CBI response to the European Commission’s public consultation on the harmonisation of solvency rules applicable to institutions for occupational retirement provision covered by article 17 of the IORP directive and IORPs operating on a cross-border basis

  1. The CBI welcomes this opportunity to respond to the European Commission on the subject of the appropriate solvency rules for IORPs. IORPs are a keytool in many Member States – including the UK – in achieving the EU’s aim of ‘adequate retirement incomes for all’ and ‘promoting the affordability and security of funded and private schemes’ and therefore any change to the regulatory framework – at Community or Member State level – needs to be fully assessed against social, prudential and competitiveness goals. Maintaining and enhancing the provision of sustainable IORPs should be the focus of any action.
  1. This is a general response. While the scope of the Directive is limited, we believe any changes to solvency requirements as currently set out by IORP would be likely to result in pressure for further changes at a later date. We therefore set out our view in this paper that the totality of the current standard is fit-for-purpose.
  1. Our comments are made from a UK-specific perspective. BusinessEurope, which represents private sector employers across the EU including the CBI and its members, has also responded to this consultation taking into account the situation in all Member States. We support the BusinessEurope response in full, and many of its themes are reflected in our own submission.
  1. Although we are making a broad response, we agree with the limited scope of the Commission’s consultation document of September this year. The 2003 IORPs Directive is still relatively new and initial evidence from firms and pension schemes across the EU is that it has largely been a success, with little evidence of inadequate member protection. This conclusion was supported by the recent CEIOPS survey on the question. Nevertheless, it must also be remembered that the Directive did not enter into force until very recently which means experience of its operation in practice is still building up. A full review of the Directive is not appropriate at the current time. We welcome, therefore, the decision to restrict the scope of this consultation to solvency standards for those IORPs directly affected by the passage of Solvency II – i.e. those where Solvency I standards are used under the current IORP directive. In practice, this means article 17 schemes and cross-border schemes.
  1. In this response, we set out our belief that the current, relatively recent, EU regulatory regime for IORPs is fit-for-purpose. On this basis we would support the Commission “writing-in” Solvency I standards to thoseareas where the IORP directive currently applies them by reference to the Solvency I Directive. This will allow the current regime to remain in place. The reasons that CBI members support this approach are:
  • IORPs typically serve a different purpose from, and do not compete with, insurance funds – different treatment is therefore appropriate
  • the costs of an insurance-style approach would be catastrophic for IORPs, employers and workers – experience with cross-border schemes has shown this.

IORPs typically serve a different purpose from, and do not compete with, insurance funds – different treatment is therefore appropriate

  1. An IORP is an institution usually set up by an employer as part of their remuneration policy. In the UK at least, such provision is heavily regulated by a number of rules:
  2. trust law obliges the trustees of the fund to act in members’ interests, protecting their accrued benefit through prudent management of the funds’ reserves and meaningful negotiation with the sponsoring employer
  3. scheme-specific funding and moral hazard laws make it difficult for employers to avoid supporting their schemes and set clear target funding levels which employers must meet
  4. the Pensions Regulator has been set up to ensure that action is taken against employers who seek to avoid their pensions duties
  5. a Pensions Protection Fund (funded by businesses through a significant cash levy) has been set up to pay out benefits where a company becomes insolvent.
  1. This framework means that running an IORP in the UK – and in many other Member States – is already a costly business. By contrast with insurance schemes, which are simple for employers to interact with, participating in an IORP in the UK is expensive.
  1. Bearing this cost in mind, one may reasonably ask why an employer would offer an IORP. As noted above, this is a choice based on remuneration policy. An IORP is a way of offering long-term security and a sustainable retirement lifestyle to staff who have worked for firms for many years. It is a powerful tool for retention – over 80% of CBI members believe that an IORP brings this benefit. Were the decision purely based on cost, however, insurance-backed schemes would be provided.
  1. For this reason, CBI members reject the idea that insurance products and IORPs are in direct competition. This is not in practice the case and should not be seen as a reason to establish a “level-playing field” on solvency standards between the two. It is right that both insurance products and IORPs have appropriate solvency standards, but these standards need to be fit-for-purpose for the products they are regulation. Fitting an insurance standard to a materially different product that is not in competition with insurance products would have significant negative consequences, which we set out later.

It is correct that IORP solvency standards are typically lower than those for insurance schemes

  1. The CBI supports the Solvency II directive in its current form. The updated solvency rules for insurance firms will be a welcome move in securing a transparent single market for insurance products. Insurance funds are operated for profit (or surplus in the case of mutuals) by businesses whose primary purpose is the offering of such funds. They typically compete aggressively for business in the commercial marketplace. Where such a product is insufficiently funded, it has recourse only to the operating company for additional funds. The fact that there is a competitive market in such funds makes strong prudential rules essential for internal market reasons – funds should compete on a level-playing field of member protection. The lack of any outside source of additional capital also makes relatively-high solvency standards appropriate.
  1. By contrast, IORPs are typically set up by a single sponsoring employer – or a small group of firms – with the aim of providing high quality pension saving for employees of those firms. They are typically idiosyncratic to those firms (the benefits are often designed with specific goals in mind on retention, for instance) and are run on a not-for-profit basis. In the UK, these funds are run by a board of trustees, whose job it is to protect the interests of the members at all times. In addition to this member-protection, the “covenant” of the sponsoring employer(s) means that additional costs that are not foreseen at the time a funding agreement is made – or any shortfall caused by poorer-than-expected investment performance – has to be made up in time for the benefit to be paid. In practice, this legal obligation of the employer to the scheme is sufficient to offset much of the risk of any lack of funding in the future.
  1. Elsewhere in the EU, where schemes are under Article 17 (i.e. where the scheme not the employer is responsible for longevity risk), the loss of further employer support is already offset by higher funding standards. This is the case, for example, in the Netherlands. CBI members feel it is appropriate to have a higher level of test where the ongoing employer duty is more limited, and that the current approach is sufficient to offset this. Such IORPs still need to be funded only on a basis prudent enough to pay out the benefits when they fall due, and they also retain the support of an employer. Solvency I standards are appropriate. Solvency II standards, if applied to such funds, would result in the kind of negative outcomes we set out in the second part of this paper.
  1. Most importantly, however,IORPs are not in generalcommercially marketed on a large scale. They are unique to each employer, and are for the benefit of the employers’ staff. They arewholesale products that are integrated into national social protection systems and regulated by national social and labour laws. This contrasts markedly with insurance companies, which offer consumer products. IORPs are also very long term investors due to the nature of their business and therefore, unlike insurance companies, their overall financial stability is not necessarily affected by specific short-term economic turbulence.

The costs of an insurance-style approach would be catastrophic for IORPs, employers and workers – experience with cross-border schemes has shown this

  1. The cost of providing an IORP has increased significantly in recent years. This has primarily been due to a combination of longer lives, higher benefit levels for scheme members (often driven by legislation requiring indexation or dependents pensions, and both EU and Member State moves to provide a higher level of security for scheme members, which comes at a cost. For employers sponsoring an IORP, the attraction of cheaper and easier to run insurance-based schemes has grown. For employees, this development has been an unattractive one, as contributions to these schemes are often lower.

Exhibit one – overfunding caused by solvency requirements in a typical UK scheme

  1. Where employers have persisted with IORPs despite this increase in costs, there is little appetite to shoulder further increases. High solvency requirements would force this onto firms. This would only require firms to put money which – as shown above – is likely to be unnecessary in the long-term. IORPs have very long cashflows and benefits only need to be paid for when they fall due. Given the existence of a sponsoring employer and trustees in most IORPs, it is possible to delay these assets’ entry to the fund from year one to a later point. This has a number of advantages. It avoids trapped surplus which is denied to the firm, whereby surplus rules mean money that is unnecessary to pay benefits on current assumptions is not available to employers until the end of the life of the scheme. This is the current situation in the UK, and would be exacerbated by a stricter funding requirement. Trapped surplus would lead to firms tying up billions of Euros of surpluses invested in gilts in IORP schemes for 40, 60 or even 80 years, when far better investment choices could and should be made.
  1. There are a number of further disadvantages associated with forcing IORPs to hold a greater amount of assets to meet their future liabilities:
  • The increased immediate cost wouldmean fewer schemes will be offered by employers, as fewer employers will be able to afford them, damaging the stock of funded pension saving and increasing the call on state-funded benefits in retirement. This would significantly damage the EU’s aim of sustainable high quality pension saving in many Member States
  • Those firms with the capacity to maintain schemes – and those with closed legacy schemes winding up – would have less available capital and will be less able to invest in growth, damaging the Lisbon goals of growth and jobs
  • Investment of funded pension assets from IORPs – many trillions of Euros across the EU – will move decisively from equities to government bonds, lowering the gilt yield. This would starve firms of equity capital for future growth. The lower gilt yield will then prove to be a self-defeating cycle, as lower yields will require greater funding, invested in gilts again, further lowering yield.
  1. CBI members have evidence that their fears any costly new solvency standard will lead to a withdrawal from the offering of IORPs. This comes from the experience in the UK with cross-border schemes, where a standard was applied in the UK following the passing of the IORP directive. This resulted in substantial moves by employers with well-funded schemes to remove scheme members in other Member States from pension schemes in the home Member State that took place when the initial IORP directive was passed. In creating solvency standards for cross-border schemes, therefore, we have already seen the diminutionof retirement saving for some workers.
  1. For these reasons, CBI members feel that any further extension of solvency standards at EU level – even if it were restricted to Article 17 and cross-border schemes – is highly undesirable. The risk to high quality provision involved is very marked, and the gains to be garnered – both on an internal market and member security basis – are extremely limited, given the fact that most states have diverse, but high quality security arrangements in place already and IORPs do not compete with insurance funds. We therefore reject the idea that the current IORP directive framework needs any change, other than those specifically required to maintain the current standards for IORPs as Solvency II passes from the acquis to be replaced by Solvency II.

Employment Policy Directorate

November 2008

1