How resilient are European pension schemes to shocks?

European matters may be coming back to the forefront given speculation that the Brexit referendum may now be as soon as this June.

The European Insurance and Occupational Pensions Authority continues with business as normal though.  On 26 January, EIOPA launched its report on the results of its stress testing exercise on European pension schemes.  There is a helpful summary of the results and an FAQ.  For further background see our report in Pensions Bulletin 2015/21.

The exercise (which had a reference date of 31 December 2014) involved data collection across 17 EU member states.  EIOPA states that its dataset comprises more than 50% of schemes by asset value, in most cases.  In the stress tests the funding position of European defined benefit pension schemes was compared across a number of stressed scenarios.  In each case the effects were evaluated using both local funding measurements and a pan-European “common methodology”.  The latter, amongst other things, discounts technical provisions at a risk free rate and also takes into account factors such as sponsor support, pension protection funds and benefit reduction mechanisms.  It is essentially the “holistic balance sheet” under another name.

• The first adverse market scenario assumes a negative demand shock. The initial shock is assumed to take place in equity markets in the EU with an assumed fall in equity prices of 45%
• The second adverse market scenario assumes negative demand as well as a supply shock. This scenario similarly entails an abrupt decline of prices across a broad spectrum of asset classes.  However, unlike the first scenario, it also assumes a materialisation of geopolitical risks which lead to a negative supply shock to the oil market and other commodities.  In this scenario equities fall by 33%
• The longevity scenario. The impact of an instantaneous permanent decrease in mortality rates of 20% is evaluated

EIOPA found predictably big deficits in the surveyed pension schemes.  On the baseline, pre-stress basis the surveyed schemes had deficits of €78bn on local funding measurements and €428bn on the common methodology.  These figures rise to €373bn and €755bn in adverse scenario 1, €346bn and €773bn in adverse scenario 2 and €164bn and €526bn in the longevity shock scenario.

There was also a stress test of defined contribution schemes.  This involved similar stressed scenarios as for DB schemes and illustrated the negative impact on replacement rates (being the proportion of pre-retirement income generated by the DC scheme) of the stressed scenarios.

We expect to hear more in April 2016, when EIOPA is due to provide its assessment of the stress test results to the European Commission.

Comment

As EIOPA states, DB schemes are more sensitive to market shocks than longevity shocks.  Moreover, the long term nature of pension liabilities is recognised.  Because recovery plans can be extended and higher contributions paid it is unlikely that pension funds can fail in the same way as other financial institutions such as banks and present systemic risk to the whole financial system.

It is also notable that EIOPA continues to cling to its holistic balance sheet idea, albeit re-branded.  And we do wonder how far off another tilt at a pan-European funding model is.  Although EIOPA rules out any changes to the IORP II directive in this regard, its chairman states that “EIOPA is fully committed to further enhancing supervisory convergence also in the field of occupational pension” which could be construed as ominous in relation to a future directive.

New member-borne commission payment arrangements to be banned from April 2016

On 26 January the Department for Work and Pensions set out the next stage of its plans to ban member-borne commission payments in respect of certain occupational pension schemes.

In publishing the response to its consultation last October (see Pensions Bulletin 2015/46), along with draft regulations, the DWP made clear that the general principles of its plans remain the same but it has now decided to place most of the compliance duties on to service providers rather than trustees.

The ban will apply to occupational pension schemes that provide money purchase benefits and are being used by an employer as a qualifying scheme for automatic enrolment in relation to at least one jobholder.  AVCs used to provide money purchase benefits in these schemes will also be covered, even where they are the only money purchase benefit provided.  Small self-administered schemes, executive pension schemes and schemes with only one member will be excluded.

The regulations provide that service providers will be prevented from levying a charge on members to recover the cost of any commission payments to advisers for certain advice or services in respect of any new commission arrangements, or variations or renewals of existing commission arrangements.  Service providers will be required to comply with this duty within one month of receiving confirmation from the trustees that the scheme is being used as a qualifying scheme for automatic enrolment.  “Integrated” service providers which offer not only administration and/or investment services but also advisory services are also covered by this ban.

Trustees will have to inform their service provider if their scheme is being used for automatic enrolment within the later of three months of the regulations coming into force, the date the scheme is used as a qualifying scheme for automatic enrolment, or the date the service provider becomes appointed as a service provider to the scheme.  Trustees will then be required to report in their scheme return whether or not the service provider has confirmed to them that they have complied with their regulatory duty.

Once a scheme is covered by the ban it will remain so, even if the scheme stops being used as a qualifying scheme for automatic enrolment.

The DWP received mixed responses about whether a ban on existing member-borne commission arrangements should be implemented at the same time.  Some said they would prefer all member-borne commission to be banned at the same time, whilst others argued that removing existing member-borne commission is more complicated and needed more time.  It is this latter argument that has won the day and therefore the DWP will consult later in 2016 on this topic.

The response includes five questions relating to the draft regulations for further consultation.  Anybody wanting to comment has a very short window to do so because this second consultation period ends on 9 February 2016.

Comment

The DWP’s decision to place the bulk of the compliance burden on service providers (with direct oversight by the Pensions Regulator) makes sense given that trustees are typically one step removed from commission arrangements between advisers and service providers and so may not have the necessary visibility as to whether such arrangements exist in relation to their scheme.  But this does result in the Regulator having a further community to regulate, exposing once more the increasingly artificial divide between the FCA and the Regulator when it comes to the oversight of DC schemes.

Auto-enrolment to get a little easier

This is the intention of draft regulations published by the Department for Work and Pensions on 26 January.  Their focus is on the small and micro businesses that are now starting to auto-enrol their workers, but many of the easements will apply to bigger businesses too.  Four main areas are covered.  The first three are as a result of practical difficulties with the current requirements and the fourth anticipates the cessation of contracting out from April 2016.

Further exceptions to the employer duty to enrol employees

The DWP intends to effectively exempt director-only companies where all employees are directors by turning the automatic enrolment employer duty into a power that the employer can but does not have to exercise for workers holding a directorship in the company by which they are employed.  The DWP states that this group is not part of the target audience for auto-enrolment and are likely to have their own pension saving.  Representations for this originally came from small businesses, but the DWP intends the exception to apply for all businesses.  The DWP also welcomes views about whether this easement should be extended to exclude directors of companies that also employ other workers.

For similar reasons the DWP also proposes turning the employer auto-enrolment duty into a power for cases of “genuine” self-employed partners of limited liability partnerships who are currently treated as “workers” for the auto-enrolment duty, but are not employees for tax purposes.  This LLP issue arose following the Supreme Court ruling and Pensions Regulator opinion in the Clyde & Co v Bates van Winkelhof case in June 2014 (see Pensions Bulletin 2014/25).

The DWP also intends to make a consequential amendment to its regulations covering the easement where employees have tax protections in place.  It will be extended to cover individuals with the new Fixed and Individual Protections 2016.

The DWP is also making an adjustment to the easement concerning employees who have been paid a winding-up lump sum but are then re-employed within 12 months.  This is to correct a possible unintended consequence of the current legislation and clarify the policy intent.

Comment

These all seem sensible easements to ease employers’ administration burdens for employees who are not the target of the auto-enrolment legislation.

Simplification of the re-declaration of compliance process

The DWP proposes an easement so that there is just one deadline set out in legislation for re-declaration of compliance.  Currently there are two deadlines depending on whether or not an employer has workers to re-enrol.  This has caused confusion and practical difficulties for employers.

Some simplifications when bringing forward staging dates

The conditions an employer must satisfy when bringing its staging date forward have caused problems in some cases and the DWP’s proposals are intended to solve these as follows:

• The current requirement to obtain agreement from a pension scheme for those employers who have no-one to enrol will be removed – in addition such an employer will be able to bring forward its staging date to any date, not just the first of the month date as currently prescribed; and
• The requirement to give the Pensions Regulator one month’s notice will be removed – instead, such notification must be no later than the day before the chosen new staging date

Transitional easement for certain formerly contracted-out salary related schemes

Since 1 April 2015 defined benefit schemes have been able to use the cost of accruals test to demonstrate that they are of an appropriate quality to be used as an auto-enrolment scheme.  It is likely that this test will be very popular with those schemes that are currently contracted-out and which will need to demonstrate that they are of an appropriate quality by April 2016 when contracting out ceases.

This test normally applies at scheme level.  However, it must be carried out at a benefit scale level where there is a material difference in the cost of providing benefits between different groups.  But in a welcome easement the DWP is proposing that, for a transitional period only, employers of schemes that satisfy the contracting out conditions on 5 April 2016 and have not changed the benefits in their schemes can apply the cost of accruals test at scheme level.

The consultation period for these regulations is short, ending on 16 February 2016.  The DWP intends to publish a response in early March 2016 and make regulations in the same month to take effect from April 2016.

Comment

These further easements build on last year’s easements which took effect from 1 April 2015 (see Pensions Bulletin 2015/11) and in principle are sensible.  Some fettling may be needed as part of the consultation process but we hope that these amendments are made into law with no problems.

PPF refreshes its guidance for restructuring and insolvency professionals

The Pension Protection Fund has published its refreshed General Guidance for Restructuring & Insolvency Professionals.

The guidance sets out the criteria that restructuring practitioners should incorporate in any proposals they make in respect of an insolvent pension scheme employer.  The PPF is not obliged to consider a restructuring proposal, and to do so, these criteria must be met.

The guidance goes on to provide information on how insolvency professionals should interact with the PPF in the event that a sponsoring employer of an occupational pension scheme suffers an insolvency event and how an eligible scheme will be assessed to determine whether it should enter the PPF.  It also provides insolvency professionals with an outline of the stages and related processes.

The guidance should be read in conjunction with the detailed guidance the PPF provides on different aspects of the insolvency process, more of which is expected to be issued during the course of 2016.

NEST proposes miscellaneous rule changes

The National Employment Savings Trust has issued a consultation on proposed changes to its scheme rules, which bring aspects of the scheme into line with changes to pension legislation and take account of the lifting of the limit on contributions and restrictions on transfers from April 2017.

The consultation includes:

• Updates to NEST’s rules to allow lump sums and partial lump sums to be paid as benefits as provided for by the “freedom and choice” changes introduced in April 2015
• Changes which reflect amendments Parliament has made to the NEST Order and the revocation of the “Disapplication regulations” to lift the restrictions on NEST (see Pensions Bulletin 2015/08); and
• “Tidying up” changes, for example to bring the rules into line with recent legislative changes such as the change to pension input periods

Consultation closes on 21 March 2016.

This Pensions Bulletin does not constitute advice, nor should it be taken as an authoritative statement of the law.  For further help, please contact David Everett at our London office or the partner who normally advises you.