Pension Funds Keep Up Their Guards

Legislative initiatives in the European Union are pushing the financial services sector towards more centralised supervision and greater focus on consumer protection. So the future of the pensions market will depend on where institutions for occupational retirement provision (IORP) fall on the regulatory map.

A pressing issue for pensions industry associations is whether the Solvency II directive – a fundamental review of capital adequacy and risk management standards for Europe's insurance industry – will be applied to IORPs. Industry associations feel that to put pension funds under the same umbrella as insurance products shows a basic misunderstanding of how the two markets differ and does not take into account the regional differences in pension markets throughout Europe.

"The issue of Solvency II for pension funds is very topical and very sensitive. It would be in the best interests of the pensions market if legislators looked at what fits with each area. We feel that insurance deals and pensions are totally different, and I say that as someone who sits on the board of an insurance company," says Jaap Maassen, vice chairman of the European Federation for the Retirement Provision (EFRP).

EFRP concerns

Its lobbying work at national and EU level puts EFRP centre stage in the debate on how Europe’s pensions industry should be regulated. Respect for the diversity in pensions systems across the EU is among the organisation's core values. At the same time, it works to bring its membership together around common goals: the provision of secure, affordable pensions and a focus on private pension provision.

"An insurance deal is set in concrete. You can’t change the premium. With a pension, there are more variables – you can change your contribution or the structure of the deal. Pensions also have a longer-term view, so a different legislative regime should apply," explains Maassen.

EFRP's view is that the diversity of workplace pensions and their regulatory requirements are not hampering the internal market for workplace pensions. Its stance on Solvency II is that its application to defined benefit and hybrid pension schemes would make them too expensive for employers to offer, which would undermine the long-term safety and sustainability of workplace pensions. So, it is now calling on MEPs to think twice about the directive.

Evading the blow

Encouragingly, there are signs that the European Commission is listening, but insurance companies are less keen to see pensions treated differently and are lobbying in Brussels, too.

"They see their market share growing if the same rules apply to pension funds. They want pensions to offer the same security as insurance products but we have persuaded the Commission that this is not a good idea," notes Maassen.

He can back up his claim with hard numbers. To illustrate the damage Solvency II could do the pensions market, its parameters were applied to ABP – the world's second largest pension fund with assets totalling €200bn – of which Maassen is a board member. The results were striking. Solvency II rules would mean ABP selling 30% of equities and switching that investment to fixed income products. This would trigger the sale of €60bn in shares on equity markets, which he feels could pose a risk to financial markets with similar sales.

The fund would have to turn away from the higher returns offered by equity markets towards the greater stability of fixed income investments in order to increase its buffers in accordance with new solvency criteria. ABP, Maassen believes, would have to sacrifice some of its returns, which have averaged 8% over the last 12 years – the kind of figure insurance companies would love to match.

"Insurance companies are better at tailor-made deals, but for collectivity and solidarity pensions can't be beaten. Extra buffers would hurt workplace pensions, which would hold less equity, have lower returns and ultimately provide lower pensions. In some countries final pensions might fall by 30-40% and funding levels would have to be increased by 40-60%."

Those countries notably include the UK, the Netherlands and Ireland, which have a large capital base compared to the likes of France, where insurance companies rule. Maassen's plea to regulators, therefore, includes the need for regulation to reflect the different characteristics of each EU member state.

He feels this is especially important as countries in Central and Eastern Europe build structures for pension provision. EFRP's CEEC Forum, which focuses on the needs of countries new to the EU, gives it a clear view of this market development through its ten members – Bulgaria, Croatia, Czech Republic, Estonia, Latvia, Lithuania, Hungary, Slovak Republic, Slovenia and Romania – and deepens the organisation's belief in the need for common terminology and values to be defined across Europe.

IORP is getting to its feet

As important as EFRP's warning to hold back on applying Solvency II to pension funds is its call to give the existing IORP Directive more time to prove its worth. This directive was adopted in 2003, but was not fully implemented until mid-2007 and consequently has not had time to bed down. Maassen perceives the IORP directive as a modern and comprehensive principle-based prudential framework for pension funds, delivering liberalisation of investments and custodians, improving cross-border services to make pan-European pension funds possible – while putting in place appropriate supervisory standards. Its implementation, however, has been slow.

Maassen believes that solvency rules for IORPs should reflect the individual characteristics of different types of pension deals, incorporate flexible parameters for contributions and indexation, define the role of social partners and sponsors in the governance structure, and take into account national variations in regulation and solvency requirements.

Defining these parameters, he feels, will be easier if the market has time to work through the implications of the IORP directive, but Solvency II would deal a blow to the market from which some pension funds would not be able to recover. He is urging the European Commission to stand by its political decision of 2003 to adopt a separate set of rules for IORPs with a minimum level of harmonisation.

There is a lot at stake in a pensions market that has seen its share of pressures in recent years, so EFRP and the industry associations that share its view on Solvency II will not throw in the towel.