Towers Watson has welcomed the European Commission’s announcement that it will not seek to impose insurance-style capital requirements on defined benefit pension schemes – at least for the time being. The consultancy predicted this outcome in a note published earlier this month.
Although UK employers will be relieved that there has been a reprieve, Towers Watson warns that celebrations should be muted. Although the Commission might find it difficult to reintroduce capital requirements, it has signalled that it wishes to leave open the possibility. In the meantime, the rules that the Commission does envisage introducing could still involve significant operational costs and upheaval.
The ‘big’ battle won: no new capital requirements (for now)
Dave Roberts, a senior consultant at Towers Watson, said: “For some employers, it may seem that they are waking up from a nightmare. The proposed measure of deficits could have made UK shortfalls look up to £450 billion bigger, but it was never made clear what employers would have to do in response. Even if they could afford to pay more money into the scheme, this might not have made the deficit any smaller because the employer’s ability to support the scheme in the future already counted as an asset under the proposed ‘holistic balance sheet’ approach.”
“Thankfully, the Commission has listened to the UK, Germany, Ireland and the Netherlands. These countries came together to engage with the Commission and were quietly picking up support from others to block the expected proposals. Rather than shouting their objections to the funding rules from the side-lines - and drowning out each other - the group presented a coherent argument opposing the Commission’s plans. Their approach has been successful and may usefully serve as a blueprint for the future.
“The Commission also faced an unwinnable race against the clock to nail down funding rules in time to include them in a new Directive before next year’s European Parliamentary elections and a change of Commissioners. It had been advised by pension supervisors that a lot more work needed to be done and that this work needed more time.
“New solvency rules for pensions will not feature in the revised Directive covering Institutions for Occupational Retirement Provision (IORPs), but work on these will continue and the issue will be re-examined under the next Commission, which takes office after next year’s European Parliamentary elections.”
The ‘small’ battles matter too
Commissioner Barnier confirmed today that he still intends to push through a revised IORP Directive and that this will consider schemes’ governance requirements and what they must disclose to regulatory supervisors and members.
Roberts said: “There has been a casual acceptance that this would be an acceptable compromise for dropping the ‘funding pillar’, because it was the capital requirements that produced the scary numbers. Instead of relaxing and indulging in ‘victory’, the UK pensions community now needs to turn its attention to what these governance and disclosure requirements might mean. The ‘big’ battle may have been won, but the ‘smaller’ ones matter too.
“There is also a risk that, in the absence of the direct capital adequacy requirements, something similar could be introduced indirectly. In some countries, not all occupational pension funds can call on sponsor support. Those that cannot may have to carry out a full Own Risk Solvency Assessment (ORSA). European Insurance and Occupational Pensions Authority (EIOPA) has suggested that only a ‘diluted’ ORSA might be needed where an employer stands behind the promise, as in the UK, but this advice anticipated that there would be new capital requirements and so the Commission could choose not to follow it. A full ORSA could yet apply to UK schemes also, in which case higher capital requirements could be introduced ‘through the back door’.
“A key question is whether information will be required to be submitted to supervisors at frequent intervals or only in response to requests that can only be made by supervisors in limited circumstances. Both the Commission and EIOPA are on record as bemoaning the absence of EU-wide pension scheme data during an economic crisis, so there may be a temptation to make schemes provide a lot of information very frequently, for example in relation to the detail of their asset holdings and transactions undertaken.
“Increased governance and disclosure requirements, while unlikely to approach the eye-watering costs that we’ve seen in relation to potential capital requirements could still lead to significant upheaval.”
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