The European Commission is seriously considering the issue of pension insurance. Rachel Fixsen asks if it is needed.

Strong safeguards are a must for members of occupational pension schemes. No one in the industry would deny that. In the UK, the plight of pensioners was probably the most painful part of the collapse of Robert Maxwell's business empire in the early 1990s.

But some tentative proposals for compulsory insolvency insurance are now being whispered in the corridors of the European Commission. Are they going too far?

The commission is set to issue a communication later this year. It will give an outline for a directive for prudential rules for supplementary pension schemes. One of the issues to emerge from the consultation period is whether there is a need for the establishment of pension insurance, and this is now under consideration by the Commission's experts.

In the US, this type of insurance is already in place in the form of the Pensions Benefit Guaranty Corporation and in Germany a similar scheme is offered through the Pensions-Sicherungs-Verein (PSV). Both these bodies protect employees' pension benefits if the employer goes bankrupt.

Axel Oster, expert detache on pensions at the European Commission in Brussels, is keen to stress that nothing has yet been decided. The German system is just one example and it may not suit pensions in other EU member states.

It is worthwhile to think about it, but this doesn't mean we will make a copy of that national rule into Community law," he says.

In any case, there are plenty of reasons why it would be unsuitable elsewhere, he says. In Germany, about 60% of occupational pension scheme liabilities are recorded as book reserves. "These insurance schemes make sense because with a book reserve scheme everything is invested in the sponsoring company," says Oster. Obviously if the company goes bankrupt the assets which were meant to be used to pay pension benefits may be lost or at least reduced. "But (PSV insurance) is a special solution for the German situation," he adds.

Insolvency insurance is only under consideration at the commission for defined benefit (DB) schemes, Oster points out. The idea has no relevance for defined contribution (DC) schemes. There may, he says, be an arguable case for defined DB to have some type of insurance cover to pay out if the company becomes insolvent. If investment performance fell short of the amount needed to pay the fixed pensions promised, the employer would usually have to fund the difference. But if the company went spectacularly bust, this may not happen.

The National Association of Pension Funds in London says because the minimum funding requirement, introduced as part of the 1995 Pensions Act, means that funds already have to be funded at 100%, insurance would be superfluous. Occupational pension schemes are subject to valuations every three years to show assets are at least equal to pension liabilities.

"Generally, we regard the funding of occupational pensions as sufficient, and we don't need additional guarantees on top of that," says Rhoslyn Roberts, director of benefits at the NAPF.

UK occupational pension schemes already pay a second levy, the compensation levy, to the Registrar of Pensions Schemes. This is part of the pensions compensation scheme which was set up on 5 August 1996 as one of the provisions of Pensions Act.

The scheme provides compensation to members or beneficiaries of occupational pension schemes where a crime has led to the pensions assets of a company being reduced. The scheme only pays out if the assets have diminished by more than 90%. In such cases the trustees of the pension fund could apply for compensation to bring the value of the assets up to 90%.

The compensation is funded by the levy which is paid by all schemes. The size of the levy is based on the number of members in the scheme and the amount of past claims made. Last year, the charge was 23 pence per member, but for this year it has been set at nil.

Roberts concedes that in theory, despite all the safeguards in the UK, it is possible for members of a final salary scheme to lose out. "Clearly you could have a situation where in the three-year period something went disastrously wrong and the assets (of a company) halved in value..." she says.

But the downside of insurance outweighs the small benefit of it, she says.

In Germany, occupational pensions can be funded in any of four ways. If the scheme is funded by book reserves or support funds, then by law it must also have insolvency insurance under the PSV scheme. But if the scheme is funded through a Pensionskasse or through direct insurance, it does not need this insurance.

Siemens is one German company which has build up assets of DM24bn ($13.4bn) to fully cover its pension liabilities, but the company is nevertheless required to pay premiums to the PSV scheme.

"We cannot say Siemens doesn't need to pay and the others do... we have to make a decision for all four ways (of pensions financing)," says Christian Urbitsch of the German pensions association, ABA.

In Sweden, a similar pensions guarantee system operates. The guarantees are offered by FPG Pension Guarantee Mutual Insurance Co for white-collar workers and AMFK Labour Market Insurances Mutual Credit Insurance Co for blue-collar workers. The annual premium is set at 0.2 percent of pensions liabilities.

Telecommunications group Telia held its pensions liabilities on the balance sheet until 1995, then from 1996 used assets to cover the liabilities with two different pension funds.

Leif Hållstedt, vice president of Telia pension funds, says some pension funds in Sweden have been in existence for many years, and these funds are not obliged to pay into the pensions guarantee scheme. But newer funds are. Hallstedt finds this an unnecessary expense, as the fund is run by a separate board whose task is to ensure sufficient assets are there to meet pensions liabilities.

It is Sweden's trade unions, rather than its government, which requires pension schemes to subscribe to the guarantee system. Telia has now managed to have its fee reduced by 50%, and currently pays an annual premium equal to 0.1% of pensions liabilities. "But I think the reduction should be at least 90%," he says. "Fees should be very much lower for those companies who have pension funds," he adds.

The FPG and AMFK insurers acknowledge that the trend in Sweden towards pension funds will change its role eventually. "The FPG guarantee will become more of a protection against financial risks than an instrument for the use of pension capital as a source of finance," it says in its annual report.

The commission says compulsory insolvency guarantees for other European countries are no more than an idea. It appears unlikely that this idea will form part of the communication later this year. But where did the proposal come from?

"Certainly the Germanic countries are keen on the idea because that is their system," says Ray Martin of Zeneca Pension Fund, who is also a representative of the European Federation of Retirement Provision. "It is my concern that (pension schemes) should only have to be insured up to the amount that they are underfunded. A fund that is 10% underfunded should only be insured for that amount," he says.

The US system of guarantees has certainly had its problems. Critics say badly managed companies sometimes take advantage of the government guarantee by failing to fund their pensions liabilities adequately. In effect, they borrow from their workers, in the form of pension promises, on the strength of a federal government guarantee. Pension plans can remain indefinitely underfunded by as much as 10%.

Last year, the PBGC reported for the first time since 1974 that it collected enough money to pay for the pensions it has had to take over from insolvent companies.

"Any sensible guarantee system for private pensions would require employers to overcollateralise them," said James Smalhout, a visiting fellow at the Hudson Institute, in the Wall Street Journal last year.

Any compulsory pensions insurance in Europe would have to be state insurance, as no private enterprise would take on the risk, says Martin. Not only would the sheer size of pensions liabilities deter any insurer, but also the fact that if one of the big companies did became insolvent, the chances are that many of them would become so at the same time. National governments could then repackage the debt as a type of government debt, as, for example in the US with catastrophe bonds.

Martin sees little chance that proposals for a Europe-wide compulsory insolvency guarantee scheme will get very far. "I don't think there'll be much support in this country or in Holland," he says."