Thierry Verkest explains the recent legislative and regulatory changes that have transformed Belgium's pensions landscape, and outlines some of the continuing debates
Belgium's first prudential framework for pension funds was introduced in 1986 and a range of specific royal decrees and guidelines followed over the years. But after more than two decades a need to review the total picture was felt and the introduction of the EU's directive on the activity and supervision of institutions for occupational retirement provision (IORP) was seen as an excellent opportunity to introduce a new framework.
The authorities rightly decided to keep social and prudential legislation separate. Legislation applicable to social aspects of pension plans was passed in April 2003 and the law on the supervision of IORPs, including new prudential rules, was passed in October 2006 and came into force on 1 January 2007.
Many provisions of the IORP directive were simply copied into the new prudential law without additional constraints. Providing flexible regulation was indeed a major objective to make Belgium attractive for cross-border pensions.
Flexibility has the advantage of allowing a tailor-made approach for each kind of pension fund. Belgium has a wide variety of pension funds such as single and multi-employer plans, industry-wide schemes and funds for the self-employed. In addition to the main role - the provision of retirement benefits - each fund may also provide death and disability benefits, but only as a supplementary activity. Risk benefits are not necessarily provided by the pension fund, but can also be funded through a separate insurance contract.
Studies have showed that substantial cost savings can be achieved through a combination of self-insurance and reinsurance in the pension fund. Not only the pooling of assets, but also the pooling of risk liabilities can lead to considerable savings. Many pension funds, therefore, also provide the death and disability benefits.
They can also manage the pension plans of different companies. These companies are generally part of the same group, with companies owning several legal entities tending to centralise the management of the different pension plans into one fund in order to be cost effective. However, being financially connected is no longer a legal requirement and following the introduction of the social law, it has been possible to extend this kind of optimisation since 2004.
By adding the multi-country dimension, companies have been able to move less cost-effective, small to mid-sized pension arrangements to a single country since 2007 (see figure 1). Since the introduction of its new legislation Belgium is on the short list of preferred countries because of the fair regulatory framework and having the experience, the people and the tools to run pension funds.
Flexibility has also been introduced in terms of funding requirements. There was a long debate between the regulator and the association of actuaries to define appropriate funding rules and the regulator finally decided to adopt the most flexible approach. One of the reasons was to avoid the introduction of a set of temporary rules that might later be found to be in conflict with expected Solvency II requirements.
Under the new rules most pension funds will have to review their financing plan. The discount rate for calculating provisions of defined benefit plans must be in line with the expected return on assets or with the market rate of high quality corporate bonds. A discount rate of 6%, which has hitherto been applied for calculating the transfer value of vested rights, will therefore not necessarily be accepted for funding purposes. Mortality tables also need to be redefined as a best estimate of the actual survival probability.
One of the major issues was to establish whether the actuarial method for calculating provisions should be the same as for determining the contribution level. The regulator decided to accept different methodologies. Consequently, contributions can be calculated with projected salaries, while this is not necessarily the case for calculating provisions. This can help fulfil the full funding requirement in the case of cross-border arrangements.
The regulator is also expecting pension funds to measure the probability of underfunding over the long term. Complex stochastic ALM studies may be replaced by simplified approaches, especially for smaller pension funds. The regulator could have imposed pre-defined quantitative rules but while this would have replaced any complex approaches it would have resulted in a severe loss of flexibility.
According to the new legislation, pension funds in Belgium need to be established under a specific legal form, the Organisation for Financing Pensions (OFP). The Belgian Association of Pension Institutions (ABIP/BVPI) has already played an important role by providing templates for drafting new bylaws compliant with the law. These templates have been used by many pension funds to change their legal form into an OFP, which has both assisted the funds in meeting the legal requirements and helped the supervision by the regulator.
We believe the ABIP/BVPI should extend this kind of support to other documents such as the management agreement, which is required to regulate the relationship between a pension fund and its sponsoring company (see figure 2).
The regulator has introduced a comprehensive governance framework to enhance the credibility of the system in the outside world and to allow the establishment of larger pan-European funds. However, in so doing it overlooked the fact that Belgium is a country of mainly small to mid-sized pension funds. These local pension funds cannot be compared to banks and insurance companies.
As an extension to the new law, the regulator issued a best-practice circular in May 2007 outlining its ‘long-term expectation' regarding pension fund governance through a list of 11 principles (see figure 4).
As part of the new governance regime pension funds should establish a set of rules describing their internal organisation and control processes, and are required to appoint an internal auditor and a compliance officer. These two independent functions are not compatible and in addition they need to be separate from the already existing requirement to appoint a certified actuary and an external auditor (see figure 3).
The governance principles are not prescribed in the IORP directive and could, therefore, have been avoided. Further increasing reporting and other requirements will inevitably raise the management cost and add further pressures to the local pension fund market.
Instead, we suggest that board members should take on the responsibility for providing additional control mechanisms like internal audit, a compliance officer or any other formal governance policy. The appointment of an external auditor and a certified actuary, combined with the supervision of the regulator, should in fact be sufficient to meet the needs of many pension funds.
The regulator argues that the complexity and the size of the pension funds will be taken into consideration when assessing governance expectations. However, no objective criterion is provided to measure the scale of a pension fund. To counter the steady growth of regulations and reporting, pension funds need to adopt a pragmatic approach.
There is, for example, no obligation to outsource the compliance and internal audit function. We expect smaller pension funds to look for an internal assignment within the sponsoring company. The compliance officer could, for example, be the person in the company most involved in the relationship with external providers.
The 2006 law also prescribes that board members need to have professional integrity and appropriate professional qualifications and experience. The ABIP/BVPI, consultants and other professionals are currently organising training sessions to help build expertise among board members.
The introduction of the prudent person principle within a flexible framework has increased the responsibility of board members. Specific insurance products have in the meantime been developed by some insurance companies to cover that responsibility. However, premiums are high and the insurance policy does not necessarily cover the whole liability. More cost-effective solutions are being analysed. An alternative could be an agreement between the board director and the sponsor covering the responsibility in the same way that would be applicable in the case of a labour contract.
Thierry Verkest is an actuary and benefit consultant and is the manager in the retirement and financial management team at Hewitt Associates in Brussels