DC in Europe: Opening Pandora’s box
Cécile Sourbes considers how the European Commission plans to regulate defined contribution pensions
The European Commission has its sights set on the defined contribution (DC) market as the growth of DC pension plans continues at full tilt.
According to the Global Pension Assets Study 2012 published by Towers Watson, in P7 countries - Australia, Canada, Japan, the Netherlands, Switzerland, the US and the UK - the number of DC schemes has increased at a rate of 7.9% annually over the past 10 years.
It therefore comes as no surprise that the Commission has made the regulation of such pension funds one of its priorities. Finding the best way to do this, however, will be difficult.
In its advice on the revised IORP Directive sent to the Commission in February, the European Insurance and Occupational Pensions Authority (EIOPA), emphasised the importance of providing DC plan members with clear information about their pension plans.
"It is important that DC members understand the decisions they need to make, at what stage of the lifecycle of the scheme they participate in and how to compare the various options that may be presented to them," the authority says.
"Several challenges arise from the member's perspective. The fact that information is generally scattered throughout a number of various documents, is way too complex to understand and not easily comparable between the various pension schemes, therefore, needs to be reviewed," it adds.
Many European pension fund associations, such as the European Federation for Retirement Provision (EFRP), share EIOPA's view. "As more and more people are relying on this type of pension provision, the governance framework becomes crucial for maintaining trust," the EFRP chairman, Patrick Burke, stresses.
"Facilitating a common framework, within a revised IORP directive across all member states makes sense. The Commission has recognised that 60m people in Europe are in underlying DC pension schemes.
"It has also recognised that there are risks in DC schemes that rest with individuals - such as investment and longevity risks - and that many of those individuals would benefit from a better understanding of the nature of the scheme they are affiliated to."
To help improve the quality of information in DC plans, EIOPA included some proposals in its advice to the Commission. First, it said, information should be provided "in all phases of participation in the pension schemes (pre-enrolment, ongoing and payout) in proportion to the choices to be made".
Second, "information must be correct, understandable and not misleading", while "information overload should be avoided".
Finally, the potential for the use of digital devices in delivering and/or making information available "should be duly taken into account".
Nothing terribly new so far. As Burke points out, many EU member states have similar legal frameworks. "The general trend seems to be to improve the disclosure of information and to make sure that this is beneficial for members," Burke says. "But, if you look at some developed DC regulatory frameworks, many of these principles are already in place."
As the revised Directive stresses, IORPs - where the investment risks are borne by pension scheme members - are not subject to a solvency regime, and their risks are not reflected in capital requirements but are borne by the members.
So what about hybrid plans? Given the nature of such pension schemes, which have DB and DC elements and where the beneficiaries still bear a significant part of the investment risk, supervisors should have "appropriate power and resources" to control the investment policy and risk management of an IORP, according to the revised Directive. "This becomes even more relevant as supervisory regimes of hybrid pension plans may not contain a full risk-based solvency approach," it continues. "Therefore, the possibility to introduce quantitative restrictions might be an important part of these powers."
The diversity in pension plans across Europe underlines the complexity in regulating DC schemes. The challenge of harmonising Solvency II measures for all types of pension schemes throughout the EU - plus the wave of protests from the pension industry - might explain the emergence of the holistic balance sheet (HBS) concept.
In its call for advice on the revised IORP Directive launched in October last year, EIOPA suggested adopting an HBS approach for cross-border vehicles as a substitute to Solvency II measures.
This surely comes as an encouraging move. The authority's decision to shy away from Solvency II options is to be applauded. But no one can argue against the fact that the HBS approach is in need of much clarification. If adopted, it might serve to accelerate the trend towards DC in Europe.