The pressure on the European Commission has continued to mount over its proposals to codify the valuation of funded DB pension fund assets and liabilities across the continent, and to apply Solvency II-style solvency capital requirements on funds.
Analysis last month by the Pensions Regulator showed that, in the most likely scenario, fund deficits would increase by £150 billion. This arises simply from a change in the calculation of technical provisions, which adds £500 billion to deficits. The Regulator is allowing, however, the full amount to be offset by £350 billion, that is, its estimate of the value of sponsoring employers’ role. The EU quango responsible for the proposals, the European Insurance and Occupational Pensions Authority (EIOPA) recently admitted that how to value sponsor support requires far greater consideration.
Sponsoring employers are currently making deficit contributions of around £15-20 billion per year, to plug an aggregate deficit of around £230 billion. Adding £150 billion to this figure would devastate recovery plans as they stand.
It would almost certainly result in more scheme closures, or the closure of more schemes to future accruals. The Regulator’s analysis suggests that, if the Commission’s proposals are implemented, less than 5 per cent of DB schemes will remain open to new members, and less than a quarter will remain open to future accrual. Following an Autumn Statement announcement, it is likely that the Regulator will be given a new statutory objective to consider the long-term affordability of recovery plans for sponsoring employers. This is ostensibly good news, insofar as it enables schemes to remain open rather than enter the Pension Protection Fund, but in combination with the Commission’s proposals it could actually have the reverse impact.
It is worth noting that the £150 billion figure actually excludes the impact of a full solvency capital requirement being implemented by the Commission. If Solvency II was applied in full to pension funds, the funding shortfall would rise instead to £400 billion. Goodnight Vienna.
The Regulator is right to worry about the impact on DB schemes and their members (and of course the Pension Protection Fund). But Oxford Economics, in research funded by the CBI, has this week released a report which considers the wider economic impact on the UK. The headline results are that, other things being equal, the Commission’s proposals would be 5.2 per cent lower than it would otherwise be in the mid-2020s, with a shortfall of 1.4 per cent still being felt in 2040.
This is based on the calculation that, if introduced in 2020, the proposals would create a capital demand on sponsoring employers of around £350 billion. If firms were to seek to plug this deficit over ten years, it would require them to make additional contributions of around 7.9 per cent of total employment costs for each of the ten years.
Overall, according to Oxford Economics, UK GDP would be 2.5 per cent lower in the mid-to-late 2020s, and would still be 0.6 per cent lower in 2040. There are of course many factors that might affect business investment and overall growth over this time period, and we cannot be sure that the OBR’s baseline projections will come to pass anyway, but if the researchers are right in terms of evaluating the impact of the Commission’s proposals in isolation, we should be gravely concerned.
There was some slightly better news from EIOPA last month when its chairman Gabriel Bernardino hinted that personal pensions would be brought into the EIOPA remit. Among the many flaws in the Commission’s proposals are that they only apply to occupational DB schemes. Many UK pensions savers are now in non-occupational DC schemes (a.k.a. personal pensions) and therefore receive far less regulatory protection.
This is not to suggest, of course, that it would be a good thing to apply Solvency II to personal pensions (in fact, the original Solvency II already applies to personal pensions in many ways because they are most often provided by insurance companies – this is one of the factors depressing annuity rates at the moment). But it would mean that, were the Commission’s proposals to lead to a flight from occupational schemes, low-quality personal pensions might be a less hospitable destination.