Solvency II may endanger retirement outcomes for future pensioners

Posted on

The European Commission is today hosting a public forum on its Level 2 implementing measures for Solvency II, the new Europe-wide regulatory regime for insurance companies. The details were compiled following advice from the Committee on European Insurance and Occupational Pensions Supervisors (CEIOPS) [1] and in consultation with industry and professional stakeholders. Whilst aimed at insurers rather than pension funds, the regulations could have a significant impact on the annuities market, a key component of the UK pensions system.

The regulations have been designed to avoid a future Equitable Life, though undoubtedly have been given impetus by the recent financial crisis. The single market had already led to the emergence of a cross-border market in some insurance products in Europe – for example variable annuity products.  Solvency II is aimed at developing a common regulatory standard for this fully-fledged single European market for insurance. In fact, many EEA countries had already started moving towards convergence with something similar to Solvency II – not least the UK. 

However since the 2008 global financial crisis, capital requirements proposed by Solvency II have become a good deal more onerous. This is despite the fact that the insurance industry has not been affected in the same way as banks by the financial crisis, and claim not to represent a systemic risk threat to the same extent [2]. 

The main pillar of Solvency II is a new standard capital requirement, based on a value-at-risk measure calibrated to a 99.5 confidence level at a 1 year time horizon. In other words, insurers will essentially be required to hold enough capital so that they could meet their liabilities even if they experience a financial calamity which has only a 1 in 200 chance of occurring, in any given year.  
Although large insurers often aim to hold capital at or above this level in seeking the approval of credit rating agencies, the Association of British Insurers has criticised CEIOPS’ proposals, arguing that they undermine the social and economic value of insurance products [3]. Solvency II is supposed to protect insurance policy holders against risks taken by insurance companies. Yet more conservative approaches to risk can, on a system-wide basis, easily make insurance products like annuities more expensive [4]. Lower annuity rates will lead to lower incomes in retirement for future retirees, or could lead to more people taking risks with their retirement income by rejecting the insurance cover inherent in annuity contracts. In the longer term, a regulatory-driven fall in annuity rates could further inhibit saving for retirement. Although the full implications of Solvency II are unclear, Axa has already withdrawn from the enhanced annuities market as a result [5].

There have been some signs of a lack of consensus between EEA member states. During the final negotiations over the Solvency II directive 12 months ago, the French government successfully introduced a lower ‘equity stress test’ (around 22% rather than the 40% preferred by many other countries). France faced accusations of protectionism as a result, but it is important to keep in mind that the pensions industries in different EU counties often diverge significantly – for instance, equity based savings products are becoming more popular as retirement savings vehicles in France, and would have been more affected by the stress test. Similarly, the UK has belatedly sought to rescue ‘liquidity premiums’ whereby (under current FSA rules) firms can hold lower levels of reserves if investing in more illiquid assets such as corporate bonds. This is important to the annuity sector in the UK, but opposed by many other EEA countries who saw this as a UK issue, perhaps because those countries do not have private sector annuity markets as we do in the UK. 

Overall, there are significant questions still to be answered in the design and implementation of Solvency II, and from this summer an EEA wide Quantitative Impact Study (QIS-5) is taking place to assess the solvency implication on the EEA insurance industry. This will be the first QIS since the global financial crisis and the strengthening of the Solvency II capital requirement so the results (due in 12 months) will be eagerly awaited.
While governments are surely right to seek to maintain financial stability, if in doing so they make annuities and other long term savings products more expensive, it will leave future pensioners worse off. This is a crucial issue given that NEST and the shift to defined contribution pensions more generally will expose more and more people to the annuity market (also, it means today’s savers would in practice be subsidising current annuitants who have already fixed their annuity rates). 

While stronger capital requirements mean that Governments won’t have to bail out firms over-exposed to risk, they may be left bailing out future generations of retirees who run out of money in retirement or whose annuity simply doesn’t provide an adequate income. 

Craig Berry

 1. See
 2. See
 3. See
 4. E Cannon and I Tonks (2009) Money’s Worth of Pension Annuities, available at
 5. See

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>