Proposed pension solvency requirements could have a "disastrous impact" on economic growth, industry bodies warn

The National Association of Pension Funds (NAPF), Trade Unions Congress (TUC) and Confederation of British Industry (CBI) have written to European Commission President José Manuel Barroso to outline their concerns ahead of recommendations due from the European Insurance and Occupational Pensions Authority (EIOPA) this week.

"As employers, employees and pension schemes, we would all emphasis that we strongly support the Commission's objective of ensuring pension scheme members benefit from risk-related regulation, but the funding measures currently envisaged by the Commission fail to achieve this," the letter said.

"By demanding dramatic increases in funding from employers, the Commission's plans would – at best – force all remaining defined benefit schemes to close and – at worst – push many businesses into insolvency, leading to significant job losses," it said.

EIOPA is set to recommend that the Commission makes European pension funds subject to the same solvency requirements as those due to come into force for insurers from 2014 as part of its reform of the European Pensions Directive (Institutions for Occupational Retirement Provision Directive or IORP). The draft insurance directive, known as Solvency II, sets out stronger risk management requirements for European insurers and dictates how much capital firms must hold in relation to their liabilities.

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. The new supervisory system should, it said, be compatible the approach taken by Solvency II in relation to the insurance industry "to the extent necessary and possible".

"One of the main drivers behind these proposals is the Commission's desire to create a level playing field between pensions and insurance in the hope that this will promote cross-border schemes, but their impact will be felt by existing defined benefit schemes which do not compete with insurers," said pensions law expert Carolyn Saunders with Pinsent Masons, the law firm behind Out-Law.com. "The employers that sponsor those schemes and who will have their fingers burned by these proposals are not likely to want to get involved in any new pension arrangements in future - cross border or otherwise."

In certain member states pensions are sold by insurance companies, which is why EIOPA 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) funded by a levy on eligible defined benefit pension schemes which will pay out to scheme members in the event of an employer's insolvency.

"If the impact of EIOPA's proposals is, as feared, to push more employers into insolvency – and more schemes into the PPF – there must be a risk that the PPF will be unable to sustain its current levels of compensation and that member security will be jeopardised further as compensation levels reduce," Saunders said.

Research carried out last month by investment bank JP Morgan suggested that extending the same solvency requirements to pension funds could cost UK businesses an extra £600 billion. Pensions law expert Robin Ellison, also with Pinsent Masons, said at the time that if implemented as suggested the regime would create "grotesquely inappropriate" liabilities and costs for pension funds and their sponsoring employers.

The UK Government has also spoken out against extending the regime to pension funds, with Pensions Minister Steve Webb going as far as to say its introduction would be a "nightmare scenario" that would inevitably lead to scheme closures.

"These plans would cause massive damage to UK pensions and undermine economic growth across Europe. Instead of making pensions more secure, they would have the opposite effect," said NAPF chief executive Joanne Segars. "The UK already has a strong system to protect pensions. During these tough economic times, Europe should focus on fostering growth and job creation instead."

The new solvency rules also propose using low risk investments, such as government bonds, to calculate a scheme's potential liabilities, the organisations warned in their letter. This would mean that pension schemes would no longer be able to make riskier investments, for example by purchasing publicly-traded company shares and equities. Losing funding from pension schemes would "restrict capital flows to businesses at a time when they are being asked to put even more cash into schemes", the letter said.

"With European pension funds holding over €3 trillion in assets, a major switch in asset allocation would have an immediate catastrophic impact on the stability of European financial markets," it said.