EIOPA to study impact of tougher pension capital requirements

The announcement by the European Insurance and Occupational Pensions Authority (EIOPA) came as part of its response (515-page / 2.7MB PDF), published last week, to the Commission's call for advice on its review of the Pensions Directive.

The regulator has proposed a "holistic balance sheet" approach to ensure that pension funds across Europe meet similar solvency requirements regardless of whatever national security mechanisms are in place.

"The extent to which the holistic balance sheet will be considered a viable alternative to the existing [implicit guarantees in the Pensions Directive] will very much depend on the outcomes of a quantitative impact assessment, which in EIOPA's view is essential," it said in its response.

EIOPA has also called for the introduction of a Key Information Document which will provide "relevant, correct, understandable and not misleading" information for all defined contribution schemes.

In its call for advice issued to EIOPA last April, the European Commission said that it was looking to introduce risk-based supervision for pension providers as part of its reform of the European Pensions Directive (Institutions for Occupational Retirement Provision Directive or IORP). The new system should, it said, be compatible with the solvency requirements due to come into force for insurers from 2014 under a regime known as Solvency II "to the extent necessary and possible".

The potential introduction of Solvency II standards for pension funds has been met with outcry from the pensions industry and Government, with research suggesting that such a requirement could cost UK businesses an extra £600 billion. Last week a group of UK pension and business organisations wrote to European Commission President José Manuel Barroso warning that the plans would "undermine the retirement prospects" of millions of citizens and have a "disastrous impact" on economic growth, while the Government's Pensions Minister Steve Webb has said that it would be a "nightmare scenario" that would inevitably lead to scheme closures.

In certain member states pensions are sold by insurance companies, which is why the Commission has considered extending the solvency rules for that industry to pensions. However the UK already has strict protections in place for occupational pensions, including a Pension Protection Fund (PPF) which will pay out to scheme members in the event of an employer's insolvency.

The holistic approach proposed by EIOPA is intended to take account of adjustment mechanisms such as conditional indexation, or built-in security mechanisms such as the strength of the employer covenant and the existence of national guarantees, it said. In its advice, it added that many of the respondents to its consultation on the requirements had stated the view that Solvency II was "the wrong initial framework for considering the capital requirements" of pension funds. The consultation received 170 responses from the industry – thirteen times as many as the average number of responses to any of the regulator's previous consultations.

Pensions law expert Robin Ellison of Pinsent Masons, the law firm behind Out-Law.com, said that the debate surrounding the new requirements was a "prime example of the law of unintended consequences". The EU's basis for introducing a prudential solvency framework was that it wanted to see the promises made to pension scheme members backed either by sufficient assets in real terms, or through national guarantees such as the Pension Protection Fund in the UK, he said.

"The question for the EU is whether, when it says the pension fund must have enough money in the kitty, it can take a more relaxed view when there is a compensation system in operation in that country and say that there is less need for assets in the kitty – and therefore less money needed from the employer," he said.

"While a holistic approach would be sensible for the UK because we have a compensation system well in place the wider view is that if the EU insists on pension funds being excessively capitalised to provide security for defined benefit arrangements, companies will simply move to defined contribution arrangements which are worse for employees generally."

"EIOPA has helpfully stressed the importance of proportionality, but it is still far from clear what level of funding might be demanded of defined benefit schemes in the final Directive. EIOPA's impact study, once complete, might make the European Commission finally realise that the imposition of stricter funding requirements is not what defined benefit schemes and their sponsoring employers need just now," added colleague Simon Tyler.