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The final countdown

The European Union’s plans for pension reform and its solvency requirements could deal a deadly blow to final-salary schemes.

dareen philp
Philp: ’The paper’s positive aspects are overshadowed by the proposals to apply Solvency II-type regulation to UK pensions. This would pile extra pressure on employers’

While the UK presses ahead with its plans for pension reform, including auto-enrolment and public sector pension reform, new European Union rules could have potentially dire implications for UK final-salary schemes.

Last month saw the publication of the European Commission’s white paper on pension reform and the bad news for the UK is that the proposals could kill the few remaining private sector final-salary schemes stone dead.

The stated intentions of the EC’s paper is “to help people save more and ensure that pension promises are kept and people get what they expect in retirement”.

It intends to help and encourage governments to boost the take-up of pension saving by encouraging private pension savings, making occupational pensions more secure and making it easier for people to transfer pension benefits within Europe.

However, many pension consultants suggest despite these good intentions, the EC’s actions could put the final nail in the coffin of private sector defined-benefit schemes due to its insistence on pushing Solvency II-type safeguardson DB schemes.

PwC head Raj Mody says: “While attempting to improve pension scheme security, these new rules could kill off occupational pension schemes.”

As part of it consultation for the white paper, the EC asked European pension regulator the European Insurance and Occupational Pensions Auth-ority to review the directive which sets out the regulation of workplace pension schemes, with a particular emphasis on how the funding rules for pension schemes could be further harmonised across Europe.

Solvency II was the EC’s answer to the standardisation of capital adequacy for insurance companies across Europe and EC commissioner responsible for internal markets and services Michel Barnier promp-ted the review to look at similar measures for pension schemes.

The EC’s white paper has formally endorsed the proposals and pension schemes face two particular issues – meeting higher funding standards than the currently have to and adopting much more cautious investment strategies.

Solvency II-type requirements would mean pension schemes would be forced to hold enough assets to meet the cost of buying an annuity for every scheme member at all times instead of the much more lenient solvency requirements, which acknowledges that scheme liabilities fall due over a considerable length of time.

The cost of meeting this higher funding standard has been put at between the Department of Work and Pensions’ estimate of £100bn and the £600bn that JP Morgan Asset Management says it will cost.

In addition, Solvency II-type requirements for pension schemes would see schemes having to move into much less risky assets, effectively fixed income and cash, as holding a significant allocation to equities would require an even higher funding ratio to take volatility into account.

Osborne Clarke pensions partner Keith Webster warns that the combination of these two factors would make it counter-productive for pension schemes to invest in equities and could undermine stock-markets and withdraw vital funding for businesses if pension schemes withdraw the billions of pounds they currently have invested.

Webster says: “UK businesses are struggling to fund their pension liabilities and any attempt to increase this burden could have far-reaching consequences for investment and growth in the UK economy.”

The National Association of Pension Funds has also condemned the decision to impose solvency requirements designed for commercial insurance companies on pension schemes, saying not only do pension schemes not compete for business and therefore do not seeking to improve their profitability, the nature of their liabilities is different and pension schemes also have a fiduciary duty to their members.

Director of policy Darren Philp says: “The paper’s positive aspects are overshadowed by the proposals to apply Solvency II-type regulation to UK pensions. This would pile extra pressure on employers. An EU pensions directive based on Solvency II capital rules would undermine European pensions, jobs and the wider economy.”

The move could have a catastrophic effect on European stockmarkets as schemes are forced into a mass sell-off of equities into less risky assets.

In a joint letter to the European Commission, the NAPF, the TUC and the CBI warn of the danger of shifting scheme investment strategies so severely. The letter says: “If liabilities were to be calculated using a risk-free discount rate – as proposed by the Commission – then pension investments would be switched away from return-seeking classes such as equities and into risk-free, high-quality bonds and gilts.

“Less equity investment would restrict capital flows to businesses at a time when they are being asked to put even more cash into schemes. With European pension funds holding over €3tn in assets, a major switch in asset allocation would have an immediate, catastrophic impact on the stability of European financial markets.

“Given the priority that must be given to increasing the economic competitiveness of the EU in the coming decades, it would be a serious mistake to do anything that would put it at risk.”


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There is one comment at the moment, we would love to hear your opinion too.

  1. Julian Stevens 6th March 2012 at 9:44 pm

    The choice for trustees and sponsoring employers will be either to wind up their schemes, on the grounds that these requirements are impossible to meet or simply to ignore them under threat of an order from the powers that be to wind them up.

    I think most scheme trustees and the sponsoring employer would opt for the latter. Civil disobedience.

    So the government orders the closure of a scheme, the sponsoring employer writes to all its scheme members notifying them accordingly and inviting them to vote on whether they wish the employer to maintain the scheme as is or to wind it up because it cannot meet these impossibly stringent new requirements.

    Every scheme member votes for the employer to maintain the scheme as is. The employer notifies the pensions regulator accordingly.

    The pensions regulator says that maintaining the scheme without implementing these new measures isn’t an option.

    The employer says that the new solvency requirements are unreasonable, impossible in fact, and will damage the wider economy. The scheme has run quite satisfactorily for 50 years (the BBC scheme is older still) and all its members want it to continue to do so.

    The pensions regulator says that the employer must conform or close the scheme.

    The employer says no.

    What then?

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