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Brussels has a seemingly unquenchable desire to harmonise everything from interest rates to chocolate, but fresh analysis of the state of Europe’s pension schemes graphically exposes the scale of the challenge when it comes to retirement provision.
According to a calculation methodology derived from the Solvency II regime due to be imposed on insurance companies, Sweden’s workplace-based defined benefit schemes typically boast a surplus of assets over liabilities of 13 per cent. By contrast, in Ireland there is a deficit (or “negative surplus”) of between 81 and 93 per cent.
In this spirit, it is fair to say the analysis has attracted negative praise, in some quarters at least.
“The results demonstrate that the impact of applying a Solvency II-style regime to pensions could be huge,” says Jane Beverley, head of research at Punter Southall, a consultant.
“[It] should lead [the European Commission] to question whether the policy should be abandoned altogether, especially given the growing chorus of opposition from the UK, Netherlands, Germany, Ireland and now Belgium.”
This quantitative impact study (QIS), drawn up by the European Insurance and Occupational Pensions Authority at the behest of the commission, forms part of the groundwork for a proposed revision of the 2003 Institutions for Occupational Retirement Provision Directive.
But whereas the original IORP directive merely laid down minimum standards for the funding of occupational pension schemes, its more demanding successor would calculate pan-European solvency figures on a common and consistent basis, presumably with the aim of forcing those that come bottom of the class to buck up their ideas.
According to the commission, the directive is designed to ensure pension schemes are sustainable and scheme members will receive the retirement income they are expecting.
“Workers have a right to transparency on the real economic condition of their pension funds and this study contributes to that objective,” says Mark English, a spokesman for the commission in London. “The aim of the review is to protect pension holders while promoting growth and jobs. An underfunded scheme is an insecure and unsustainable scheme.”
Much of the criticism of the QIS has come from the UK, where the aggregate deficit of the 6,432 schemes is calculated at €527bn (24 per cent of liabilities), compared with €350bn under the current funding rules.
The wider deficit partly stems from the fact that, at present, the UK allows schemes to discount the value of future liabilities using a rate based on the expected return on assets, providing this rate is prudent. Eiopa’s QIS assumes a (lower) risk-free discount rate, meaning liabilities are higher.
The QIS also adds an additional explicit risk margin, essentially the additional capital a third party taking on the liabilities would need to hold to cover risks that cannot be hedged.
Analysis by David Roberts, senior consultant at Towers Watson, suggests these factors increase the UK’s liabilities by €613bn.
Further, the QIS insists on a solvency capital requirement, essentially a buffer against extreme events. This adds a further €234bn, says Mr Roberts.
However, these sums are partially offset by Eiopa’s first stab at pricing in the value of backstops that may ride to the rescue if a fund got into difficulties. It adopted the recommendations of the UK’s Pensions Regulator, pricing sponsor support at €658bn and that of the UK’s Pension Protection Fund at €13bn.
Nevertheless Steve Webb, the UK’s pensions minister, urged the commission to “abandon these reckless plans” that “would harm businesses’ ability to invest, grow and create jobs”, and force more scheme closures.
Worse still, the UK’s deficit figure could yet be revised higher. Sponsor support is valued at 31 per cent of liabilities, compared with 1 per cent in Belgium and zero in Ireland.
Eiopa warned that the methodology behind the UK’s calculation “may materially misstate the value of sponsor support” and said it would conduct further work in this area.
However, Deborah Cooper, retirement partner at Mercer, the consultancy, argues sponsor support is worth more in the UK than in most other countries.
“It’s disproportionately bigger because of the legal structure. There is no formal reliance on sponsor support [elsewhere]. Schemes can be wound up leaving a deficit, whereas in the UK sponsors can’t walk away,” says Ms Cooper.
The Irish figures partly stem from this lack of sponsor support. “There is no legal requirement that an employer must stand behind the pension promise,” says Mr Roberts.
Predictably, the well-funded Nordic schemes come out of the analysis well, with Sweden typically boasting a surplus of 13 per cent and Norway a deficit of 3 per cent.
However, even the highly regarded Dutch industry, often held up as an exemplar, has a shortfall of 21 per cent.
In Germany, the pensionskassen sector (where schemes are backed by insurance contracts) also has a deficit of 7 per cent of liabilities. However, the pensionsfonds industry (more akin to standard occupational DB schemes) is perfectly in balance.
The latter typically benefits from significant support from strong corporate sponsors as well as access to contingent assets and the safety net of a pension protection scheme.
At this stage, the significance of the findings remains unclear. The commission has yet to make any firm proposals, but having come this far through the process, it seems unlikely it would shy away from attempting to force pension schemes to close the funding gaps the analysis has identified.
Ms Cooper is not alone in warning of the potential consequences of such legislation. “Requiring companies to fill these deficits would bankrupt some companies, so pension scheme members would not get their benefits anyway and maybe they would not have their jobs,” she says.
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