The European Commission has dropped proposed solvency requirements from an overhauled pensions directive that will be put forward this autumn.
The Institutions for Occupational Retirement Provisions directive, which is aimed at improving the governance and transparency of pension schemes in the European Union (EU), will no longer include the issue of pension fund solvency.
Previous measures proposed under Solvency II rules, had been opposed by the UK government, due to concerns around significantly increased costs.
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The Quantitative impact study on institutions for occupational retirement provision (Iorps): preliminary results for the European Commission, published by The Pensions Regulator and the European Insurance and Occupational Pensions Authority (EIOPA) in April 2013, showed the Europe-wide rules could increase UK DB pension deficits by around £150 billion.
Michael Barnier, the commissioner responsible for internal markets and services at the European Commission, said the directive will not cover the issue of the solvency of pension funds, and that there is a need to deepen knowledge before taking decisions on any European initiative on the solvency of pension funds.
“This proposal will not cover the issue of solvency rules for pension funds, which will, for the time being, remain an open issue,” he said.
“In my view, the situation should be re-examined once we have more complete data.
“I emphasise that with regard to solvency rules, we must not lose sight of the need to guarantee in the longer term a level playing field between different providers of occupational pensions.”
This was a very significant announcement from Commissioner Barnier and a huge relief both to UK employers with defined benefit pension liabilities and to all those who have an interest in the investment strategies of occupational pension schemes.
It was expected that the solvency rules would force occupational pension schemes to shift away from long-term view of investment risk and avoid equities by matching investment strategy to the movement in liability values linked to a risk-free discount rate. Abandonment of these proposals will allow pension schemes to focus more appropriately on the long-term nature of their liabilities and investments.
The focus of discussion of the review of the European pensions directive has been very much on the solvency requirements because the impact of these was expected to be so material for markets and for employers with defined benefit pension schemes. It is good that the concerns raised by the pensions industry, employer groups, trade unions and affected member states, such as the UK, Ireland, Germany, the Netherlands and Belgium, have been taken on board.
Occupational pensions in the UK, in particular, are not ‘like’ insurance products because they are not marketed in the same way and principally provide security for a pension promise made by an employer to its employees in the context of an employment relationship.
Commissioner Barnier states that he will press ahead with the less controversial governance and transparency provisions. These currently propose more consistency of supervision for occupational pension schemes across the EU which may lead to increased transparency requirements for The Pensions Regulator in the exercise of its supervisory powers. Some of the governance proposals, such as the requirement for trustees to carry out an ‘own risk and solvency assessment’, are linked to the abandoned solvency proposals, so these elements will need to be reviewed now that the solvency rules are not being changed.
There is also a provision for the revision of the definition of ‘cross-border activity’ which may lead to schemes with overseas guarantors being treated as operating cross-border and being therefore subject to more stringent funding requirements, under the current directive. This is still one to watch.
The Commission has listened to the outcry from businesses about the crippling £450 billion cost of applying a Solvency II regime to pensions.
We’ve long campaigned against the proposal, saying it would harm companies’ ability to invest, with devastating effects on jobs and growth.
While we welcome this decision to drop additional funding requirements, businesses will want to ensure the other conclusions of the review do not heap unnecessary additional costs on employers.
We welcome the announcement that the proposals for funding and solvency requirements for pension schemes are not being pursued in the short term. The preliminary analysis published by EIOPA had demonstrated both that the impacts could be significant, and also that much work still needed to be done to make the holistic balance sheet a credible concept.
At the same time, the statement makes it clear that solvency will ‘remain an open issue’. This suggests it is likely to reappear at some point in the future. The Commissioner notes that there is still a ‘need to guarantee in the longer term a level playing field between different providers of occupational pensions’. This means that, perhaps, the idea of the holistic balance sheet has not yet gone away for good.
The proposed revisions to the IORP directive will now cover only governance and disclosure. Although we have fewer concerns about these areas, we still need to see the detailed proposals. There could still be significant administrative costs for pension schemes in the pipeline.
Employers sponsoring pension schemes will be greatly relieved that the damaging proposals that would have greatly increased pension funding requirements have been set aside. The Pensions Regulator estimated as part of a Europe-wide impact study that UK occupational pension schemes as a whole would have needed to raise an extra £150 billion compared to the current funding regime, and meet the costs of carrying out the complex calculations involved. This would have accelerated the demise of quality pension provision and undermined the UK’s competitiveness.
Commissioner Barnier says that the issue of solvency rules should be re-examined in future. We remain unconvinced of the rationale for change, however, we hope that the European Commission will give proper consideration to proportionality and the unique circumstances of occupational pension schemes in putting forward any revised proposals for capital requirements.
Meanwhile, the European Commission will proceed with the other aspects of the review of the directive, namely governance and reporting requirements, with a proposed directive planned for autumn 2013. This is likely to result in a much-increased focus on risk management and changes in the way trustee boards work. It seems that pension schemes, and sponsoring employers, will still have plenty of issues to get to grips with in the coming years.
We welcome this decision, but it’s important to remember that the Holistic Balance Sheet proposals are just one part (Pillar 1) of the European Commission agenda for extending to pension schemes the Solvency II requirements that are being developed for insurers. Opposition to this approach has been focused on this part of the proposals because it was seen as potentially the most damaging. This means that to date there has been little discussion of the other Commission proposals.
The European Commission also confirmed today that it intends to proceed with its proposals to extend the Pillar 2 requirements (relating to the governance and risk management) and the Pillar 3 requirements (relating to standardised disclosures to supervisors and to members) from Solvency II across to pension schemes.
Although the high level Pillar 2 and Pillar 3 proposals look at first sight to be motherhood and apple pie, the detailed requirements for insurance companies have caused them a lot of work. Unless the requirements are adapted appropriately for pension schemes, which are generally much smaller and simpler than insurance companies, they will be unduly onerous, particularly for smaller schemes.
The great diversity of pension systems across the EU makes it very difficult to devise a one-size-fits-all system. We welcome Commissioner Barnier’s sensible decision not to go ahead with new rules on pension scheme funding. This is good news for British pension schemes.
The proposals could have increased UK defined benefit pension deficits by 50%, causing great damage to pension schemes and their sponsoring employers.
We welcome this change of heart by the European Commission. If they had followed through on their proposal that pension schemes should hold a significant amount of surplus capital to cover contingencies it would have not only had a devastating impact on remaining DB pension schemes and the employers that sponsor them, but also had a detrimental impact on DC schemes.
While the news is excellent, we need to remain vigilant that the new Commission, which will take office late next year, doesn’t try it on again.