Employers, business organizations, politicians, and pension experts are lining up to dump criticism on European plans to impose legislation designed for the insurance industry onto company-sponsored pension plans. The proposals could cost British employers a whopping $565 billion (£350 billion, €440 billion), and businesses in other European countries would be similarly affected.
The European Commission has not yet finalized all the rules needed to create the so-called Solvency II regulatory regime for the insurance industry, even after some six years of effort. Still, the commission appears determined to force through similar rules that would impose a huge financial burden on European companies that offer pension benefits. Most affected will be those in the United Kingdom, Ireland, Germany, and the Netherlands, because of the nature of their pension provision for employees.
The proposals would cause “significant damage to the [European Union] economy,” concludes a report by Oxford Economics that was commissioned by the Confederation of British Industry (CBI). GDP growth, jobs, business investment, household living standards, and export competitiveness would all be adversely affected by several percentage points over at least the next three decades, the report says.
Under debate for much of the past year, the issue is now coming to a head because an important assessment exercise is drawing to a close. The European Commission’s Market Directorate asked EIPOA, a European organization that represents national pension regulators, to look at how the solvency rules could be applied to employer pension plans.
Many have tried to estimate the direct effect the rules would have on pension funds as a result of changes in the way assets and liabilities would have to be calculated, as well as other costs that would be heaped on the industry. Estimates for U.K. plans range from £250 billion to £660 billion. The U.K. government’s Department for Work and Pensions recently put the cost at around £400 billion. Oxford Economics put the figure at £350 billion.
“There is a vast difference between these numbers,” said one pension expert, who asked not to be named. “But they are all vast.” The huge variation arises from the fact that slight differences in the actuarial assumptions have significant impacts on the calculations.
Further, it is not yet clear what the EC will seek to impose, partly because the Solvency II rules on which the pension rules would be based have not been completed. The huge funding shortfalls that would be created would hamper companies’ profits over many years and hinder their ability to compete, grow, invest, and pay dividends. Multiplier effects throughout the economy would depress household income and consumption.
The EC says defined-benefit (DB) pension plans (where, typically, the value of the annual pension promise is directly related to an employee’s length of service and “final salary” upon retirement) carry an insurance-like guarantee that employers must provide for. Therefore, the commission’s thinking goes, Solvency II-like rules are required.
Solvency II is designed to ensure that an insurance company is able to pay out on claims on catastrophic events such as hurricanes without becoming insolvent. The European authorities are considering a regime based on Solvency II that would make pension plans also sufficiently robust to survive rare, catastrophic events.
However, many experts say that such robustness is unnecessary. While an insurance company must be able to pay out on claims right away, pension funds may have many years or even decades to reclaim their value after, say, a global financial crisis before having to meet all of their obligations.
Further, such experts say, the proposals ignore employers’ ongoing covenant to meet shortfalls and fail to consider the U.K. Pension Protection Fund, a state-sponsored scheme funded by the pension industry, to meet any shortfall when the sponsoring company fails.
Neil Carberry, director of employment and skills policy at the CBI, told a parliamentary select committee last March that there would be another side effect from the proposals; that is, they would effectively force pension funds to invest in the lowest-risk assets, such as U.K. government securities and the highest-quality corporate bonds. “There would be far less investment in equity and other corporate bonds, which is likely to have a significant effect on capital markets,” he said.
Joanne Segars, chief executive of the National Association of Pension Funds (NAPF), added, “The impact of pension funds suddenly having to pile into bonds would be a further downward pressure on bond yields. We have already seen . . . that the impact of QE2 [the second phase of quantitative easing] over the past few months has added an additional £90 billion to pension scheme deficits.” The extra shortfall arises because of the lower discount interest rate that would apply for calculating the net present value of plans’ liabilities.
In November, U.K. pensions minister Steve Webb branded the EC plans “devastating,” “dangerous,” “reckless,” and “wrong-headed,” adding that the government was urging the EC not to pursue the proposals. His blistering attack was supported by the NAPF, and Segars told Money Marketing: “The UK has one of the strongest pension protection systems in Europe already and does not need this regulation.”
At the recent European Forum for Manufacturing conference, Bernard Wiesner of Bosch Group noted that the phrase regularly deployed to justify the proposals is “level playing field,” meant to describe the interaction between employer-sponsored pensions and the insurance industry. He branded the phrase “fatal” and said its use is counterproductive. He drew a distinction between the commercial use of financial products for profit and the “social benefit” of employer pensions.
“Occupational pensions offer the most efficient form of capital-based retirement provision,” he said. “This outstanding efficiency is heavily based on components such as collective organization and nonprofit structures.”
At the same event, Ursula Fassbender, managing director of Ford’s German pension fund, said, “If the European Commission decides to burden companies with additional workload and cost, I would expect that some companies will close [their] pension scheme for future hirings.”
U.K. data supports that assertion. The U.K. government Department for Work and Pensions (DWP) estimates that the proportion of companies offering DB pension plans to new employees will fall from 16% to just 5% in the next 20 years. Currently, while most plans do not admit new members, they typically allow existing ones to continue accruing benefits. The DWP estimates that the proportion of companies doing so will fall from 58% to under 25%.
Tim Thomas, head of employment policy at EEF, an organization representing British manufacturers, says, “There is clearly a desire within the European Commission to pursue an extension of Solvency II to occupational schemes in the face of opposition from organizations such as EEF, the pensions industry, individual employers, the governments of some member states, and, importantly, the trade unions. Every conceivable stakeholder with an interest in the provision of safe, sustainable, and adequate pensions has expressed opposition. It seems only the Commission wants to pursue this.”
Thomas adds, “Manufacturers have, over many years, supported workplace pensions. Around 14% of EEF members still have DB schemes open to new members. Solvency II [for pensions] could prove to be the end of these schemes.”