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Regulation Roundup: Pension outlook in Europe

IPE reviews regulatory and legislative changes affecting pensions in key European countries

Denmark

Overall, the past year has been quiet on the pensions front. There is, therefore, little by way of legislation in the pipeline.

However, in August 2016, the then minority centre-right government of the Venstre party embarked on several policy initiatives. 

The biggest was a long-term plan for the Danish economy called A Stronger Denmark 2025. This plan also contained proposals for changing the pension system.

The main pension proposal was a six-month increase in the retirement age, currently 65 years, intended to fund other initiatives in the plan. Between 2019 and 2022 the retirement age was to increase in stages to 67 years. In 2030, it was to go up to 68 years, again in stages. Further increases could then take place to reflect higher life expectancy. 

The plan also contained proposals to curtail the Age Savings Scheme, which allows individuals to save up to DKK29,800 (€4,000) per year and withdraw tax-free cash lump sums, without tax deduction on amounts paid in.

The new proposals cut the annual savings limit to DKK5,000. However, in each of the five years before retirement age, individuals would be allowed to deposit up to DKK50,000 per year, and still enjoy tax relief on payouts. 

This proposal was intended to help solve the problem of the high overall taxation of payouts from pension schemes. At present, large payouts from schemes are not only taxed, but recipients’ state pension payments are reduced. 

A new tax credit for workers was proposed within the income tax system, which would have been reduced as salary increased. However, those with retirement savings above a certain level could avoid this reduction.

In November 2016 there was a change in government as the minority Venstre party could not muster sufficient support in parliament for its agenda. The new government consists of three right-wing parties, including Venstre. As a result, the entire Stronger Denmark 2025 plan was axed.

Finland

The third and final phase of the solvency regulation reform, as well as a major pension reform, took effect in January 2017. 

The solvency reform extends the variety of risk sources that are taken into account by the quantitative solvency requirement. It also requires that the processes for assessing and controlling non-quantifiable risks be reported to the Financial Supervisory Authority (FSA).

An important reform applying to all statutory pensions also took effect in January. Its main aim is to stabilise the contribution rates needed to finance statutory earnings-related pensions. This raises the minimum statutory pension age gradually from 63 to 65, linking the age limit to life expectancy post-retirement during the 2020s.

In 2016, the government and social partners signed the so-called competitiveness agreement, an overarching package of reforms intended to boost growth and employment in the economy.  

As part of this, employer and employee contribution rates to occupational pension schemes will be frozen between 2017 and 2021.

It was also agreed that a contribution rate of 1.2% of wages will be shifted from employers to employees between 2017 and 2020. Once this has taken place, employees will pay an average 17% of wages, and employers an average of 7.4%. The package as a whole also includes new tax reliefs for employees.

Competition regulation is also being changed in the pension fund sector. Last year, the financial services authority (FSA) set out regulations on the disability risk cover that pension funds are allowed to offer employees, enabling employers to be more competitive. The issue falls within the scope of the competition rules for multi-employer pension funds. The regulations took effect in March 2016.

The contribution rate to finance disability pensions is equal across Finland. However, if a pension fund takes successful measures (such as offering advice) to lower the risk among its employer clients, it can deliver the difference between the expenses of a particular low-risk client and the average, to the client as a bonus.

The second move affects the allocation of bonuses related to administration. Part of the contribution rate paid to multi-employer pension funds is earmarked for administrative costs. If the true costs are lower than the corresponding contribution income, employers also receive a bonus based on this difference. 

The Ministry of Social Affairs and Health (MSAH) has confirmed that throughout 2017 and thereafter, the proportion of contributions allocated to administration costs, as well as the difference between that amount and the actual costs, will be lower than before. The bonus payable was 50% of the difference, but the ministry has also said clients may be paid the entire surplus instead. From 2018, pension funds may allocate these according to their own formula, subject to ministry approval. 

The Market Abuse Regulation came into force across the EU on 3 July 2016. It contains two major features which affect institutional investors in Finland, the first of which is the new requirement for so-called ‘inner-circle’ transaction reporting. The European Securities and Markets Authority (ESMA) is still in the process of defining the term. Until it does, the Finnish FSA has taken the view that to be in the inner circle, an entity has to hold a meaningful position within the company’s administration, as well as own at least 10% of it.

This leaves most major Finnish pension funds out of the obligation to report such transactions for the time being. In any case, the FSA is also able to access the relevant information. 

The other new feature is the requirement to document so-called market-sounding processes. To help pension funds comply, The Finnish Pension Alliance (TELA) has developed best practice instructions for market soundings for its members. 

Reijo Vanne, leading economist at TELA, says: “At present, market sounding and the obligation to document the sounding processes do work quite prudently and by the book in Finland.”

Germany

The government has published a draft law that could significantly change the German pension landscape. The proposed law, (Betriebsrentenstärkungsgesetz, or BRSG), would, for the first time, open the door to pure defined contribution (DC) schemes in Germany. It is intended to come into effect on 1 January 2018. 

At present, many insured schemes can be accounted for as DC, as the employer’s obligation is limited to paying contributions. However, it is currently not permissible under German law to fully discharge the employer from the legal liability for the actual pension benefit. This is seen by the government as an obstacle stopping small and medium-sized companies from offering pension schemes. 

Under the draft law – which is fairly controversial – only social partners (unions, not works councils) would be able to establish pure DC schemes. Payouts would be limited to annuities, but without guarantees, so that pensions could be reduced during the payout phase.

The same draft bill increases the maximum amount for tax-free contributions to pension providers from 4% to 8% of the social security contribution ceiling – for 2017, this would jump from €3,048 to €6,096 per year. The ceiling for social insurance contributions would stay the same. Meanwhile, the social insurance treatment of transitional allowances (Übergangsgelder) and of pension settlements (Abfindungen) has been clarified. The competent social insurance institutions have confirmed that transitional payments – between termination of employment and retirement – are not subject to mandatory social insurance contributions. 

On the other hand, according to a ruling of the Federal Social Court (Bundessozialgericht), payments from pension settlements are treated as retirement income (Versorgungsbezug), regardless of when the settlement amount is pid, and even of the legal validity of the settlement. 

As a consequence of this interpretation, only contributions to statutory health and nursing insurance need to be deducted from the settlement amount at the expense of the employee or pensioner.

Several court judgments influencing pension law have been made, over the past year. The Federal Labour Court has given an unexpected interpretation of the article in the Company Pension Law on the calculation of vested rights for direct insurance schemes (§2 Abs. 2 BetrAVG). 

According to the court, it is insufficient for scheme rules to state that the vested entitlement is limited to the insured benefit. Instead, the employer must explicitly request such limitation of the vested entitlement at the time of the termination of employment (at the latest, three months after). 

If it fails to do so, the vested right is calculated on a pro-rata basis. The difference between this pro-rata claim and the insured benefit will have to be borne by the employer.

The Federal Labour Court has also made it easier to change existing pension schemes, by modifying the rules for doing so. In companies without a works council, the employer may now change a collective pension scheme unilaterally. 

But this does not leave employees without protection. Any changes to the employee’s detriment, in particular reductions in benefits, require a proportionate justification, such as an employer’s financial problems. 

Netherlands

The general election this month has provoked debate on a number of pension-related themes. In particular, freedom of choice is proving a popular policy with the public. 

One proposal being debated in parliament’s upper chamber is to make the retirement age for the state pension (AOW) more flexible. The plans would make it possible to defer or bring forward an individual’s retirement age.

At present, the state pension age is 65 years and nine months but it will rise to 67 years and three months from January 2022. The pension age in second-pillar pension plans will rise to 68 years from January 2018. 

The proposed law would make it possible to start drawing the state pension from five years before the official retirement age in return for a lower pension, or beyond the official retirement age in return for a higher pension. The exact amount received will depend partly on second-pillar provision. However, the proposed law has attracted a lot of criticism and, as yet, there is no timetable for enactment.

Meanwhile, the election has also forced some legislative initiatives to be delayed until the make-up of the new government is known. 

A working programme for plans to future-proof pensions was published more than a year ago by Jetta Klijnsma, secretary of state for social affairs. The main emphasis is on intergenerational solidarity, freedom of choice, a collective approach and responsibility for risk-sharing. 

The general principles in the programme, proposed by the Dutch Social and Economic Council (SER), came up with four variants. Studies by the SER highlighted two serious options:

• Defined benefit (DB) plan with degressive accrual;
• DC plan with collective risk-sharing. 

The first has two sub-variants – a DB scheme with guarantees and a conditional DB scheme. In both variants younger participants accrue more pension rights than older participants. Within the variant for DC with risk sharing, participants would have their own pension account. 

However, it is unclear how the accrued rights will move to the new system, says Corine Reedijk, senior asset-liability management (ALM) consultant at Aon Hewitt

Klijnsma has postponed any further decisions on future-proofing until after the election.

The general pension fund (APF) – a pooling vehicle similar to industry-wide schemes, but with ring-fencing of assets – has now been introduced, and six have been launched.

The policy of the Dutch Central Bank is to limit the number of pension funds, and APFs are considered a viable alternative for small funds. But there has not been a wholesale move towards the APF model.

To join an APF, pension funds need to have a financially healthy position, which means their funding ratio has to be at least 104.3%. To achieve this, many small funds would have to cut pension rights by around 10%, says Reedijk.

In contrast, moving to an industry-wide pension fund would not oblige a pension plan to improve its funding ratio.

A law allowing DC plan members to buy a variable annuity at retirement, as an alternative to a conventional annuity, became effective last September. The amount of the flexible payment varies over time according to investment returns. Pension plans may offer an individual variant, a collective one, or both. 

Increases or reductions in the collective variant can be spread over a maximum of five years. 

There are different options for the transfer of the capital into a payment:

• Partial transfer of capital to purchase a fixed annuity, the rest for flexible payment;
• Deferred fixed annuity to be paid at retirement age, with the rest for flexible payment from retirement age.

In addition, it is possible to purchase a decreasing annuity, and spread the investment returns over a maximum of five years.

If a pension fund offers both an annuity and flexible payment, participants lose their right to shop around for the annuity with another provider. 

Reedijk says: “Communication will become more important for DC plans, as participants have to make a number of choices. All in all, these are complicated choices, which will be difficult to make without a good understanding of the options.”  

Meanwhile, a law on pensions communication was passed in 2016, with the first two phases now in force, and the third taking effect this year. The aim is to ensure individuals in pension plans are aware of the pension options they can choose, the potential risks, and how much pension they can expect.

Pensioners will therefore become entitled to access the national pension register for both state and second-pillar pensions during 2017. The register will have to show the pension they can achieve under three different scenarios –  optimistic, pessimistic and expected outcomes. 

The law requiring an employer to seek works council approval if it changes pension provider has now been passed and came into force on 1 October 2016. Previously, approval was only required where the existing or new pension provider was an insurer, premium pension institution or IORP in another country.

Sweden

Legislation to incorporate Solvency II into Swedish law, for both life and non-life insurance companies, was enacted by the Riksdag in late November 2015 after a delay. 

Sweden’s occupational pension business is mostly carried out by life insurance companies, both for DB and DC pension funds. There are also pension funds set up as friendly societies. However, these funds make up only a small part of the occupational pensions sector in Sweden. 

The government has said it will publish a proposal for a regulation applying to insurance companies and friendly societies this autumn. 

Both of these must change their legal status to a new type of entity – an occupational pensions company – which can offer only occupational pensions. 

The rules will probably be based on IORP II, with additional risk-based capital requirements. 

What these capital requirements will look like is not yet decided. But since an occupational pension business is not obliged to follow the Solvency II regulation, the risk-based capital requirement will not be the same as in the Solvency II regulation.

Insurance companies offering both occupational pension and life business will either have to follow Solvency II regulations for the whole business, or split their business into two entities – a life business following Solvency II rules, and an occupational pensions entity following the appropriate rules.

The transitional rules for occupational pension business within insurance companies came into force in January 2016 and will be valid until the end of 2019. 

Some pension liabilities fall outside insurance companies and occupational pension funds, in the form of book reserves within the profit-and-loss accounts of ordinary companies in DB form. They are secured either by assets in specific pension foundations, or by purchasing credit insurance from specific insurance companies.

In practical terms, these liabilities fall outside the jurisdiction of Finansinspektionen (FI) the financial regulator, but are monitored by specific legislation. FI has a special mandate to change the way technical provisions (TP) are calculated in this area, and has made some changes regarding the calculation of discount rates. 

Tax relief on private pension premiums was abolished in 2016, with the exception of the self-employed, and employees without occupational pension rights other than from the state system.

Instead, companies now offer other, tax-efficient  savings products, but these are subject to withdrawal at any time.

It seems that many people will continue paying private pension premiums, thus paying income tax twice on these investments – when paying the premium, as there is no tax relief, and again as pension income.

After government pressure, a code of practice was worked out under FI supervision, covering certain information sent to policyholders and pension beneficiaries. It took effect last year. 

The code, which is compulsory other than for group occupational pension schemes, aims to improve the content and transparency of information for individual transfers of DC plans and private pension savings between life companies. 

The information includes brief product details, current accumulated values and fees, and also transfer charges from both companies involved, to provide proper consumer comparisons. However, the right to transfer pensions capital is still at the discretion of insurance companies for policies signed before 2007. 

FI has carried out an evaluation of this new regime, which shows that after some initial setbacks, most companies have produced a steadily increasing number of information leaflets. 

The regulator has also commented negatively about fees charged as a percentage of pension capital for transfers from a handful of specific companies, which could lead to substantial reductions in individual pension pots. The current legal framework leaves FI powerless to prevent these fees being charged.

A slow but steady trend towards DC schemes  has led to negotiations between employers and the unions. The total proportion of DB pension capital in Sweden under FI supervision fell to 24% at end-2015 (compared with 29% at end-2010). 

DC pensions can be sold as traditional life, unit-linked, or even deposit-based contracts. There is also a trend among companies to persuade employees to choose unit-linked instead of with-profits savings. 

“However, the development of DC pensions is generating a lack of information among employees as they change jobs frequently, thereby creating several paid-up DC policies,” says Göran Ronge, an actuary at FI. “As a result, the pension insurance industry, after pressure from government and the Consumers’ Insurance Bureau, has seen the need for joint co-ordination in providing data on current and forecast pension savings and expected pension payments on their websites.” 

This includes DB and private pensions, and there is also the ability for the employee to project their future total pension compensation level for a specific retirement age and future salary increases.

Switzerland

Now in its third year of parliamentary scrutiny, the Altersvorsorge 2020 (AV2020) pensions reform package may well reach the statute book by the end of 2017.

The most important legislative project affecting Switzerland’s pensions system, AV2020 aims to ensure the financial sustainability of the system while guaranteeing the current level of benefits, and constitutes a comprehensive reform of both first and second pillar systems.

For both pillars, it contains proposals to harmonise the normal retirement age at 65 for men and women. First-pillar-only reforms include changes to survivor benefits and increasing VAT by up to 1.5%.

In the second pillar, the proposals would lower the minimum conversion rate – used to calculate pension payouts from accrued assets – from 6.8% to 6%. However, there is disagreement over how and to what extent the reduction in future pensions should be compensated.

To compensate for the proposed cut in the conversion rate, the aim is to increase the pension capital saved by individuals. This is to be achieved by increasing both the pensionable salary as well as the contributions from both employers and employees. 

Whereas the parliament’s upper chamber wants to increase the state pension by CHF70 (€66) per month to compensate for the drop in occupational pensions income, the lower chamber is for a compensation within the second pillar only. The bill has been debated for a second time in the upper house of parliament and is now with the lower house. If a consensus can be reached on the above issues, the final vote could be taken by the end of the spring parliamentary session in March.

“There is no plan B, so it is not an option to reject the bill outright,” says Simon Heim, head of Swiss Life’s employee benefits legal practice. “However, once the bill is enacted, a referendum is inevitable because a vote would have to be held on the VAT increase. It would likely take place in September.” The law is planned to take effect in 2018.

An amendment to the law on vesting in pension plans (FZG/LFLP), approved by Parliament in December 2015, is still awaiting the updated ordinance from the federal council in order to take effect. The amendment applies to so-called 1e plans – top-up plans which companies may offer to higher-paid employees on the portion of their salary above the ceiling for mandatory contributions, currently CHF126,900 per year.

At present, members are assured a minimum level of benefits, even if they opt for a risky strategy that delivers poor returns. The amendment transfers the burden of investment risk to plan members by waiving certain guarantees if the member chooses the investment strategy.

The attraction for pension funds and their sponsors is that it allows them to remove liabilities from their balance sheets. However, for guarantees to be waived, the bill says the plan must offer at least one low-risk strategy.

“The final version of the bill left some questions open as to the definition of ‘low risk’, which now needs to be clarified in an ordinance,” says Heim. “Furthermore, the draft ordinance limits the number of investment strategies to three. This has brought heavy criticism from the industry, which is arguing that if the individual is bearing the investment risk, they need to have more flexibility in choosing products.”

Heim says it appears likely that these questions will be resolved in the next few months so that the legislation can take effect later this year.

The revision of the Swiss civil code regarding splitting vested pension benefits for divorcing couples came into force at the beginning of the year, improving the position of the non-working spouse. Pension providers had to amend and update their rules to comply with the changes.

There has been progress, albeit slow, on the government’s initiative to curb the perceived abuse of statutory supplementary benefits by people using their second-pillar savings for luxury expenditure.

At present, individuals reaching retirement age are generally allowed to withdraw their second-pillar savings as a cash lump sum. Some people have supposedly spent this money on lavish holidays or at the casino, subsequently claiming supplementary first-pillar benefits. Following the preliminary draft bill in 2015, an updated draft version was published in September 2016.

One of the key elements in the original draft – restricting cash withdrawals of the mandatory portion of pension fund savings – is retained. 

“The public consultation following the first draft showed that all the cantons were in favour of this measure as they have to bear a substantial portion of the costs of statutory supplementary benefits,” says Heim. “But both the liberal and the conservative forces in the Parliament are expected to oppose this proposal.”

UK

The Pension Schemes Bill, which covers DC plans, is now going through Parliament. It introduces a new authorisation and supervision regime for master trusts along with best-practice standards, and will ensure that the costs of winding up any master trust will not be met by members. The law is expected to be enacted this year, although the full regulatory code is not anticipated until 2018. 

Meanwhile, the money purchase annual allowance (MPAA) was reduced from £10,000 to £4,000 in the autumn statement of 23 November 2017. The MPAA is the total amount of contributions that can be paid into DC pension schemes each year to qualify for tax relief. 

Tim Gosling, policy lead for defined contribution at the Pensions and Lifetime Savings Association (PLSA), says: “Reducing the MPAA will negatively affect pension saving for many who have used the pensions freedoms. As there is no evidence of re-cycling of tax-free cash, the MPAA should be retained at the current level.”  

In November 2016, the Financial Conduct Authority (FCA) published an asset management study expressing doubts about value for money in the investment consultancy market, and made a provisional referral to the Competition and Markets Authority.

An open consultation is now looking at ways in which market efficiency can be improved, including reclassifying some pension funds as consumers rather than institutional clients. 

There is a wide variety of standards across the financial services industry concerning transfer of assets. Last December, several pension and investment trade associations published a consultation paper on transfers and re-registration. This was done in consultation with the Department for Work and Pensions, the FCA and the Pensions Regulator (TPR).

The proposals include imposing a new 48-hour standard for each step of the transfer process, and creating a governance body to monitor firms’ performance against the standard.

The introduction of the lifetime individual savings account (LISA) also represents a shift in the savings market. The much-publicised scheme allows consumers aged 18 to 40 years to save up to £4,000 per year, with a 25% top up by government. This fund can be used either for the purchase of a first house, or accessed after the age of 60 without tax implications. 

The downside is that if the saver withdraws money early they suffer a 25% penalty on the entire value of the LISA

A consultation by HM Revenue and Customs was due to close this February. Graham Vidler, director of external affairs at the PLSA, says: “At present, the LISA leaves savers exposed to multiple risks. Strong governance is the key and LISA savers would benefit hugely from the quality of governance that is the norm in workplace pension saving.”

This year is potentially significant for defined benefit pensions. Groundwork was laid last year by the House of Commons’ work and pensions select committee and the consultation on British Steel, whose pension scheme was a key factor in the successful attempt to stop the main sponsor, Tata Steel, from shutting its UK plants. 

A green paper is expected to include proposals to strengthen the powers of TPR. It may also include steps to facilitate greater consolidation of schemes with the aim of addressing the challenges facing DB schemes and their sponsors.

The FCA will issue a policy statement this spring following a consultation on implementing the new Markets in Financial Instruments Directive (MiFID II) in January. 

Local Government Pension Scheme (LGPS) funds will be watching carefully to see whether the FCA has retreated from its intention to reclassify local authority pension funds as retail investors. 

The PLSA opposes this. Joe Dabrowski, head of governance and investment at the PLSA, says: “We are concerned that the new approach does not reflect the experience and expertise of local government pension schemes, and would have serious implications for their ability to manage their investments in line with their pension fund liabilities. It could impair their ability to invest in certain asset classes, such as infrastructure.”

Meanwhile, the reform of LGPS investment regulations has been enacted, allowing these funds to pool their investments. LGPS pools will be busy gaining FCA authorisation in time for the commencement of the pools in April 2018.

Lastly, Brexit will, of course, affect the pensions sector. The PLSA says it will be lobbying for access to the single market but protection for UK-only schemes from any future EU pensions solvency regime.

Officially at least, however, the UK government is preparing to implement the new IORP II Directive by the deadline of 12 January 2019. This would involve a consultation over this coming summer. 

But the extent to which this is affected by Brexit remains to be seen. Also in the EU mix is the European Market Infrastructure Regulation (EMIR) review. The European Commission is expected to launch a review of this key legislation on the OTC derivatives markets in the next few weeks, leading to EMIR II. The PLSA will be monitoring the implications for the pension fund exemption from central clearing, which currently runs until August 2018.

Researched and written by Gail Moss

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