Gail Moss reviews pension regulation and law changes under discussion in seven European countries
The Danish pensions and insurance industry has spent the past year negotiating with the government to effect a number of minor changes in pensions legislation.
However, a law enacted in mid-2012, which reduces taxes on earned income, has sparked animated debate within the industry.
Until now, pension pots have been taxed on an ETT basis (exempt contributions, taxed investment income and capital gains of the pension institution, and taxed benefits).
But the new law has changed the tax treatment to a TTE basis. As from 1 January 2013, contributions do not attract tax relief, while payouts are made tax-free.
However, existing pension accounts built up under the old regime can be treated under the new rules if the saver pays upfront the tax which was originally due on pay-out at pension age. This would normally mean a 40% tax charge.
As an incentive, the government is giving a tax rebate to savers who do this during 2013.
Capital transferred to the new regime is being taxed at 37.3%, the lowest rate of tax for earned income.
But the Danish Insurance Association (DIA) has strongly opposed the move.
“This is an attack on the general ETT system,” says Karen Leth Jensen, senior consultant, DIA. “The ETT regime is better because it ensures the public sector gets tax receipts from pension pay-outs at the point where the same people may need more state funding because of their age.”
Jensen says the reform means that public spending on pensioners will partially move from a funded system to pay-as-you-go, which she considers to be a retrograde step.
Meanwhile, Solvency II is still to be incorporated in Danish legislation. With the postponement of Omnibus II, and the setting up of another impact assessment round, all bets are now off as to when this will happen.
The first two phases of solvency regulation are now in force.
The main effect of the first phase has been to use a more accurate risk classification for bonds and loans when applying Finland’s risk-based solvency requirement formula.
The second phase came into force on 1 January 2013 when the period of temporary regulation expired. It created a common buffer (solvency capital) for pension funds against investment and insurance risks; previously, there had been separate buffers for the two types of risk.
The third and final phase of the regulation process will deal with all the risks recognised in Solvency II in a national framework. This should take effect in or after 2015.
The rules on pensionable age are still the subject of the biggest pensions debate in
The statutory retirement age is flexible, from 63 to 68 years. Employers’ associations are in favour of raising the lower age limit, while trades unions are generally against. The Social Democratic Party is also against raising the lower age limit, but those other political parties in the cabinet which have expressed a view want to raise the age limit.
However, last year the social partners agreed on some minor changes in age limits. A part-time pension cannot now be taken until the age of 61 instead of 60, and an actuarially reduced pension is no longer available for those retiring at 62. The changes came into force on 1 January 2013.
In addition to the permanent negotiating group of the social partners, a high level expert group chaired by Jukka Pekkarinen, director general of the ministry of finance, is now at work.
The group’s role is to prepare alternative policies for the next pension reform coming into force in 2017, at the latest. A key element of these policies is changes to the rules on pensionable age, but other rules could be changed as well. The group should publish its report at the end of 2013.
The pressures on pension rules have not come primarily from the financial sustainability of the pension system itself, but because the government is committed to making the entire public economy sustainable once more.
So given the present economic situation, it was not a surprise that the working group for pension indexation did not suggest any improvement in the rules, from the point of view of pensioners.
Currently, for those retiring after age 63, the accrual rate is high (4.5% of their annual salary). However, a cohort-specific adjustment is also made to the monthly benefit. This is related to the change in life expectancy at age 62 for successive cohorts, compared with those born in 1947, for whom the coefficient was defined as one. As life expectancy rises, the coefficient for more recent cohorts is reduced.
Since the major pension reform of 2005 came into force, the average retirement age has increased by 1.4 years to 60.5 years, as at 2011. Both government and social partners are aiming for an average retirement age of 62.4 years by 2025.
But actuaries have calculated that the incentive of high accrual rates and life expectancy adjustment after 63, together with the continuing decrease in the incidence of disability, will not be enough for the target to be reached.
No new laws were enacted in the past year for the pensions sector – indeed, the Solvency II legislation (tenth amendment to VAG) was rejected by the Federal Council (Bundesrat) in late December.
However, some progress was made on plans for future legislation.
The debate on reforming legal insolvency protection for occupational pensions came to an end. The Association of German Employers (BDA) had led this discussion over several years, wanting existing systems to be adjusted towards a more risk-oriented system. At present, employers’ contributions to this system are not really related to the insolvency risk of the employer.
However, BDA members who support this change have not been able to bring the BDA membership as a whole to agree on a common position.
The government suffered a Parliamentary defeat over the tax treatment of occupational pension systems.
It planned to ban certain tax-efficient procedures which had been allowed by the Federal Tax Court (BFH). These procedures enable employers to increase their book reserves (the figure for tax purposes) without raising the level of their pension promises.
But Parliament refused to pass the new laws.
Finally, the federal government has continued consultation with the pensions industry to decide what further legal measures need to be introduced for state pensions. So far, it seems to be clear that measures will have to be taken to raise the minimum level of state pensions to prevent pensioner poverty.
Discussions are taking place between the political parties as to which groups of pensioners should be included.
The emergence of a centrist Liberal-Labour coalition after parliamentary elections last September has had mixed results on the pensions front, with progress in some areas, and other projects postponed.
“At first glance, things may seem in limbo, but under the surface the tectonic plates are shifting,” says Tim Burggraaf, principal, Mercer. “The government is trying to make necessary and very big changes, but they are difficult to implement because of their complexity.”
Fundamental changes in the Pension Act, including a new FTK supervisory framework, have been delayed by a year.
Instead of the two FTK1 and FTK2 supervisory structures planned by the previous government, the likely outcome now is to have one model, FTK2, accommodating both nominal guaranteed and conditional real pension arrangements.
“The real framework in practice means that all plans will effectively become DC schemes, potentially leading to lower pensions over time,” says Burggraaf. “We’ve seen two large industrywide funds preparing to make that move, and many more are likely to follow them.
The reality that there is no such thing as a true DB plan is slowly getting noticed. The fact that there are collective elements included in such DC plans does not change their fundamental character. Naming them collective DC plans sounds good, but does not really differentiate them.”
Jette Klijnsma, state secretary for social affairs and labour, said she will present legislation to the Dutch Parliament before Christmas 2013, to take effect from 1 January 2015.
The ‘September Package’, a set of temporary rules including relief measures to prevent the need for benefit cuts and contribution hikes, also introduced a new – although temporary – discount rate methodology involving the ‘ultimate forward rate’ (UFR).
Klijnsma has set up a committee to study the new discount rate and advise on its future.
Meanwhile, contributions to the state pension scheme (AOW) have also gone up. And an increase in the retirement age to 67 by 2025 has been enacted, to be achieved by gradual increases on a monthly basis.
The new government has also acted swiftly to claw back some of the tax reliefs given to pension savers over the past two decades.
For second pillar schemes, it intends to introduce a cap on tax-free accruals at an income of €100,000, and reduce the yearly tax-free pension accrual from 2.25% in 2013, to 1.75%, probably in 2015, leading to fundamentally lower pension levels.
At the same time, and despite the September package, many funds will still be below their recovery path and will cut accrued benefits. This means new pensioners will get around 7% less in pensions during 2013 than for the previous year.
Burggraaf adds: “Obviously, the same applies to younger active members who suffer from both issues: they will see lower accrual rates for the future, as well as cuts. The question is whether or not the intergenerational solidarity will hold.”
The low level of annuities is also still an issue; members of those DC plans that have not rebalanced into lower-risk securities as active members retired will receive drastically reduced pensions, since Dutch members of DC plans are forced to buy an annuity when they retire. “Unfortunately, our government still forces people to waste their money by buying high-priced annuities at a single moment in time,” says Burggraaf. “If they would only grasp what the rest of the world already has done, and allow for at least partial spend-down modelling, that would significantly reduce this problem.”
There are no signs of legislation to deal with the issue, although recent products have tackled it using various types of protection (such as long duration bonds) close to retirement. However, a range of DC products is being developed by providers – for instance, funds that allow real or nominal annuities to be purchased during the accrual phase, in order to smooth out variations in annuity rates and third generation lifecycles.
Regulations published under the new Insurance Business Act and setting up a new legal framework for friendly societies including pension funds are now in force, with a transitional period until the end of 2014.
The risk-based calculation of solvency will now have to be implemented for undertakings covered by the Act, including pension funds but excluding pension foundations. The government committee responsible has suggested this is done by updating the Act to comply with Solvency II.
Consultation on these proposals has ended and the government is now preparing a bill for the Swedish Parliament (Riksdag).
New rules for the demutualisation of life companies and the principles of handling bonus capital, along with transfer rules for pensions, have been proposed by another government committee and sent for consultation. The aim is to ensure fair treatment for existing policyholders on demutualisation, especially the right to transfer DC pension savings (which make up most of the Swedish pensions market) on an individual basis, both private and occupational.
No recommendations have yet been published. The consultation period for comments was due to end in February this year.
As in other European countries, changes to the Swiss pensions system to cope with an ageing population and the financial crisis are taking up much of the legislative timetable.
But another, less pressing, issue has caught the public imagination – the fight to outlaw so-called “rip-off management salaries”.
A public vote was scheduled for 3 March on a proposed law to allow shareholders of listed companies a veto over company remuneration plans, and to ban severance and advance payments. Pension funds would have an obligation to exercise their voting rights in the best interests of their members, and disclose how they voted at shareholder meetings.
Parliament has published its own counter-proposal, which has similar aims but is a more balanced solution. But pension funds would still be required to exercise shareholder rights, “if possible”, and disclose their voting behaviour.
The counter-proposal would become effective, subject to a referendum, if the “popular initiative” is defeated.
“A problem with the original proposal is defining the best interest of plan members,” says Simon Heim, pension lawyer at Towers Watson. “Does it simply mean getting the best return, and would you need to consult members? Furthermore, the pensions industry says the new regulations would mean higher costs. However, this issue will only affect larger pension funds, as smaller ones typically invest through pooled vehicles.”
Another proposal amending the law on vesting in pension plans was published last October. The public consultation was due to end in February.
The proposed legislation waives certain guarantees if plan members individually choose the investment strategy for their plan. However, guarantees are not entirely waived, so pension schemes would still be obliged to offer minimum retirement benefits.
Sponsor companies hope that these plans could be treated as DC plans under international accounting standards (IAS), in order to derisk their balance sheet.
“But it doesn’t improve the situation for sponsor companies because while even small guarantees remain, these plans will likely still be regarded as DB plans under IAS rules, so there will still be some risk,” says Heim.
The long road to comprehensive reform of the second pillar continues, a key objective being to allow more flexibility in terms of retirement age, while making early retirement less attractive.
One challenge for the government will be to reduce the guaranteed conversion rate in occupational schemes (used for converting the member’s account balance to a pension), while another hot topic is profit sharing between insurance companies and pension scheme members.
A consultative document was published last year, and more draft proposals are expected later this year. But legislation is unlikely before 2020.
An initiative is under way to help enforce child or spouse support payments by potentially blocking withdrawals from the pension pot of a spouse who has failed to make the requisite payments. Any request to withdraw capital from this spouse’s pension fund has to be reported in advance to the authorities, who must give their assent.
“This is generally agreed to be a good thing, but might mean more administrative work for the pension fund,” says Heim.
Legislation is unlikely to be enacted before 2015.
Meanwhile, a revised legislative proposal requiring the splitting of pension benefits on divorce was expected to be published this spring.
The government’s long-awaited White Paper on pensions was published on 14 January 2013. This proposes a new flat-rate state pension of £144 (€167) per week, in 2012-13 terms. The increase will be funded by merging the basic state pension with the state second pension (SERPS), and introduced in or after April 2017.
“This should reduce the need for means-testing, making it more worthwhile for people
to save,” says James Walsh, senior policy adviser, EU and international at the National Association of Pension Funds (NAPF). “However, it means the end for contracting-out
of SERPS by defined benefit schemes, and will require careful thought by scheme managers to make the transition as smooth as possible.”
The legislation will be published later this year, with enactment expected during 2014.
Proposals to reinvigorate occupational schemes have gained momentum. Pensions minister Steve Webb wants to introduce more risk-sharing between employers and employees, making DB schemes more sustainable, while alleviating some of the risk for members of DC schemes.
A discussion paper published last autumn contained practical examples developed by government working groups. The logical next step would now be a Green Paper, but as yet there is no indication as to what form it will take, or when it will be made.
The Pensions Regulator (TPR) is still consulting on a new regulatory framework for DC plans to ensure good outcomes for members. A key element is the analysis of the way its six principles work in practice – these include proper governance, administration and communications to members. TPR says this should be achieved by support for the market; a robust regulatory framework focusing on key risks in DC schemes, and regulatory intervention where inadequate attention is paid to those risks; and enforcement only where it is needed for the market to deliver good member outcomes unaided.
The consultation ends on 28 March, with the final code of practice and guidance for scheme trustees appearing later in the spring.
In response to industry lobbying, a government consultation has now been promised on the effects of quantitative easing on DB scheme funding.
Meanwhile, with the requirement to purchase an annuity by age 75 now lifted, the government has set up stakeholder working groups to look at educating the public on the open market option – their right to shop around for the best rates.