Questions on the European Commission’s PEPP proposal
• The EC’s proposed pan-European Personal Pension Product (PEPP) aims to stimulate pension saving.
• PEPPs will have a maximum of five savings options, including a low-risk default fund.
• It is unclear whether the proposals will be attractive for providers or savers.
On 29 June the European Commission issued a proposal for a regulation on a pan-European Personal Pension Product (PEPP), accompanied by a Commission recommendation on the tax treatment of personal pension products, including the PEPP. At the same time, an impact assessment and a supporting study on tax aspects were published.1
The Commission is pursuing three main aims. The first is to unlock a competitive cross-border European market for third-pillar personal pension products to allow more European citizens to transform savings – still widely held in bank accounts but in fact serving retirement purposes – into much more productive long-term pension products with institutions that can transform these savings into long-term investments. This could potentially contribute substantially to the Capital Markets Union (CMU).
The second main aim is to close the ‘pension gap’ – a substantial amount of European citizens do not have access either to second-pillar pensions or financially attractive third-pillar pension products, and therefore have difficulty in retirement. The Commission finds this undesirable, particularly as the sustainability of first-pillar pensions is under pressure, a pressure to which ageing populations will only add over coming decades.
The third aim is to encourage cross-border provision and portability of pensions.
To facilitate its aims, the Commission proposes introducing a ‘second regime’ for PEPPs. PEPPs are minimally defined in the proposed regulation but will receive a European passport. National regimes will not be harmonised but a new European regime will be added. This approach is similar to what the EU has applied to UCITS.
The PEPP proposal sets out standards for product features such as investment rules, transparency requirements, switching between providers and portability. Consumers will be able to choose between a maximum of five savings options (including one default) and member states will set the conditions for the saving phase and the payout of the capital. At the same time, the tax recommendations are intended to convince member states to include PEPPs in their tax incentives for national third-pillar pension products.
The basic idea behind this proposal is attractive. But will it really achieve its aim? We see a series of questions that can be grouped in a few categories:
• Will PEPP close the pension gap?
• Will it contribute to the CMU?
• Can we expect enough providers to enter the PEPP-market?
• Will there be substantial uptake?
The three most important observations to make here are that PEPP should be set in the context of wider pension strategy; that the effective opening of national tax incentives is crucial; and that the approach chosen may be over-reliant on markets.
A PEPP is based “on a contract between an individual saver and [a PEPP provider] on a voluntary basis, has an explicit retirement objective, provides for capital accumulation until retirement with only limited possibilities for early withdrawal before retirement, [and] provides an income on retirement”.
The terms ‘individual saver’ and ‘voluntary basis’ underline the third-pillar characteristics. But this does not cover all pensions. Interestingly, recital 11 of the proposal on the additionality of PEPP refers only to not replacing or harmonising national personal pension schemes, but does not say anything about the potential risk of PEPP driving out second-pillar pensions.2
Obviously, closing the pension gap should imply that more people will have an adequate pension, from whatever pillar, than is currently the case. We feel the PEPP proposal would gain if it were part of a wider pension strategy, and at the very least it should be clear how we will measure the closing of the pension gap.
The impact assessment states that all economic additionality to the existing national markets for personal pension products depends on the access of PEPP to national tax incentives.3 This will grow organically to €1.4trn by 2030, reaching €2.1trn by that date if PEPP is introduced and has access to tax incentives in all member states.
Doubts about the final outcome are legitimate, given that firstly the Commission tax recommendation does not bind member states, and secondly, even the Commission admits in its impact assessment both that national tax experts have taken a critical approach and that experience so far of member states implementing recommendations in the field of direct tax is at best very limited.4
Many people find pensions both unattractive and complicated. Pensions are about paying premiums now while reaping benefits in future decades. This means it is easy to postpone any decision until it is too late to save for an adequate pension. This indeed is the very beauty of compulsory second-pillar pensions and of systems like auto-enrolment in the UK.
Relying just on markets may not suffice. Indeed, in the Netherlands we observe – notwithstanding the availability of tailor-made personal pension products that allow for tax incentives – that self-employed sole-traders by and large do not buy these products.
Obviously the contribution of PEPP to the CMU will depend on the additionality discussed above. But PEPP should also be considered a way of transforming savings held in relatively less productive forms into long-term investments, and rather in equity than in debt. Compared to the current situation this certainly should work. However, the proposal does contain rules to protect consumers that may limit PEPP providers in terms of contributing to the aims of the CMU.
First, the Commission has introduced the possibility for PEPP savers to switch to other PEPP providers at least once every five years. This should encourage competition and thereby drive down costs, but it also implies a potential reduction of the investment horizon for PEPP providers. From this perspective, the switching option may be on the frequent side; from the perspective of savers it may be less satisfactory than linking it to life events such as divorce or cross-border relocation.
Furthermore, European policymakers should realise that while additional long-term savings generated through the PEPP proposal are important, further encouragement of second-pillar pensions in IORPs could also contribute considerably to this objective. In fact, IORPs account for substantially more assets under management in the EU than personal pension plans. We are therefore looking forward to the Commission acting upon recital 20 of IORP II and creating a “high level group of experts to enhance second pillar retirement savings in member states” as well.
Opening up the PEPP market, now dominated by insurers, to asset managers, investment firms and IORPs regulated in European law, should boost competition in the internal market.
However, although this proposal contains many interesting promises for potential PEPP providers, it perhaps presents just as many complicated requirements. On the one hand, creating a European-quality label for a PEPP is positive, while the ambition to allow for digital advice distribution and provision is very attractive and could stimulate innovative fintech solutions, for instance. On the other hand, the fact that member states remain completely free to decide whether or not to open up their national tax incentives makes it very difficult to assess a potential business case to enter the market.
Furthermore, certain requirements may present a considerable hurdle. We understand that PEPP providers must be able to provide proper ‘compartments’ for savers from three years after the regulation comes into force, as and when any saver wishes to move to another member state. This in turn obliges PEPP providers to have sufficient understanding of the tax law of all member states or to gain that understanding very quickly.
It is also unclear how asset managers, which may not be permitted to provide an annuity, can open a compartment for a member state where tax incentives are only available for products that pay out in the form of an annuity.5
Similarly, we do not fully understand how the role foreseen for IORPs as PEPP providers would fit with articles 6 and 7 of IORP II, which limit the scope of activities an IORP can engage in and allow member states to impose stricter rules.
In the Netherlands, for example, IORPs are in general not allowed to provide individual pension products on a voluntary basis to anyone other than those who are already participants of the pension fund involved. Depending on the type of employment found by a PEPP saver in another member state, it may therefore not be possible for Dutch IORPs to offer PEPPs.
The Commission should clarify this issue, also in relation to considerations of fair competition and to the possibilities of compulsory participation in a pension fund based on a collective contract between social partners.
We have already expressed some doubts about the procrastination of individuals when it comes to managing their retirement. In addition, specific practicalities of the PEPP proposal may turn out to be more of a hindrance than a help. For example, the proposed obligation for providers to offer a safe default option consisting of a nominal guarantee on premiums paid could – in the current environment of generally very low long-term interest rates – eat away most of the potential investment returns. This in turn may reduce the default PEPP option to an unattractive proposal.
To conclude, based on these considerations our conclusion can only be provisional and it will be important for the Commission to provide more of a general pension policy against which the proposal can be judged.
Too many questions remain open for any decision as to whether this proposal presents a viable business case for providers on the one hand and will offer attractive PEPP products for savers on the other.
We note an imbalance between obliging PEPP providers to be able to open compartments in all member states, versus the absence of any obligation on member states to open up their national tax incentives. In addition, limits applicable to specific types of PEPP providers may preclude them from offering PEPPs in all member states or to all European citizens. The core of the idea looks promising but many aspects still have to be clarified.
Johan Barnard is APG’s head of European public affairs and Wilfried Mulder senior policy adviser at APG
1 Documents can be found at https://ec.europa.eu/info/publications/170629-personal-pension-products_en
2 The same goes for the ‘key performance indicators’ provided in the impact assessment for the eventual evaluation of PEPP five years after its introduction.
3 The supporting study on tax incentives of EY published by the Commission illustrates the complexity that already would stem from the diversity of existing tax incentives, often more than one per member state, even if these were to be opened. We noted that the description of Dutch tax incentives is not correct, or at least over optimistic.
4 Impact assessment pages 34, 56, 61, 63 and 70.
5 Which until 2008 was the case in the Netherlands with an alternative now for credit institutions that can pay out in instalments over five years for small pensions, and 20 years for high pensions.