Today is the deadline for submissions to the European Insurance and Occupational Pensions Authority (EIOPA) consultation on the methodology for its quantitative impact study (QIS) on its proposed approach to a new EU pension fund directive. The TUC is standing side by side with a range of UK-based stakeholders, such as the CBI, the ABI and the NAPF – as well as DWP and HM Treasury – in opposing the new directive.
And we believe that the QIS exposes inherent flaws in EIOPA’s approach. Essentially, the European Commission wants to apply Solvency II, new insurance regulations which stipulate (among other things) the level of capital that must be held by insurance companies in order to mitigate risks, to defined benefit pension funds. One of the principal concerns of UK stakeholders is that the validity of this objective has never been put to formal public scrutiny. As such, the Commission has asked EIOPA how Solvency II can be applied to pension funds, not whether this is the correct approach.
In response to this challenge EIOPA has produced the ‘holistic balance sheet’ (HBS). Crucially, defined benefit pension schemes, especially in the UK, enjoy forms of security much less tangible than those available to insurance undertakings; specifically, the existence of the sponsor covenant (i.e. the support of the employer sponsoring the pension scheme), and government-backed pension protection mechanisms (such as the PPF in the UK).
In its insistence on codifying occupational retirement provision across the continent, EIOPA insists that these mechanisms be treated as scheme assets. The TUC believes this would fail to capture the unique nature of the UK pensions system and its security arrangement. There is a significant risk that these ‘assets’ would be undervalued – reliant as they are on trust-based relationships that are unquantifiable. Similarly liabilities could be overvalued as EIOPA seeks to introduce a uniform approach to measuring liabilities, undercutting the more sophisticated approaches taken by trustees and the Pensions Regulator. The HBS approach could therefore significantly exaggerate scheme deficits, further undermining defined benefit pension provision.
On the other hand, given the inherently subjective nature of the calculations that EIOPA wants pension funds to undertake to value sponsor covenant and pension protection schemes, there is also the considerable risk of ‘pseudo security’ as schemes undertake complex and costly valuation exercises to produce results that tell us very little about the actual financial and economic circumstances that pension funds find themselves in.
The HBS, if implemented through a revised pension fund directive, would be a significant administrative burden on pension funds – one that cannot be justified given the expected lack of reliability of the results. Simply undertaking the QIS, through which the HBS will be finessed, would be a significant burden upon pension funds. Given that fully participating in this exercise will be very expensive for the majority of schemes, those that participate could be a biased sample of large pension plans, that is, those that can more easily absorb the costs.
The inclusion of solvency capital requirements (SCR) in EIOPA’s proposals is indicative of the extent to which they are based on Solvency II. Yet a solvency regime similar to that required by financial services companies providing insurance schemes is not the same as that required by defined benefit pension schemes that have long-term predictable liabilities and are backed by a participating employer. Furthermore, most UK funded pension schemes are geared towards achieving buyout-level funding, which is below that required by an SCR-based system. And once bought out, schemes would become subject to an SCR at a more appropriate stage as they would come under the regulatory umbrella of the insurance regulations.
Perhaps the most alarming potential implication of the proposed directive concerns the wider economic impact. Defined benefit pension funds are major long-term investors. If the HBS approach leads to more scheme closures or, just as importantly, a de-risking of pension fund investment portfolios, this could negatively impact investment, destabilise capital markets and ultimately affect economic growth across Europe. There seems to be a significant discrepancy therefore between the pension fund proposals and the European Commission’s Growth 2020 agenda.
Indeed, Commissioner Michel Barnier – responsible for the EU internal market, and the main backer of the pension fund proposals – has promised a green paper on promoting long-term investment, in response to concerns about the impact of Solvency II on the ability of financial services companies to support economic growth. This is very much welcome – and we hope that some of the lessons learned can also be applied to Barnier’s plans for pension funds.
There is certainly a role for the European Union in pensions provision. EIOPA has so far imported only the first ‘pillar’ of Solvency II, on financial requirements, into its plans for pensions. While we believe this is hugely problematic, European initiatives across the other two pillars – which concern governance and communications – could in fact be beneficial to pensions provision in the UK, across both defined benefit and defined contribution pensions.