This month's Off The Record considers the question of whether second pillar pensions are over regulated, and whether over-regulation may be damaging defined benefit (DB) pension schemes in particular.

In the UK, concern about the over-regulation of defined benefit (DB) occupational pensions has been growing. In a poll by the National Association of Pension Funds (NAPF), two thirds of the country's providers of occupational pension schemes said that the need for deregulation was their biggest concern for the future - far ahead of improving longevity and pension scheme deficits.

Over-regulation is blamed for the demise of the DB schemes. An independent report for the UK's Department for Work and Pensions, by Chris Lewin, former head of UK pensions at Unilever, and Ed Sweeney, former joint deputy general secretary of trade union Amicus, argues that one of the important reasons for the flight from DB schemes in recent years has been the ever-increasing regulatory burden. They recommend removing or easing regulatory obstacles in DB schemes that are hindering sensible courses of action by companies.

The danger of over-regulation of the second pillar is causing concern among providers of occupational pension funds in continental Europe. The European Federation for Retirement Provision (EFRP) says that occupational pensions must not become over-regulated and costly if they are to survive and prosper.

Others argue that regulators are too concerned with ‘fixing holes' - tackling individual issues but neglecting the overall picture. Examples of flawed regulation include solvency requirements that force pension funds to switch out of equities at the wrong time, further damaging share prices and preventing them from reaping the full benefit of the market recovery.

So what should be done? Should the burden of regulations affecting occupational pensions be eased? Or have the regulators done a valuable job alerting pension funds, and their sponsors, to issues such as risk management?

The prevailing view of the pension fund trustees, administrators and managers who responded to our questionnaire is that occupational pensions are, indeed, over burdened with regulation. A substantial majority (81%) agree with the proposition that second pillar pensions in Europe, whether these are DB or defined contribution (DC), are over-regulated.

Somewhat fewer (62%) think this is the case in their own countries. Respondents based in the UK, Netherlands and Switzerland generally feel over-regulated while respondents from France, Italy and Germany feel that the regulators have got it about right. There is an even division of opinion among managers of Swedish pension schemes, however.

Supervisors have been criticised for being over-protective of the individual investor, and most respondents (95%) agree that regulatory bodies should not aim to protect investors from every possible disaster.

Don't blame the framework

It has been suggested that the problems occupational pension funds face have been caused, or at least aggravated, by the regulatory frameworks in which they operate. Many of our respondents feel this is going a little too far, and only
a relatively small majority (60%)
feel that regulatory frameworks are to blame.

Yet there is strong agreement (86%) with the suggestion that that some of the unintended consequences of pension regulation (regulators compelling pension funds to sell equities at the bottom of the market) often outweigh the benefits (maintaining solvency and funding levels).

The manager of a Danish pension fund points out that pension funds do have some discretion with regard to timing when selling equities: "This can go either way, depending on when the pension fund decides to act." Accountants, through the application of new accounting standards, are as much to blame as regulators, says manager of a Swiss pension fund. The manager of a Swedish pension fund agrees: "The change for accounting for pensions is as much to blame [as the regulators] if you include the rating agencies' new way of evaluating funding and book reserves."

Overall, there is strong feeling that regulatory measures to prevent further widening of pensions deficits have encouraged short-termist thinking in institutions with long time horizons. A large majority (90%) of our respondents agree that regulatory concern about pensions deficits is pushing pension schemes into short-term reactions.

Three in four respondents (76%) agree that regulatory constraints hinder the necessary long-term approach for pension fund investment. The manager of one UK pension fund says that schemes are being forced to make "inappropriate investment decisions with long term consequences".

 

The bigger picture

There is also a feeling that regulators ignore ‘the big picture', focusing instead on small issues. Two thirds of our respondents agree that too many regulatory authorities in Europe are engaged in ‘fixing holes'.

Yet some pension fund managers spring to the defence of their regulators. "The Pensions Regulator has done a valuable job in raising awareness of risk management and the importance of company covenants," one UK manager says.

At a European level, three out of four respondents (75%) feel that regulators do not understand or choose to ignore, some of the fundamentals of the industry; for example, the higher the minimum guaranteed returns are set, the lower expected real returns will be. Although, as some respondents point out, the levels of ignorance or lack of understanding will vary from country to country.

One UK manager states: "There appears to be a vast over-reaction and over regulation of schemes where there is little risk of default and over reaction to the Equitable Life-type situation [The UK insurer which almost collapsed in 2001] This has led to a trend of forcing investment down a line of reckless conservatism."

 

Get talking?

One often voiced complaint is that there is a lack of dialogue between regulators and financial sector representatives. Yet opinion amongst our respondents is divided on this with only a slight majority (57%) in agreement. The manager of a Swedish pension fund says: "They talk about topics that are interesting to them at that moment, without the 80 year perspective you need to have as a pension fund." For others it is the dialogue with government that matters. "Governments just refuse to listen," a UK pension fund manager comments.

Yet there are a few words of praise for regulators. Two thirds (66%) agree that regulation, in general, has increased pension funds' awareness of the need for risk management. Yet there are some doubters. "I think trustees are already risk-aware," one manager remarks. "Politicians are just another risk"

Predictably, perhaps, there is a feeling that regulators do not understand the burdens of the pension fund manager. Only a third of respondents think that regulators are sufficiently aware of the pressures faced by pension funds and their asset managers.

"They seem to think it is a matter of right and wrong, not a matter of where the buck stops," one Scandinavian manager observes. "In Sweden the buck stops with the employer or the insurer in a DB plan. A long term perspective is hard to fathom if you have to evaluate every employer that has a pensions promise."

A UK manager is kinder: "They have a difficult job to do and I think the Pensions Regulator has made some serious effort to understand, but political and other pressures are too great for them to apply commonsense elsewhere."

In general, our pension fund managers feel that regulation uses up a level of resources that could be more profitably employed. One UK pension scheme manager perhaps speaks for many when she says: "If a small part of the costs of regulation over the years had been simply levied to provide a communal rescue fund, with some meaningful deterrent against using it as a dumping ground, we would all be much better off with far less regulation and confusion in the financial world, and with more pension funds flourishing as a result."