A European Market for Personal Pensions: An Opportunity for Industry and Investors
The European Insurance and Occupational Pensions Authority (EIOPA) recently published a preliminary report on the creation of a single market for personal pensions. The report responds to a request for technical advice by the European Commission and will be followed by wider discussion after the 2014 European elections, likely leading to legislative action.
The debate on strengthening pension systems in Europe is a longstanding one amidst an ageing population and shrinking workforce. The 2008 financial crisis and deterioration of public finances made even more patent that generous systems financed from taxation or social contributions are increasingly difficult to finance. In parallel, the persistence of low interest rates keeps putting pressure on the solvency of defined benefit schemes, typical in the occupational pensions space.
Personal pensions play an increasingly important role in supplementing other sources of retirement income. They are typically contracted by the individual acting in a personal capacity but may benefit from employer and/or government contributions or tax exemptions. No common approach exists today as to the structuring, governance, and distribution of these solutions in Europe. This post considers the opportunities and challenges in creating a single market for personal pensions.
As in every European exercise, citizens in some member states stand to benefit more than others. Multi-pillar pensions systems are not fully developed except for in a handful of member states, yet all member states would benefit from developing pension systems where they are currently lacking. Most individuals would be able to access higher quality and less costly solutions as a result of an EU-wide framework, brought by the sheer size of a single market and its economies of scale and scope.
Some pension providers may lose out where they have been sheltered from competition. But others stand to gain from increased awareness of the need to save on the part of individuals and higher trust among consumers in regulated and supervised pension solutions. While competition may erode margins for some, a larger investor base should make revenues grow overall. The opportunity for asset managers is unparalleled, likely more important than the one offered by the development of the Undertakings for the Collective Investment of Transferable Securities (UCITS) framework.
The EU economy would also benefit from efficiency gains and, particularly within the euro area, further economic convergence. An appropriately devised framework can also strengthen the long-term orientation of investment in the real economy, given the long horizons involved in saving for retirement and the ability of large funds to hold strategic equity stakes and invest in less liquid asset classes.
The challenges of developing a single market for personal pensions are great. Any proposed framework will need to demonstrate its ability to add value to national solutions and overcome the obstacles to integration arising from the differences in contract law and taxation across member states. Overcoming these obstacles will be central to achieving cost efficiency for investors.
EIOPA considered those and other barriers in a previous report and consultation and, while there are technical solutions, some of which are relatively easy to implement, most would require member states’ consensus. Take for instance taxation, where member states could converge towards a common tax structure while keeping full discretion as to the precise level of taxation.
Social and labour law are largely out of scope, as the proposal would, in principle, not address occupational pensions, which would remain under the Institutions for Occupational Retirement Provision (IORP) directive. Yet, borderline cases, such as ‘group pensions’ and ‘first pillar-bis’ schemes, add some complexity to the picture. The development of a single market for personal pensions could however benefit both systems by fostering competition and business sophistication among providers.
Overcoming these challenges will not be easy. And once done, the market will not deliver its full potential until it reaches sufficient scale through participation and accumulation. Make no mistake, developing a pan-European market for personal pensions will be the endeavour of a generation. Upcoming posts will take a closer look at the proposals on the table and discuss their implications for investors.
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