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Capitally inadequate

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EU plans to extend capital requirements to all DB schemes spell trouble for all concerned says Teresa Hunter

Whatever happens to the Euro, it is premature to bank on an end to infernal meddling from annoying technocrats any time soon.

So, while on one level side-splittingly hilarious, the latest EU proposals on pension scheme funding have to be taken seriously.

The European Insurance and Occupational Pensions Authority is proposing extending insurance-style capital requirements to all company pension schemes. In essence, this may require final salary schemes to be not only fully funded, but to hold additional capital to cover any unforeseen calamities.

Whoever said Europeans haven’t got a sense of humour? Here we are in the UK with plenty of funds struggling to maintain their commitments to what can seem like 100-year recovery plans, and they want us to fill the gap, with knobs on, pronto.

I say 100-years, because, let’s face it, some schemes are never going to recover a respectable funding position, and will limp on in ailing health until long after anyone reading this article is dust.

Had this all been suggested thirty years ago, when the pensions industry basked in huge surpluses, it might have made sense. But with deficits vast and climbing, such a suggestion has to be sheer fantasy. Costs would go through the roof and not only for salary-linked schemes.

The law is as yet largely untested as to what would happen if companies in Italy, France or Spain had to make good their promises to UK pension schemes

All schemes, including defined contribution, would have to hold an operational risk fund to cover all kinds of muck ups, admin errors, premium contribution mistakes and the like. There would be additional costs in monitoring and complying with rules. How many employers will be happy to put up this cash? These proposals would also require all pension schemes backed by a parent elsewhere in the EU to be fully-funded at all times. The UK has long adopted an open-door policy, when it comes to foreign ownership, leading to increasing numbers of UK schemes supported by foreign parents elsewhere in the EU. The law is as yet largely untested as to what would happen if companies in Italy, France or Spain, for example, had to make good their promises to UK pension schemes.

So forcing such arrangements into full funding has obvious attractions from the scheme members’ point of view. But this again begs the question, where will the money come from?

Who will be obliged to fill the black holes, the UK operation or the overseas parent which has assumed responsibility for any short-fall?

Cries of “zut alors” won’t be the half of it when parent boards wake up to the implications of what they have gotten themselves into. Profitable subsidiaries elsewhere around the globe might have to be sold to shore up a UK pension fund. Oh to be a fly on the wall when such conversations are taking place in Paris, Frankfurt or Madrid. So far detail of how any of this will work is scant. In the end it will likely boil down to technical gobbledygook only the anoraks among us are able to follow.

Investigations to identify the sponsoring employer are likely to prove crucial, particularly where successive restructuring has muddied the water. Woe betide any advisers who have carelessly allowed liability to slip from one part of a group to another.

But this could have huge implications for Government too. Will public sector pensions be forced to hold some form of capital reserve?

How could this impact on Nest and auto-enrolment? Such funds would certainly be caught by the requirement for an error reserve. Who would be responsible for the reserve? The Government or the underlying funds, or both?

Unfortunately, the initial consultation period is now over, so it is too late to protest. But be ready with your pen when proposals move on to the next stage, if we are to have anything left of a private pensions industry.

Teresa Hunter is a freelance journalist

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