Revision of the IORP Directive: pitfalls to avoid
Written by Bernard Delbecque
Bernard Delbecque warns of the potential limitations from the European Commission’s review of the IORP Directive
The European Commission has launched a review of the Directive on Institutions for Occupational Retirement Provision (IORP). To contribute to the review process, the European Insurance and Occupational Pensions Authority is now finalising its recommendations on how to improve the directive. The results will be discussed at a public hearing on 1 March 2012.
Three objectives are being pursued by the commission: facilitating cross-border activity, introducing a risk-based supervision of IORPs, and addressing the specific needs for the regulation and supervision of defined contribution (DC) schemes. Whilst we understand the importance of these objectives, we fear that the end result will not entirely live up to expectations, for different reasons.
Firstly, we think that the subsidiary principle, according to which pensions and pension systems are the responsibilities of member states, will result in limited progress towards the completion of a single market for occupational retirement provision. As Commissioner Barnier recently emphasised, there are still very few cross-border pension funds in Europe, less, in fact, than 100 compared to around 140,000 IORPs existing in the European Union. It is therefore essential to simplify the legal, regulatory and administrative requirements for setting up cross-border pension schemes with a view to enabling employers and employees to reap the full benefits of the single market.
Secondly, we are concerned that the implementation of some of the proposed new regulatory measures, in particular the Solvency II rules for calculating capital requirements and the Solvency II requirements for governance, would add costs for employers or reduce the level of benefits for beneficiaries. Many experts believe that the additional burdens would outweigh any perceived benefits and accelerate the process of defined benefit (DB) scheme closures in Europe. Regarding DC pension schemes, the application of additional capital for operational risks and other similar measures would reduce the benefits payable on retirement and discourage employers to set up DC schemes.
It would be ironic were the IORP Directive review to result in a reduction in the number of employees covered by occupational pension schemes, as one of the most important challenges facing Europe today is the low level of pension savings and the looming decline in replacement rates from public pensions. Thus, it is vital to strike the right balance between the objectives of wanting a high level of security for all occupational schemes and improving citizens’ access to complementary occupational and private pensions.
Finally, the fact that the Solvency II capital rules are in favour of bonds is problematic. These rules have already led to an overall reduction in insurance company asset allocation to equities and we fear that, as the regulations come into force, this trend could grow. Applying Solvency II-style regulation more broadly would make it more difficult for companies to raise equity, thereby constraining long-term financing companies. It could also deny pension investors from investing in inflation-hedging assets suited to matching long-duration liabilities. Furthermore, it would be very negative for the market if all investors with long liabilities had to invest under the same rules, even when their structure is very different. This would lead to very similar behaviour of all market participants which would increase volatility and contribute to systemic risk.
Against this background, it is not possible to support new solvency and governance requirements for IORPs without knowing their likely quantitative impact. In order to provide a fair assessment of the proposed new regime, a robust and transparent methodology will have to be developed to take into account the impact of higher up-front financing costs for IORPs, additional reporting requirements, DB scheme closures, reduced benefits payable on retirement, forced de-risking of pension fund asset allocation, systemic risk, and the lower contributions of IORP to the financing of companies and therefore to the growth of the European economy.
Bernard Delbecque is director of economics and research at Efama