By Rowan Harris, Actuary at Barnett Waddingham LLP
How blithely Michel Barnier, Commissioner in charge of the Internal Market and Services, has been trying to allay our fears about the European Commission’s revision of the Directive on Institutions for Occupational Retirement Provision (“IORP Directive”). It’s all “hyperbole”, he claims; he promises “fair and proportionate” legislation. However, the outcry in the UK refuses to die down. The UK Government, the Pensions Regulator, NAPF, CBI, TUC… all are presenting a united front against proposals to change the funding rules applying to occupational pension schemes. So why are we still worried?
“Level playing field”
Adopted in 2003, the first IORP Directive was broadly welcomed in the UK. The new funding regime gave trustees the power to ensure their scheme was funded appropriately, taking into account each scheme’s circumstances. Regular monitoring and greater attention to risk has emerged, while still permitting a wide variety of investment and funding strategies. Yet these developments were barely given time to bed down(with implementation by all EU member states taking until 2007) before the European Commission decided that further action was necessary.
The problem that the European Commission perceives is that while the first IORP Directive set up a framework for pension provision across borders, there has been little take-up of this option. The Commission thinks this is because the IORP Directive is inadequate;in practice, UK supermarket Tesco has stated that differences in social and labour laws are to blame. Responding to pressure from insurers in some countries, the European Commission wants to harmonise pension provision so that occupational pension schemes administered in-house, or by third parties,are on a level playing field with those administered under insurance policies, and believes that this will enhance cross-border provision and choice.
This might work well in France, where there is already direct competition between pension schemes and insurance companies, but in the UK and the Netherlands – where the majority of defined benefit pension liabilities are located – it could be a disaster.Pension schemes are generally much smaller, and there are more of them, than insurance companies. Defined benefit pension provision is voluntary, and is not run to make a profit: that is left to the employer’s core business. And as the Euro crisis is showing, uniformity of regulation simply doesn’t work where there are differences in the underlying systems.
The proposals
Under the revised IORP Directive, defined benefit pension schemes will need to disclose a “holistic balance sheet” (see chart 1). This balance sheet aims to capture all the elements of a scheme’s assets and liabilities, including, on the asset side, the value of sponsor support and any pension protection scheme. The scheme’s technical provisions are likely to be calculated on a self-sufficiency or solvency basis, referred to as the “best estimate” value of liabilities, but with reference to swap yields rather than the scheme’s actual investments (and so not a best estimate based on the expected normal course of events). Schemes may also be required to hold additional capital to cover risk margins.
What this all means in terms of cash contributions to UK defined benefit pension schemes is unclear. Much of the detail that would allow us to quantify the impact, such as changes to recovery plans and capital requirements, has yet to be agreed. The European Insurance and Occupational Pensions Authority (EIOPA) is giving advice to the European Commission on policy options, but the final decisions will rest with the politically motivated Commission.
Working at cross-purposes
The European Commission is committed to pushing through a revised IORP Directive before the change in presidency in 2014. This means that EIOPA has not had sufficient time to formulate its advice. Documents running to hundreds of pages have been published with too short a consultation period, and a single impact study is proposed. That impact study is itself flawed. It considers only whether Solvency II-style calculations are possible for pension schemes, and side-steps the awkward question of the financial impact on hard-pressed pension schemes and their sponsors. The flaws extend to the calculations themselves, which will be based on inadequate data and parameters.
It is deeply concerning that the European Commission is rushing through such a fundamental change to regulation. Legislation affecting the retirement income of millions of people deserves greater scrutiny.Looking at the big picture here risks losing sight of the public interest – the effect on employees’ pensions. If the Commission truly wishes to improve pension provision across Europe, it must consider properly the costs and benefits of its proposalsat the level of individual pension scheme members.
Unnecessary tinkering
The proposals, as they stand, are an over-reaction to a non-issue.The current IORP Directivehas proven to be robust while also permitting flexibility, and the European Commission should resist tinkeringwithout properly considering the nature of pension provision in each member state. Good regulation should not sacrifice long term provision for the sake of short term security.
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