EIOPA will give their final advice to the Commission in mid-February on the reform of the IORP Directive, with a view to publishing a draft Directive later in the year. While this may sound very technical, the outcome of the consultation could be pivotal – and extremely adverse –for UK defined benefit (DB) pension schemes and the wider European Union economy. It is an issue that significantly concerns the TUC.

Various studies have estimated that the outcome of the proposals in the EIOPA consultation could significantly increase the costs of DB pension scheme liabilities and ultimately result in scheme closures. DWP estimate that total UK pension scheme liabilities could increase by over £100billion. Others put the cost much higher, for example JP Asset Management put the figure at £600billion. This is very worrying for scheme members who may have no alternative source of pension saving, or if they do are likely to have a less generous replacement defined contribution (DC) scheme where members are exposed to risks.

So why is the Commission looking to review the IORP Directive? A key theme running through the consultation is that there a desire for consistency across IORPs and financial institutions, and for harmonisation in the regulation of funded occupational pension schemes and insurance.

As the EU authority for both occupational pensions and insurance, EIOPA will adopt a consistent approach to both sectors. Differences in approach between both sectors will need to be justified. (p. 9)

We are very concerned that the European Commission has asked EIOPA how scheme funding requirements should be further harmonised, not whether they should be harmonisation. The Solvency II Directive (2009/138/EC) applies to annuities and the management of contract-based pension schemes provided by insurance schemes. The Solvency II Directive fundamentally reforms capital requirements for insurers and reinsurers across the EU, and it is currently expected to come into force in 2014. Solvency II places a lot higher funding requirements on insurance schemes than on pension schemes as they operate on a short-term basis.

There are major concerns regarding the implications of Solvency II for occupational pension schemes. Harmonisation of regulation for occupational pension schemes and insurance, and Solvency II being the default regulatory framework except where justified could have very serious implications for DB schemes. We do not think it is appropriate to apply a solvency regime relevant to financial service companies providing insurance to occupational pension schemes. Occupational pension schemes have long term predictable liabilities. The application of a Solvency-II inspired regime would increase DB occupational pension scheme liabilities by 20-30%.

While the EIOPA consultation did not propose the direct application of Solvency II capital requirements to DB schemes it presented the idea of a ‘holistic balance sheet’. The EC’s intention of the holistic balance sheet is to record on a consistent basis both assets and security mechanisms, including both on and off balance sheet items. For example in the UK this would include the employer covenant and the Pension Protection Fund alongside pension scheme assets and liabilities. However, we are concerned that this idea is inspired by Solvency II and would significantly increase scheme’s technical provisions (the value of its liabilities). Furthermore, it is not a tried and tested approach.

Under the current IORP Directive schemes are not required to value a scheme’s technical provisions at a risk-free discount rate (discounting is the amount of future payments, expressed in today’s terms). However, the consultation examines valuing a scheme’s technical provisions on a risk-free rate basis.

The Commission would like the valuation of assets, technical provisions and other liabilities to be market consistent and based on sound economic principles ie. made according to the ‘fair value’ principles adopted for Solvency II ie. that both assets and liabilities would have to be assessed on market consistency principles (p.76).

Market consistency to value liabilities and assets means that market prices are used where available on a mark-to-market, or fair value basis, to indicate their current market value. The downside of market-consistent valuation is that it generally leads to a high volatility of results. Furthermore, market-consistent risk-free rates do not sit well with the long-term nature of IORPs. The use of a market consistent risk-free rate to calculate technical provisions (which is central to the idea of a Holistic Balance Sheet) would place greater pressure on schemes and ultimately lead to a high level of DB closure.

Given the diversity of pension provision across the EU, the application of a harmonised Solvency II-derived regulatory framework to insurers and funded occupational pension schemes is both undeliverable and undesirable. The UK already has a robust system of member protection in place for DB schemes underpinned by the employer covenant, the work of the Pensions Regulator and the Pension Protection Fund.

We are also concerned about the adverse impact a revised IORP Directive could have on the EU economy. Given the current European economic situation the potential impact of a revised IORP Directive could be particularly unwelcome. De-risking of investment portfolios, as pension schemes move from equities to risk-free investments could negatively affect economic growth, investment and destabilise capital markets.

The consultation also had no accompanying full impact assessment and evidence setting out the detailed case on the need for the reforms. For example, at present there are only 84 cross-border IORPs of around 140,000 IORPs in the EU and the Commission would like there to be more. The Commission and EIOPA have provided no detailed evidence demonstrating why the regulatory framework should be amended. Our view is that the low number of cross-border schemes is not due to the wording of the Directive needing to be changed. Instead, it is due to lack of demand, and the different pension systems and tax regimes that exist in Member States. It is very concerning that decisions may be taken without a full impact assessment and evidence being provided. Indeed, when an impact assessment is published it is understood it will not examine all aspects of the consultation.

The Government’s amendment means that the 33,000 women who would have worked two years longer than they expected to receive their Basic State Pension will no longer have to do so. However there will still be many thousands of women who will work up to 18 months longer than they originally expected to receive their Basic State Pension. In making this change to women’s SPA the Government has broken the Coalition Agreement.

The Pensions Bill brings forward the increase in the SPA to 66 by six years. The Pensions Act 2007 originally set out that it would increase to 66 between 2024 and 2026. Both women and men are affected by the bringing forward of the SPA, but it particularly affects women aged 56 and 57. Furthermore, in September, the Pensions Minister announced that the increase in the SPA to 67 and 68 will be brought forward.

There are two stages for increasing the SPA set out in the Bill. Firstly, equalisation of the increase of the SPA between men and women will be accelerated from April 2016, so that women’s SPA reaches 65 by November 2018. This will be followed from December 2018 by the increase in the SPA from 65, reaching 66 by April 2020. The Government amendment changes this so that men and women reach 66 by October 2020.

DWP analysis shows that the increase in the State Pension Age falls disproportionately on women, disabled people and possibly on certain ethnic groups.

Increasing the SPA affects people on lower incomes more because they have a shorter life expectancy and they therefore lose a greater proportion of their state pension payments. Better off pensioners will have other pension resources and other assets. An increase in SPA will therefore have little impact on their retirement age.

Furthermore, people on lower incomes are more likely to have health issues or to have physically demanding jobs that make it harder for them to work longer. And they are often totally dependent on state pensions, particularly women. The 2011 Scottish Widows’ survey of pension provision found that only 51 per cent of women in 2011 are making enough provision for their retirement.

And Age UK’s recent survey of women aged 50 to 57 found that 23 per cent of women could not work longer because of health problems, 15 per cent were counting on having more time in retirement for their caring responsibilities and 8 per cent were unemployed with little chance of finding a job.

However we welcome another Government amendment to the Bill which provides greater powers to cap pension scheme charges for deferred members, thereby enabling the Government to protect all scheme members from high charges, not just active members.

This goes some way to addressing the matter of active member discounts, or what consumer groups and unions term ‘deferred member penalties’, where scheme members are charged more on leaving an employer. We are also aware of some employers requiring leavers to transfer out of their pension. While this is welcome move by the Government and indicates Ministers are listening to concerns we would like the Government to act now rather than to keep it as a reserve power should they wish to use it in the future.

He said

“once we’ve gone from the DB extreme where the employer shoulders all the risk, to the DC extreme where it’s all borne by the member, hopefully we can push it back a little bit.”

We know that occupational pensions and coverage in the private sector has – unfortunately – declined. The closure of DB schemes to new members and to future accrual for existing members continues to be seen. And all too frequently good quality DB schemes are being replaced by less generous DC schemes where all the risk is placed on members. The average employer contribution rate for DB occupational schemes is now 16.6%, compared with 6.1% for DC. And by 2010 only 39% of male employees and 28% cent of female employees belonged to an employer-sponsored pension scheme in the private sector, compared with 52% and 37% respectively in 1997.

The coalition agreement said

 “We will simplify the rules and regulations relating to pensions to help reinvigorate occupational pensions, encouraging companies to offer high-quality pensions to all employees”

DB schemes provide the most secure pension provision for scheme members. But a middle-ground between employers closing to DB and moving to pure DC (where all the risk is placed on members) would be welcome. The key question is what the Government actually does to stimulate risk-sharing and encourage occupational pensions.

The TUC has always accepted the case for a regulatory regime for occupational pensions that makes schemes easier to run. However, we are not persuaded that the level or extent of regulation has been a major cause of the problems with DB schemes, or the move from DB to DC schemes. We do not want to see a lightening of regulation that will result in employers reducing members’ pension benefits or the closure of DB schemes – reducing regulation under the guise of increasing risk-sharing could simply act to further reduce pensions provision rather than improve it.

So, in examining risk-sharing the Minister should be guided by three questions: Will it encourage employer engagement in good quality pension schemes? Will it produce pensions at adequate levels? What control and protection will scheme members have within any envisaged new schemes? We await with interest further details of what the Minister intends to do.

Two key findings are the growing shift to defined contribution provision, and the change from RPI to CPI to uprate private sector schemes. The latter has resulted in a significant shift in the value of pension liabilities. The aggregate FTSE 100 pension deficit now stands at £19bn, down from £51bn on the previous year. But, as LCP recognises, this is at the expense of scheme members. If CPI were to average 0.75% per year less than RPI, a pensioner retiring at age 60 on 10,000 per year would see their benefit eroded by nearly 1,200 per year in today’s terms by the time they reach age 75.

The difference is even more significant for a deferred pensioner whose pension has yet to come into payment. According to LCP a 45 year old expecting RPI uprating up to retirement and during retirement could lose around a quarter of the value of their pension.

Not all companies are affected to the same degree as a result of the change to CPI for private sector schemes as it depends on the wording of the scheme’s rules, but for example, BT has had a huge reduction in its scheme liabilities of £3.5billion. The TUC continues to oppose the change to CPI for all pensions and benefits.

Another noteworthy finding is the continuing shift to defined contribution pensions. Fifteen more companies closed their final salary schemes to future accrual in 2010 or announced their intention to do so. The survey doesn’t examine the type of pension held by different types of employees, but this is something that both the TUC and ONS have explored is further detail.

The ONS Pension Trends survey recently showed that membership of employer-sponsored pension schemes is closely related to income. Employees with high earnings are more likely to be a member of a pension scheme than those lower down on the wages ladder. In 2010, only 16% of male and 27% of female full-time employees earning less than £300 per week belonged to a pension scheme.

The TUC’s own PensionsWatch examines director’s pensions. In 2010 it found that the highest paid directors in each company have pension pots worth £5.26 million, providing an average annual pension of £298,503. The average director’s pension is now 26 times the average occupational pension (£8,736).

The survey also showed that despite companies continuing to move away from defined benefit(DB)  schemes for ordinary staff, the majority (54%) of top directors are still in DB schemes and many directors are in more than one scheme. Nearly two thirds of companies (63.5%) provide DB schemes for at least some directors. The most common accrual rate was 1/30^th – far more generous than the 1/60^th to 1/80^th typical for the majority of ordinary scheme members.

For directors in defined contribution (DC) schemes, the average company contribution was £134,760 and the average contribution rate was 19%, around three times the rates normally available to employees (6.7%).