Bill of rights for the mobile
The European Commission’s proposal for a directive on improving the portability of supplementary pension rights, if accepted, could significantly improve the position of mobile workers – both across borders and within member states – but about which many concerns have been expressed regarding excessive costs.
Vladimir Spidla, the European commissioner for employment, social affairs and equal opportunities pointed out when the proposal was introduced that 2006 was the European Year of Workers’ Mobility and said: “If we expect workers to be mobile and flexible we cannot punish them if they change jobs. Pension rights must be fully transferable.”
The commission had been attempting for some time to produce a directive on portability, involving detailed consideration by the Pensions Forum, and had asked the social partners to negotiate on an agreed framework.
However, although there was agreement that mobility of labour was important and that transferability of rights was desirable, it was not possible to reach agreement primarily because of concerns by the employers’ side that increased costs would be imposed by the directive, whereas they considered that the terms of a pension plan should be a matter for the individual employers and worker representatives to agree.
Accordingly, the directive is intended as a minimum framework which will be transposed into the local legislation of member states in a manner which will no doubt differ according to the practice and tradition in each state.
The directive focus on four aspects of portability of pension rights:
q Acquisition of rights;
q Preservation of ‘dormant’ rights;
In relation to acquisition of rights, the directive sets specific minimum requirements for:
q Minimum age for entry to plan – 21 years;
q Maximum waiting period (unless the minimum age has not been reached) – one year;
q Maximum vesting period ie, before acquiring a right to benefits on leaving the plan – two years.
For some member states, these requirements would mean that pension rights would be acquired by a greater number of workers and hence there would be some increase in costs for employers. For example, in Belgium the minimum age can be set as high as 25; there can be a waiting period of up to two years in Spain and vesting periods in a number of member states are five years. However, in for example, the UK and Ireland, these provisions would not impose any additional costs as they are not more onerous that the existing requirements in these states.
Article 5 of the directive deals with preservation of dormant rights. It states that: “Member states shall adopt the measures they deem necessary in order to ensure a fair adjustment of dormant pension rights so as to avoid that outgoing workers are penalised.”
This rather ambiguous wording is explained further in paragraph (7) of the introduction to the directive which says: “This objective could be achieved by adjusting dormant rights in line with a variety of reference measures, including inflation, wage levels, or pension contributions which are in course of being paid, or the rate of return on assets under the supplementary pension scheme.”
Taken literally, the wording of Article 5 would appear to require that for a plan providing defined benefits linked to final salary at retirement, the accrued or ‘dormant’ rights of a member who leaves the plan should be increased between leaving and pension age in line with the wage increases he would have received had he remained in that employment (or by reference to some proxy such as an earnings index).
This would ensure that his or her supplementary pension rights earned for that period of employment would be the same, regardless of whether he or she remained in that employment to retirement age or moved to another employer. If this became a requirement, significant additional costs would arise for employers who offered such plans.
The directive suggests that an acceptable alternative would be to increase the dormant rights in line with price inflation, which would retain their purchasing power over the period from leaving the employment to pension age.
This is already a statutory requirement in the UK and Ireland (although in both countries there is a maximum percentage increase which would apply if inflation were at higher levels than at present) and is provided on a discretionary basis in the Netherlands.
Clearly there could be significant costs if inflationary increases have to be provided where no increases would currently apply – even with inflation at 2% per annum, the adjustment applied to dormant rights for somebody who left employment 25 years before pension age would be over 50%, with a corresponding increase in the cost to the employer of providing the benefit.
However, the cost of the benefit is still less than that which would have been provided for the member in respect of that period of service had he or she stayed to pension age and received a benefit based on final salary.
In passing, it should be noted that Article 5 also permits member states to establish a threshold below which preserved rights do not have to be maintained within the outgoing plan, but can be transferred by payment of a capital sum to another plan. This is to avoid incurring excessive costs in administering small benefits.
The directive deals with transferability in Article 6, which provides that within 18 months of leaving an employment, a worker must be given the right to transfer his or her acquired pension rights within the member state or to another. The reference to the determination of the transfer value in Article 6(2) echoes the language of Article 5 in relation to the adjustment of dormant rights: “Member states, in accordance with their national practice, shall ensure that where actuarial estimates and those relating to the interest rate determine the value of the acquired rights to be transferred, these shall not penalise the outgoing worker.”
The Groupe Consultatif Actuariel Europeen (GCAE) undertook a survey of the then EU member states in 2001 and this concluded that the approach to calculating transfer values, and the responsibility for determining the assumptions, varied significantly across Europe. The GCAE then proposed principles for the calculation of transfer values from defined benefit plans which I believe are consistent with the requirement of this article. These are:
q The transfer value should be the fair value of the benefits to which the member would be entitled as a deferred pensioner on leaving service;
q Allowance should be made for any entitlement to:
a) Revaluation in the period to retirement;
b) Indexation in the period post retirement;
c) Benefits for dependents on death before or after retirement;
q The transfer value should be based on the vested benefits;
q The mortality tables used should be standard tables which are generally accepted in the member state, unless scheme specific tables can be statistically justified on the basis of adequate scheme experience data;
q The discount rate should reflect market rates of return expected from classes of asset appropriate to the liabilities, having regard to duration, and revaluation and indexation provisions. Relevant asset classes would include government and corporate fixed-interest bonds, government and corporate index-linked bonds, equities and property.
The GCAE is in the process of updating the survey to see if practice in relation to the calculation of transfer values has changed since 2001, particularly following the adoption of the IORPS directive.
There is considerable scope for different views in relation to the assumptions to be adopted, even within a member state. For example, in the UK the actuarial profession has been unable to reach a consensus on whether the rate of interest used in placing a value on the acquired rights should represent a market rate ie, the yield on an appropriate bond, or the expected cost to the plan of providing the benefits which would use a higher interest rate allowing for expected outperformance of the assets held by the plan.
The UK government has recently taken on the responsibility for determining how transfer values should be calculated, as the actuarial profession were of the view that this was more a social policy decision than a technical or professional one.
The main issues arising from the directive have been in relation to defined benefit plans. In general, pension rights built up in a defined contribution (DC) supplementary pension plan can easily be transferred to another DC plan as the value of the accrued pension rights is usually represented by the value of the fund which has been accumulated in respect of the member who wishes to transfer his or her rights. Some costs may arise as a consequence of the transfer but the directive specifically provides that such costs must not be disproportionate to the length of time the worker has been a member of the plan.
The directive also requires that information be provided to members of a plan on how their rights will be affected by termination of employment, including, if requested, details of the benefits which would be provided if employment were terminated. Information must also be provided to deferred beneficiaries on request.
The proposed deadline for the adoption of the directive by member states is 1 July 2008, although an extension of five years is permitted for the introduction of a two-year vesting period. In addition, member states may exclude pay-as-you-go and book reserve schemes from the transferability requirements of the directive, although this exemption will be reviewed by the commission after 10 years.
It is likely that there will be much more debate on this proposal before the intended implementation date of 1 July 2008!
Philip Shier is chairman of pensions committee of Groupe Consultatif Actuariel Europeen, which represents European actuarial professions