Eleven years have passed since the European pensions industry digested, welcomed and, in some cases, bemoaned the Directive for Institutions for Occupational Retirement Provision, or IORP I as it became known. This year, the European Commission once again took up the arduous task of updating this Directive, publishing its legislative agenda before submitting it to the European trialogue machine.
The Commission has highlighted the need for this overhaul, IORP II, on the basis of how many things have changed within the EU in the past 11 years. It has welcomed more members, populations have increased, longevity has risen even further and, of course, the global financial crises have occurred.
According to the Commission a more “harmonised and robust” framework would aid the development of provision in member states that do not yet have developed pensions systems.
“It would also bring about a higher, EU-wide minimum level of consumer protection, which disseminates best practice across the EU and prevents an unequal level of protection,” the Commission said.
The new proposal has four key aims: to ensure IORPs better protect members; to keep members better informed; to increase cross-border pension activity; and to encourage pension fund investment in long-term economic growth strategies.
The published version of the Directive has many elements to it, so just how do all these fit together? And does it work towards those aims?
Risk evaluation and governance
The new Directive states a requirement for pension schemes to perform risk evaluations regularly, and specifies the need for this to be done immediately should a scheme’s risk profile change significantly.
Embedded within all of this is an outline of what schemes need to do, which includes qualitative assessments on “the margin for adverse deviation” when calculating technical provisions. It also requires assessments on sponsor support, operational risks and emerging risks related to climate change, natural resources and the environment.
Details of how this risk framework will actually be implemented still remain sketchy, however, with the European Insurance and Occupational Pensions Authority (EIOPA) instructed by the Commission to provide technical assistance.
The Directive does specify that the delegated act should not introduce “additional funding requirements beyond those foreseen in this Directive”, looking to alleviate fears that any risk evaluation could lead to further solvency requirements, much to the relief of many in the industry.
Depending on how EIOPA applies this risk evaluation framework to European schemes, it could become a significant cost burden. While some of the wording may seem like common sense to professional and larger funds,
the need for immediate and transparent risk evaluations could become a heavy burden for small to medium schemes.
Under the banner of governance, the new Directive also sets out requirements for fit and proper management, as well as remuneration policies. National regulators will need to ensure trustees and advisers have the knowledge and experience for “sound and prudent” management, and are of good repute and integrity. However, the actual definitions remain a national concern.
With these proposals in particular, the detail is significant. In the long run, the additional cost and requirements IORP II imposes need to be balanced with the additional benefits for member security. However, no one can claim that a better understanding of risk by scheme trustees is necessarily a bad thing.
The flagship element of the Commission’s reform and harmonisation of member communications is the standard for a Pension Benefit Statement. Included in the Directive are strict requirements for all schemes to offer a two-page annual statement to members, dictating what information needs to be included.
The new statement, with an entire chapter dedicated to the finer points, is to be no longer than two pages of A4, with even its title being specified by the Commission. It will contain information on guarantees, balances, contributions, costs, projections, investments, past performance and supplementary details, such as where to obtain additional information.
The Commission’s motive for this is based on the single market, with its view that all citizens should be able to relocate to another member state, transfer their pension and receive a statement in the exact same format.
However, while this requirement will be helpful for members in newer member states and smaller schemes, much work has already been done in the Netherlands, the UK and Denmark in tailoring and improving member communications for national needs.
The Pensions Federation in the Netherlands has warned of communications overkill. The developed Dutch market already provides “demand-based” communications, with the basic levels provided and more available on request.
In the UK, NEST, the state-backed DC-trust scheme, has spent significant amounts on creating tailored communications to its target audience, and has been applauded for its success.
The advantages of a simple EU-wide member statement are obvious. In developed second and third pillar markets, member transparency and communications have long been a hot topic. So perhaps a Commission intervention could put debates to rest.
A further element of the Directive focuses on easing cross-border pension provisions.
The Commission says its aim is to ensure “institutions should be able to transfer pension schemes across borders”. This falls into the need to facilitate IORP organisation on an EU scale.
As in IORP I, the proposal sets out that pension funds should be allowed to invest in other member states, following the rules of their home state, to reduce the cost of cross-border activity. It also aims to outlaw the imposition of additional investment requirements, sometimes set by regulators.
The Directive has revamped its policy of scheme transfers, with member states told to fully allow EU pension schemes to be transferred between states, subject to standard authorisation, with strict requirements and timely actions.
While the ease of cross-border activity will generally be welcomed, one omission has been a bone of contention.Previous leaked drafts of the Directive had removed the need for cross-border pension schemes, which offer guarantees, to be fully funded at all times. The relaxation of this provision was widely welcomed by the pensions industry, and seen as a positive step forward for cross-border activity. However, catching many commentators by surprise, this provision was then removed shortly before publication of the Directive.
The Commission says it is maintaining the status quo to ensure “sound cross-border provision”. This explanation was accepted by few, with industry figures decrying last-minute lobbying from those against relaxed solvency requirements for pension funds – in other words, the insurance industry.
Again, any relaxation of rules would be positive for pension schemes looking to operate across member states.
Risk investments in the long term
Key to the Commission’s plans for long-term investing across the EU (see page 18), the IORP Directive also includes snippets of support for pension funds.
Key mainly to investors in Austria, Germany and Italy, the Commission has removed the right for member states to restrict investments in risk assets, particularly ones that promote economic growth.
Some member states currently restrict allocations to just 10% of assets. However, new rules now set 70% as the new minimum national regulators can impose.
The move is meant, mainly, to allow pension funds to invest in infrastructure, a key focus for the Commission going forward. However, many regulators currently class infrastructure debt as collateralised, due to its structure.
This has impacted a fund’s ability to invest in the asset class, much to the dismay of the EU as a whole.
While the larger pension fund markets, such as The Netherlands, the UK and the Nordics, do not impose these restrictions, any additional investors moving towards long-term projects stand to benefit from the Commission’s aim. The benefits of infrastructure and long-term finance to funds are obvious, and any additional ability to pursue those investments is likely to be welcomed.