The Pensions Regulator has finally released its response to its consultation on regulating defined benefit pension schemes along with the simultaneous release of the final new code on funding defined benefits, its latest annual funding statement and two new documents: the defined benefit regulatory strategy and the defined benefit funding, regulatory and enforcement policy. It’s a bit of a mixed bag.

I set out a critique of the draft proposals back in January. These boiled down to two main criticisms:

  • That the new system proposed was effectively a return to the one-size-fits all approach of the Minimum Funding Requirement, which had done so much to undermine responsible scheme funding by employers; and
  • That the focus on governance, reverse stress testing, covenant advice, etc, effectively smuggled in from EIOPA’s latest IORP Directive, was likely to be a problem for small schemes.


So what has the Regulator’s response been to these criticisms? Well, on the one-size-fits-all approach which was proposed as the Balance Funding Objective (BFO), the response is comical:

  • They have changed the name of their funding objective. The BFO is now called the Funding Risk Indicator (FRI). It is otherwise unchanged. This is reminiscent of the Lenny Henry sketch at the time that Windscale was renamed as Sellafield: “In future, radiation will be referred to as magic moonbeams”.
  • They are going to keep all their risk indicators secret. I have set out below their response in full on this point.

We believe that there may be potentially significant benefits to be gained in using the FRI and publishing more detail on our risk indicators in terms of providing clarity around standards, especially for small schemes, driving consistency and providing a useful framework for evaluating impact. However, after careful consideration of the risks and benefits highlighted in consultation responses, we have concluded that we should develop further our approach to risk assessment over the next year, including our risk indicators, to make sure it is sufficiently robust to support our intended uses beyond using it, alongside our other risk indicators, to prioritise our engagement. We have decided, for the time being, not to publish in detail where we set our risk indicators (beyond a high level description) in the funding policy document or in the annual funding statement.

So how will this work? Will the Regulator display charts like this one each year?

TPR graphWill they then berate the schemes and their advisers who were so bad at guessing where their secret line was? Because be in no doubt, with the speed of the revolving door operating between the Regulator and the industry it regulates, these indicators will get out and then gradually get disseminated through the pensions industry, from the biggest consultancies (who can easily fund having their consultants on secondment to Brighton) downwards, just as the Regulator’s previous “secret” link between assessment of covenant strength and “expected” discount rate assumptions did.

And what about the problem with small schemes? This is, in my view, considerably better handled by the Regulator. However, it does all comes down to its idea of proportionality.


The response to the consultation states:

Many respondents were concerned that proportionality did not follow through consistently in the consultation code or it was not explained clearly how it could be applied in practice. In particular, some thought our expectations around the extent of the analysis required to assess the covenant seemed disproportionate. The concern was that it would be difficult and costly for small schemes to apply the code’s principles.

I was one of those respondents. It continues:

We have reviewed the drafting to ensure that proportionality is properly referenced and emphasised throughout. We are looking to develop additional guidance to support the final code and will consider whether the proportionality principle can be explained further through illustrative examples.

On covenant assessment, we had already made clear (under the ‘Working with advisers’ section) that trustees may chose not to commission independent covenant advice as long as they can satisfy
themselves that they are sufficiently equipped, independent and experienced to undertake the work to the appropriate standard. In the section on ‘Employer covenant considerations’, we have emphasised the need for a proportionate approach (for instance, in-depth analysis may not be necessary if the scheme is relatively small or there has been no material change in the covenant since the last review). We also stress that assessment should focus on the knowledge gaps and where value can be added. Finally, we have made clear that the scope of any covenant review will depend on the circumstances of the scheme and it is, therefore, not always necessary for trustees to consider all the factors listed in the code.

In addition the Regulator has dropped the size of employer and strength of covenant as factors for trustees to consider in deciding on what is proportionate for their schemes, realising, rightly in my view, that the absolute size of employer and strength of covenant are much less important than the relative size of employer to scheme and risks to the scheme from failures of covenant which are already mentioned.

This all seems sensible. I do, however, think they will struggle to go further in setting out what proportionality means, since the problem of defining it has bedevilled the Solvency 2 project from the beginning and has still not been fully resolved. The IORP Directive is no clearer in this respect. What the Regulator could do is make a clear distinction between schemes with less than 100 members and the rest in terms of their responsibilities under the Code, reflecting the fact that the IORP Directive does not apply to these schemes.

Small schemes and risk-based prioritisation

But perhaps they have. Concerns were raised in the consultation about considering the size of the scheme in deciding whether to subject that scheme to greater scrutiny. It was argued that smaller schemes tended to be less well administered and advised (presumably by advisers and administrators of larger schemes!), more risky than larger schemes and should receive greater regulatory scrutiny. Some also questioned the usefulness of education without what they felt was the same prospect of regulatory scrutiny. I admit that I was one of those expressing concern about a lack of scrutiny coupled with a much increased regulatory burden for small schemes before the Regulator’s latest concessions on proportionality.

In their response the Regulator defended its actions by stating that large schemes all other things being equal, are of greater concern to us as they have the greatest impact on members and risk to the system (90% of members and liabilities are concentrated in the 1,210 largest schemes). However they expect the same standards of the small schemes that they aren’t scrutinising so hard. Bearing in mind that the Regulator regulates scheme managers rather than members (and many of those small schemes have just as many trustees as the larger ones) I don’t think this is a very convincing defence, but it seems to be preferable to admitting that they are just regulating schemes that fall under the IORP Directive.

Next steps

So a big raspberry for the secret FRI and a qualified welcome for the changes on proportionality. The final code has now been laid in Parliament and is expected to come into force in the next few months, subject to the parliamentary process. So if you think that there is more than a little tweaking left to do to this legislation, you need to start lobbying now.

Germany has surprised the European Commission (EC) by suddenly insisting that stiffer data protection controls are incorporated into the negotiations for the Transatlantic Trade and Investment Partnership (TTIP), which began earlier this year, and for which the second round has started this week. For those of you who have not heard of it before (understandable, as the negotiations so far have had a deliberately low profile), the purpose of the TTIP is to create a single transatlantic market, in which all regulatory differences between the United States US and the EU are gradually removed. The EC calls it “the biggest trade deal in the world”.

As the EC goes on to say:

On top of cutting tariffs across all sectors, the EU and the US want to tackle barriers behind the customs border – such as differences in technical regulations, standards and approval procedures. The TTIP negotiations will also look at opening both markets for services, investment, and public procurement. They could also shape global rules on trade.

Concerns have started to emerge about the massive transfer of power from governments to corporations that the final deal might allow. However Germany’s intervention on data protection is just the latest of a list of reasons that have been advanced for why the TTIP talks are unlikely to go anywhere. From the legislative schlerosis of the US, to protectionist instincts on both sides recently strengthened by austerity, to French paternalism towards their film industry, to European fears about an influx of GM foods, the TTIPing point will never be reached, they say. So nothing to worry about then.

Or is there? A document published last year by the US Chamber of Commerce and BusinessEurope explains how it would be able to overturn existing legislation which got in its way. And if the long tortuous progress of Solvency 2’s implementation date, the bureaucratic equivalent of the man with the end is nigh sandwich board on his back, endisnighhas taught us anything, it is that unimplemented regulatory frameworks can still have massive impacts. Just this month it was revealed that the best funded pension schemes in the FTSE 100 are insurers, precisely because of the impact of those schemes on insurers’ solvency capital requirements under Pillar 1 of Solvency 2. And the clear rebuff to EIOPA from exporting these requirements to occupational pension schemes has not prevented the work to develop a framework for imposing them from continuing.

So what would TTIP mean for defined benefit (DB) pension schemes? Well, at first sight, not very much. US DB schemes tend to have funding targets equivalent to FRS17 levels, which would be seen as at the weak end of UK funding targets. However, as we have seen with the process of market harmonisation in the EU, horse trading may lead to the US being stuck with stiffer requirements imported from the EU on pensions in order to maintain subsidies for US farmers, say.

And there are two features of the US DB landscape which would be an issue for many UK DB schemes.

The first is the recovery plan length, which typically does not exceed 7 years in the US. Possibly not too onerous in many cases, if coupled with a FRS17-type funding target, but the EIOPA caravan has surely travelled too far for any dilution of funding target to be allowed at this stage. A 7 year recovery plan would however represent a considerable increase in contribution requirements for many schemes within the UK’s current funding environment.

The second is the restrictions placed on US pension schemes which fall below prescribed funding levels. If the funding level falls below 80%, no scheme amendments are allowed which would increase benefits until the funding level has first been restored to 80% or above, and certain types of benefit payments are restricted. These restrictions become much more stringent below 60% funding, when benefit accrual must cease and the range of benefits which cannot be paid out is extended to cover “unpredictable” contingent events.

We may not be out of the woods of Solvency 2 yet as far as DB pension schemes are concerned. But even if we do manage to break out of EIOPA’s grip, it may be only to find ourselves surrounded by a larger forest.

Illustration by Emma J Hardy

Illustration by Emma J Hardy

shutterstock_154809119The Wizard of EIOPA is back. Gabriel Bernardino, the chairman of the European Insurance and Occupational Pensions Authority (EIOPA), outlined in May the powers he thought were necessary for EIOPA to enhance its role as a European Supervisory Authority for the insurance market. Insurers are currently busily opposing such calls.

On 5 September, therefore, he changed tack with a speech about pensions instead, entitled Creation of a sustainable and adequate pension system in the EU and the role of EIOPA.

“The creation of an adequate, safe and sustainable pensions system is one of the key objectives of the European Union and EIOPA is committed to contribute by all means to the development of such a system,” he boomed, despite the EU’s Constitutional Treaty not mentioning pensions anywhere among its objectives. He went on to state that EIOPA approved of assets and liabilities being valued on a market consistent basis. So far, so uncontroversial.

But then he continued. “EIOPA suggested a number of elements to reinforce the governance of IORPs: for example the performance of an own risk and solvency assessment.” What? An ORSA? You mean that thing that has led the insurance industry to spend millions on consultants, conferences and which, 5 years on from when it was first mooted, is only currently fully implementable by 24% of European insurers with all of the resources available to them? (Moody’s Analytics, in their July 2013 survey of 45 European insurers, concluded that 24% of the insurers interviewed had their processes, methodologies and models in place to fulfil Pillar 2 requirements – the key one being the ORSA).

He wasn’t finished. EIOPA proposed to require defined contributions (DC) schemes to produce a Key Information Document (KID). This would contain “information about the objectives and investment policies, performance, costs and charges, contribution arrangements, a risk/reward profile and/or the time horizon adopted for the investment policy”. So, a massive amount of additional bureaucracy around the default funds in a DC scheme by the sound of it, with no appearance of understanding that members of DC schemes can choose their own investment policies, nor a word about the hottest issue in DC provision at the moment, ie the level of charges. Surely he is KIDding?

Next he carried on a bit about the “holistic balance sheet” concept, despite it having recently been kicked into the long grass for implementation by pension schemes he clearly desperately wants to bring it back if he can, before giving his interpretation of the findings of the quantitative impact study (QIS) as part of the process to advise the European Commission on the review of the IORP Directive. This boiled down to:

  • Some pension schemes have surpluses, others have deficits.
  • Schemes can either make up deficits by paying more contributions (“It is not unusual that future sponsor support needs to cover as much as 25% of liabilities.” Said the Wizard, with the air of a man discovering a new physical law) or by reducing benefits.

I think we can all agree that however much the QIS cost it was worth the money.

Then we moved onto the Swedish part of the speech. “I would like to take this opportunity to thank the Swedish pension industry, the Swedish pension protection scheme (PRI Pensionsgaranti) and the Swedish supervisor (Finansinspektionen) for their contributions to the QIS. Sweden was the only member state with sufficient financial assets to cover the pension liabilities as well as the solvency capital requirement. Pension funds showed on average even a substantial surplus over the SCR of 13% of liabilities. Of course, an important reason for these positive outcomes is that Sweden already imposes a prudential regime that is market consistent and risk based, by using the quarterly Traffic Light stress test. In my view, this clearly illustrates that a future European regulatory regime should be market consistent in order to ensure a comparable and realistic assessment of the financial situation of pension funds; and risk based in order to provide IORPs with the right incentives for managing risks.”

What? According to the Swedish Pension Agency’s annual report on the Swedish Pension System for 2012, it consists of a pay-as-you-go scheme (the inkomstpension) and effectively an insured personal pension (the premium pension). So it clearly illustrates precisely nothing for a defined benefit occupational pension system like that of the UK with total buy out liabilities of around £1,700 billion (according to the UK Pensions Regulator’s Purple Book for 2012). However, did I mention where this speech was taking place? Sweden.

It was time for the Wizard to return to building his empire. EIOPA need more resources, more powers and now, apparently, more of a mandate. Obviously the m-word is a bit of a problem for all European institutions but it grates on the Wizard particularly. Despite the Solvency II omnibus grinding along on the hard shoulder and the first attempt at new funding targets for occupational schemes being rebuffed, he believes that now the time is right for a foray into personal pensions. He refers to occupational pensions as “the so called 2nd pillar” which confused me at first as I thought that was the risk management part of Solvency 2. However, then I realised that it was just that Eurocrats are obsessed with pillars because now he is calling personal pensions “the so called 3rd pillar”. And he wants to run them with the same efficient competence we have come to associate with the Wizard.

The Wizard wants a new sort of personal pension known as an “EU retirement savings product”. This would avoid “the traps of the short term horizon” (ie pesky scheme members deciding they need their money earlier than EIOPA decree they can have it) and “managed using robust and modern risk management tools” (does he mean things like the stochastic techniques and Value at Risk methodologies which have shown no discernible ability to manage risk in banks to date?). Finally “it should have access to a European passport allowing for cross border selling”. There has been scope for UK occupational pension schemes to become cross border schemes for some time now. Hardly any have taken up this “opportunity” so far because it came with a requirement to immediately increase the level of funding of a defined benefit scheme to buy out level. For defined contribution schemes, as we saw with the fate of stakeholder pensions, the appropriate vehicle very much depends on the form of social security system in place, the degree of means testing and when it happens and, most importantly, how it interacts with the state pension system. One size will definitely not fit all, and I expect that the Wizard’s EU retirement savings product will remain a largely theoretical entity for this reason.

However, my favourite part of the Wizard’s speech was left until last. “It is our collective responsibility to face reality,” he offered, with no hint of irony. I fear that the Wizard’s sense of reality is more a type of magical realism where people can fly, or turn into unicorns and EU officials can regulate things they don’t understand without unintended consequences.

“Please help us to move in the right direction,” he concluded. I think we should all do precisely that, by opposing what the Wizard of EIOPA proposes for pension schemes of all kinds.

My post on 24 April suggested that the threat posed by EIOPA’s proposals for occupational pension schemes (or IORPs, as they call them) went well beyond increases to funding targets, specifically setting out tougher regulation on:

  • Governance requirements;
  • Fit and proper requirements of pension scheme trustees;
  • Risk management requirements; and
  • The establishment of own risk solvency assessments.

“Solvency II” type funding targets have now been postponed, but the other threats remain. So what is the true nature of this threat?

It is easy to portray “Europe” as some massive irresistible force which can only be opposed by an increasingly immovable UKIP-type object. However, occasionally the curtain gets whipped away to reveal, Wizard of Oz style, a few technocrats frantically pulling the levers up and down to maintain the illusion of unquestionable authority.

Gabriel Bernardino, the Wizard of EIOPA, certainly appears to be feeling the strain of maintaining this illusion. Last week he suggested that EIOPA needed more power and more money, some of which needed to come from levies on “the industry”, ie individual pension schemes.

Coincidentally, the Pensions Regulator has also issued a report on occupational pension scheme governance in the UK. There are 128 tables in its accompanying technical report but, picking out one or two statistics on each of the four of EIOPA’s focus areas I have highlighted, it suggests that meeting the tougher regulations on governance and risk management is likely to cause UK pension schemes considerable problems.

For instance, the 70% of small and over 50% (I’m assuming this, the Regulator’s summary of DB/Hybrid medium schemes’ responses only total to 90%) of medium schemes which have trustee meetings less frequently than once a quarter are unlikely to be seen by EIOPA as adequately providing “continuous operational governance”. As EIOPA’s advice recognises (the italics are mine): “many IORPs do not have truly continuous operational governance (e.g. IORP governing bodies that meet monthly or less frequently), so their operational characteristics fundamentally differ from insurance entities”. And the 3% or so of medium-sized schemes who admit to never having had a trustee meeting at all would I assume be seen as not providing operational governance at all.


Next up, if the requirements to establish that trustees are fit and proper persons to govern pension schemes were a worry, the revelation that 57% of small schemes and 41% of medium schemes have no training plan in place for its trustees will not help matters.


Meanwhile, it comes as a bit of a shock to those of us who thought that the Pensions Act 2004 did away with actuaries and other advisors acting as judge, jury and executioner of policy decisions for the pension schemes they represented, that 26% of small, 17% of medium and 18% of large schemes generally let their advisors take the lead on making decisions. Again this is not going to help trustees establish that they are fit and proper to govern their schemes.


It might be hoped that trustees could have a reasonable stab at meeting the risk management requirements of their schemes. However, a stubbornly persistent 13-15% of small and medium schemes (both defined benefit and defined contribution) who have at the very least some form of risk register review it less than once a year.


Finally, there are those who believe that the kicking of a new capital requirement for defined benefit pension schemes into the long European grass, if not the Eurasian Steppe, will just lead to the beefing up of the proposal of a pension scheme own risk solvency assessment along the same lines as insurers are currently developing, ie expecting each pension scheme to develop its own solvency target (which may introduce something equivalent to the holistic balance sheet by the back door) and a reasonably plausible account of how they expect to get there. The nearest thing we have to this in the UK at the moment is for those schemes who are developing a ‘flight path’ to buy out or ‘self-sufficiency’ (itself a concept which may not survive the Wizard of EIOPA). Over half of small and medium schemes have no such plan.


So much to be concerned about here, and none of it without cost. The Wizard may feel he needs help to wiggle levers to maintain an illusion of European managerial competence, but few people the other side of the curtain believe in this any longer. And, with the loss of this illusion, EIOPA’s ability to bully schemes into measures not previously thought necessary in the UK despite nearly 20 years of increasing domestic regulatory hyperactivity in this area recedes. If Bernardino can get the Pensions Regulator to implement all of this and get it to pay EIOPA for the privilege of being more intrusively regulated into the bargain, he will be a wizard indeed.


On 9 April, the European Insurance and Occupational Pensions Authority (EIOPA) published the preliminary findings of the quantitative impact study on its proposed changes to the Institutions for Occupational Retirement Provision Directive (or IORP II as some have started to call it). That sentence might not mean much to many people. But once you understand that EIOPA is the pensions regulator for the whole EU and that IORP is the European word for pension scheme you will probably be expecting bad news. And you would be right.

The study showed that the combined deficits of the 6,432 defined benefit pension schemes in the UK as at 31 December 2011 would have increased from £300bn (the UK Pensions Regulator’s calculated figure) to £450bn (based on methodology designed to bring pension funding more in line with insurance company reserving).

The National Association of Pension Funds warned that this move would put a “huge burden” on remaining UK defined benefit pension schemes and the businesses that run them.  Steve Webb warned that “The EU’s latest figures show the extremely high cost its plans would place on UK defined benefit pension schemes.”

Others were less positive about the proposed changes.

However, I am reminded every time this story is reanimated by the latest stage in the unending dance of death of the European insurance and pensions legislative process, of the line Tom Cruise uses in Mission Impossible to calm objections to his scheme to break into CIA Headquarters. It really is much worse than you think.

IORP II was set in motion with 3 main aims:

  • to make cross border schemes more widely used (which are avoided by most UK employers as they require an immediate increase in funding level in most cases);
  • to create a level playing field between pensions and insurance; and
  • to make sure that this level playing field includes a common supervisory system at EU level which is risk-based.

Which all adds up to a lot more than just a new funding requirement.

Therefore, quite apart from any proposals on extra funding, in over 500 pages of advice to the European Commission last year, EIOPA recommended:

  • The same governance requirements for pension schemes as for insurers. Getting governance and the documentation of it right has and continues to be a challenge for insurers with all of the resources available to them. Can trustees of pension schemes realistically be expected to do the same?
  • Fit and proper requirements for pension scheme trustees equivalent to the requirements of boards of insurance companies. The implication is that the current trustee toolkit might not cut it any more. Might this mean the end of the non-professional trustee?
  • Similar risk management requirements for pension schemes to those of insurers. This would include the possibility of pension schemes needing to set up contingency funds for “operational risks”, eg errors made in administering the scheme that might lead to losses, for the first time.
  • The requirement to conduct an Own Risk and Solvency Assessment (ORSA) for pension schemes. Again, these are very demanding exercises for insurance companies who have whole departments devoted to conducting them.

I could go on. Unfortunately the one thing that is certain is that EIOPA will go on. They have demonstrated through the tortuous nature of the process to date that their tolerance of bureaucracy is almost unlimited. There is a principle of proportionality referred to in the recommendations, which is supposed to mean that no organisation has requirements foisted on it totally out of proportion to the risks it poses to the financial system, but this has yet to be properly tested.

My fear therefore is that what we might have assumed would be regarded as unreasonable requirements of groups of mainly volunteer trustees trying to look after member benefits in their pension schemes will be viewed by the European institutions who will vote on these recommendations as nothing of the sort.