States will struggle to match EU aspirations with market realities
Suggestions within the EIOPA consultation indicate pressure to align the IOPR Directive with Solvency II (SII), says Mercer. The consultancy believes that if implemented, these elements could add substantial cost to the UK’s DB pension provision and send pension systems and sponsors into limbo as nation states struggle to reconcile EU aspirations with local realities.
Mercer welcomes the development of a stronger governance and risk control framework as beneficial for plan members, shareholders, and local guarantee funds, such as the UK’s Pension Protection Fund. However, the consultancy believes that any move to impose a one-size fits all solution to pan-European pensions will place further costs on European businesses and is entirely unsuited to the vagaries of local European pensions markets. The consultancy has also pointed out that the consultation suggests new challenges placed on trustees which may herald the end of the UK’s lay trustees.
“The consultation covers all aspects of the IORP Directive, making it unwieldy and lacking in focus. Part of it relates to the requirements imposed on Pan-European pensions. These are of great interest to our clients, so we welcome anything that facilitates their development, but practical solutions to the particular difficulties they face risk getting sidelined by the drive towards harmonising regulatory approaches,” said Dr Deborah Cooper, head of Mercer’s regulatory Team.
“The sheer complexity of the document makes providing a considered and consistent response a mammoth task. Since there is no impact assessment attached, we are concerned that the pressure to align the IORP Directive with Solvency II risks losing sight of the financial consequences for employers in the few countries with funded defined benefit schemes, who will be most affected by proposals.”
According to Mercer, while it is too simplistic to say that EIOPA is proposing to apply (SII) to pension schemes without recognising the differences between them and insurance companies, there are indications in the consultation that the sentiment is there. According to the consultancy, proposals to include extra margins over and above technical provisions in the balance sheet - similar to solvency capital requirements - risk ignoring employers’ objectives when they sponsor pension provision for their employees, which are different from those providing insurance products.
Were SII to be applied without taking into account pension scheme’s different characteristics and objectives, the cost of maintaining the same level of reserves in their pension schemes as currently fall upon insurance companies, would be prohibitive and drive many companies to insolvency. As it is, the current proposals are already estimated to add additional costs to the provision of DB schemes in terms of disclosures, trustees’ qualifications and the complexity of the regulation.
“Asides from the additional capital cost implications that this has,” says Dr Cooper, “it took a long time for EIOPA to implement SII, and national regulators are still working with local insurance companies to establish local regulatory procedures. If that is anything to go by, depending on the approach adopted for the revised IORP Directive, the challenges posed would take so long to implement that employers still committed to DB provision might consider altering their pension schemes to avoid the costs involved in sorting it out.”
“Each local market and their pension arrangements are as different as snowflakes; a one-size-fits-all approach will not work in every case.” concludes Dr Cooper.
To address differences between pension schemes and insurance companies, the consultation suggests that scheme managers should have to place a 'value' on company’s covenant which auditors will sign off in scheme accounts. Leaving aside the difficulty of valuing a covenant, practices such as these will require sophisticated understanding of company structures.
“This may herald the end of the UK’s reliance on lay trustees,” said Dr Cooper, “and this is simply one impact in one area of the UK’s pension environment. EIOPA has a mammoth task in devising a single regulatory regime that will fit the number and variety of pension schemes found throughout the EU. If left unchallenged, the most likely outcome of this Sisyphean task is that pension scheme sponsors will find themselves gridlocked as national regulators struggle to apply EU concepts ill-suited to pension arrangements in local markets.”
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