PEPP: More questions than answers
Many issues remain to be clarified concerning the PEPP
- The pan-European Personal Pension Product (PEPP) is designed to facilitate cross-border provision
- It is unclear whether enough providers will enter the PEPP market
- It is uncertain whether a provider can simultaneously implement a Basic PEPP and an investment option
- The tax treatment of a PEPP will define its attractiveness
Wilfried Mulder and Johan Barnard
The regulation on the pan-European Personal Pension Product (PEPP) was published in the Official Journal (OJ) of the EU this July before coming into force in August. It will be applicable 12 months after the publication in the OJ of the delegated acts referred to in several articles of this regulation.
European policymakers are pursuing several aims with this regulation. It is, however, uncertain whether the new rules will help, due to a lack of clarity in the final text. More precision is therefore desirable.
The PEPP has two main goals. The first is closing the pension gap. A substantial proportion of EU citizens does not have access to either second-pillar pensions or third-pillar products. The European Commission considers this undesirable, while first-pillar pensions are under financial sustainability and ageing pressures for the foreseeable future. The means to achieve this is to unlock a competitive and cross-border European market for third pillar personal pension products, in order to allow more European citizens to transform savings held in bank accounts into productive long-term pension products from institutions that can transform these savings into long-term investments. This could contribute substantially to the Capital Markets Union (CMU).
The second aim is to encourage cross-border provision and the portability of pension products.
To realise these aims the PEPP is designed as a European second-regime product, which can be marketed across the entire EU once registered by the European Insurance and Occupational Pensions Authority (EIOPA).
The PEPP is minimally defined in the regulation. This sets out standards for product features such as investment rules, transparency requirements and portability. Consumers will choose between a maximum of six saving options (including one default option, the Basic PEPP) and member states will set the conditions for the accumulation and the decumulation phases.
This basic concept is attractive, but several challenges remain. These can be grouped into two categories. First, whether enough providers will enter the PEPP market. Second, whether there will there be considerable uptake of the PEPP by end-users. Overcoming these difficulties will define its success.
Opening the PEPP market to various types of providers (insurers, credit institutions, asset managers, investment firms and EU IORP directives) should boost competition in the internal market.
In this respect, we do not understand the envisaged scope for activities of IORPs as PEPP providers. Article six prescribes that IORPs may apply for PEPP registration if they are, pursuant to their national law, authorised and supervised to provide personal pension products (member state option). But article 49, prescribes that IORPs (and also other possible PEPP providers) which also offer the coverage of biometric risks can do this only by co-operating with an insurance company which is allowed to take these risks according to sectorial law. In our view, it is not clear how this provision will work for IORPs allowed to offer a PEPP or other personal pension products. Will this IORP be obliged to co-operate with an insurance company if such products contain biometric risks? And if so, how can that be consistent with the fact that coverage of biometric risks is a primary activity of IORPs themselves?
To a certain extent, a similar question arises with regard to the decumulation phase. Article 58 regulates the forms of pay-out that PEPP providers may make available to PEPP savers, and one of these forms is annuities. Does this mean that all PEPP providers may offer annuities, or does this imply that only insurance companies are allowed? And do other providers have to co-operate with an insurer if they want to offer annuities?
Also, with regard to the conditions for the decumulation phase – as set out in article 57 – a lack of clarity remains. Article 57 paragraph 2, for example, prescribes that member states might determine a maximum period before reaching the retirement age for joining a PEPP, but there is neither clarity for the reasoning nor how this should work in practice.
Another question can be posed in respect of the possibility also mentioned in this paragraph for member states to impose conditions for redemption before the minimum age for decumulation, notably in case of hardship. It is not clear how this provision should be understood. Can early redemption conditions be posed in any situation or only in case of particular hardships. And how should this term be defined? Does this refer solely to occupational disability, or should other cases also be taken into account? Is this something that can differ per member state? And how does this relate to tax law?
Last, but not least, attention should be paid to the fact that a significant number of articles in the PEPP regulation provide bases for delegated acts and regulatory technical standards by EIOPA. These acts and standards will refer to the provision of information by PEPP providers, costs transparency, caps on costs and fees, risk-mitigating techniques, etc. In order to avoid unwanted negative effects on the potential entrance of sufficient providers, not only of IORPs but also by financial markets participants from other business sectors, EIOPA should refrain from issuing too-strict measures as these will create costs for providers (and make offering a PEPP less attractive). This is important because overly detailed rules could result in an overload of information for customers, which might negatively influence the uptake of the PEPP. Caps on costs and fees may be helpful to customers, but only if they allow for realistic comparisons across all PEPP providers and provide clarity about all costs and fees providers will charge to customers, and which may impact on return.
More a hindrance than a help?
Other specific practicalities of the PEPP regulation may also be more of a hindrance than a help with regard to uptake.
For example, questions can be asked with regard to the obligation laid down in the articles 42 and 45 for providers to offer a safe default investment option in the form of a basic PEPP. Such PEPP must consist of a nominal guarantee on premiums paid, which in periods of low or even negative long-term interest rates erode most of the returns on investments that a PEPP provider can deliver. This will reduce the basic PEPP to an unattractive proposal. The same will probably happen for the other option for a provider to offer a basic PEPP as allowed in the regulation, namely to use a risk-mitigating technique consistent with the objective of recouping capital. In this respect, the question arises as to which techniques will then be possible, given the fact that the aim must be to “recoup the capital”. And what is the difference between a guarantee and “recoup the capital”?
More generally, a remaining question is whether a PEPP provider could implement a marketing strategy by offering the two propositions simultaneously. First, a basic PEPP with a guarantee in combination with the statement that the perspectives on a positive return are limited and that this is a replication of a long-term saving account. Second, a more attractive investment option which will in practice be chosen by each PEPP saver. Or is there a specific article in the PEPP regulation which prohibits this?
Failing on portability
The regulations for PEPP savers switching savings to another provider, as laid down in article 52, could also form an impediment to uptake by PEPP savers. Such switches can, based upon paragraph 1, be done both to a PEPP provider in the same member state (domestic switching) or to one in another member state (cross-border switching). But, this paragraph only allows switching from one (entire) account to another (entire) account, not switching from one or more specific sub-accounts (as defined in article two, and created for each member state in which a provider provides a PEPP) to one or more other sub-accounts.
In addition, this paragraph only allows switching to a new PEPP account with the same sub-accounts opened with the receiving PEPP provider. As a result, this paragraph, for which the rationale is unclear, could limit possibilities to switch. Furthermore, the question arises as to how this provision will work in practice when the forms of the pay-outs of a PEPP differ from sub-account to sub-account (which is allowed in article 52, paragraph 2). In particular in the case of a sub-account in the decumulation phase with a pay-out in the form of lifetime annuities, taking into account that article 52, paragraph 2 prescribes that PEPP providers will not be obliged to provide a switching service. Will a switch of the entire PEPP account, including all the other sub-accounts, then be impossible?
Taking into consideration these questions the switching provisions could turn out to be difficult to realise and form an impediment to the uptake of PEPPs. A practical solution might be to allow switching between individual sub-accounts.
Last, but not least, the tax treatment of a PEPP will be a key factor. In respect of tax, the commission published, parallel to the 2017 launch of the proposal for a PEPP regulation, a recommendation “on the tax treatment of personal pension products, including the pan-European Personal Pension Product”, with the goal of convincing member states to include the PEPP in their tax incentives for national third-pillar pension products. Since then no more developments have taken place in respect of the tax treatment of the PEPP.
Don’t forget the second pillar
We support the aims pursued with the PEPP regulation and these rules can be considered as a step towards reaching these aims. But several questions are unresolved and it is unclear whether PEPPs offer a viable business case for providers and savers. Additionally, the absence of any obligation on member states to open up their national tax incentives may be a serious impediment to a significant uptake of PEPPs.
Furthermore, it would be advisable for the new commission to provide a general pension policy and to clarify the role which the PEPP regulation could play in this policy. In this respect, policymakers should realise that the additional long-term savings to be achieved by the PEPP are important, but the encouragement of second-pillar pensions in IORPs could also contribute considerably, taking into account that fact, IORPs count for substantially more assets in the EU than personal pension plans. We are therefore also looking forward to the recommendations of the high level group of experts to enhance second-pillar retirement savings in member states which was, based upon recital 20 in the IORP II directive, installed by the commission in 2018.
Wilfried Mulder is senior policy adviser and Johan Barnard is head of European public affairs at APG