPA strived for a market-coverage of 50% of the respective national IORP sectors. This was achieved in Germany with a selection of Pensionskassen and Pensionsfonds representative of the German market.

BaFin's view confirmed

The outcomes of the stress test confirm once again BaFin's view that persistently low interest rates will remain a major challenge for the German IORP sector. This applies even more when considering a negative development of the capital markets – the scenario applied in the stress test.

In response to low interest rates, German IORPs have already taken a number of measures in recent years. In particular, they have increased their technical provisions and reduced benefits from profit participation. In this context, BaFin is in close contact with the IORPs. The measures are to be continued in the coming years. While pure defined contribution schemes, introduced by the Act to Strengthen Occupational Pensions (Betriebsrentenstärkungsgesetz - BRSG - only available in German) (see Expert article of BaFinJournal July 2017) could be a good way to avoid the problems resulting from high interest guarantees in the future, they do not help cope with the high guarantees of the past.

"The EIOPA stress test for IORPs is another indication that, despite the measures already taken, some Pensionskassen may get into difficulties in the coming years if they do not receive funding from external sources" said Frank Grund, Chief Executive Director of Insurance and Pension Funds Supervision. Such funding could be provided by shareholders of Pensionskassen or by employers who use Pensionskassen to provide retirement benefits to their employees.

There are often complex issues associated with the provision of external funding, for example when a very large number of employers are involved. From BaFin's point of view, it is therefore important that Pensionskassen involve potential external providers of funding at an early stage in order to find the most effective and efficient solutions for all parties concerned.