IORP II Directive: Additional Protection for Occupational Pensions Holders
The 2003 directive on Institutions for Occupational Retirement Provision (IORPs) introduced minimum common rules for workplace pension funds in Europe. The rules were indeed minimal and had an enabling purpose: to make the cross-border provision of occupational pensions possible when the plan sponsor and the IORP are located in different countries of the EU. It also aimed to facilitate the pooling of schemes by companies operating in several countries.
So far, given the diversity in national prudential requirements and social and labour laws, the IORP framework has gathered limited success. In 2013, there were only 82 cross-border IORPs out of approximately 120,000 schemes. Only a handful of member states have developed the provision of workplace pensions, which also explains the limited uptake. However, as Europe would like to generalise second-pillar pensions, the creation of a single market becomes instrumental.
Reforming the IORP Directive: To What End?
The first IORP directive reform has been under discussion since 2010. Since then it has faced intense opposition regarding the intended harmonisation of prudential requirements against the backdrop of the introduction of Solvency II for life insurers. The creation of a single rulebook for quantitative aspects has been formally postponed, pending additional assessments by the European Insurance and Occupational Pensions Authority (EIOPA).
Only recently did the European Commission table its legislative proposal, which contains measures to further facilitate cross-border operations but, most importantly, focuses on increasing the protection of plan holders (beneficiaries or end investors). IORP II will require higher quality and more informative communications with plan holders, coupled with more sophisticated governance and risk management. In addition, the directive will remove barriers to invest in less-liquid assets.
IORP II Provides a Comprehensive Framework for Communications
IORP II contains a comprehensive framework for communications with plan holders, which closely mirrors the principles developed by the Organisation for Economic Co-operation and Development (OECD) and EIOPA. The framework targets the full life cycle of the pension solution — before the employee enters the scheme, during the accumulation phase, before retirement and during de-accumulation. It is meant to serve both defined benefit, and defined contribution plans — but with a focus on defined contribution and hybrid solutions, given their growing importance.
- Pre-enrolment information: Before joining a scheme, prospective members should receive information about contributions, costs, investment options and opt-outs, where applicable. Information shall include whether and how environmental, social and governance (ESG) criteria are considered. It is uncertain whether employees will receive a key information document (KID) since IORPs are excluded from the Packaged Retail and Insurance-based Investment Products (PRIIPs) regulation agreed to recently.
- Annual statements: The European Commission will create a standardised format for pension benefit statements, easily understandable and comparable across schemes and countries. The pension benefit statement will be a maximum of two pages and specify (1) whether a guarantee exists and, where it does, its features and accrued rights, (2) the total sum and detailed breakdown of costs and contributions, (3) pension projections under best estimate assumptions, (4) a description of the investment profile and options, (5) a synthetic risk–return indicator for defined contribution plans, (6) a qualified reference to past performance and (7) where and how to obtain further information.
- Pre-retirement information: Members should be informed about their options in the de-accumulation phase (annuities, drawdown plans and others) at least two years before retirement. This information will include the advantages and disadvantages of alternative options and the key aspects to consider when making the decision to purchase one of them.
- Information during the pay-out phase: After retirement, beneficiaries should be informed about their benefits and options by the relevant provider, in particular where they continue to bear significant market or other risks — for instance, when de-accumulation takes the form of a drawdown plan and the remaining sum continues to be invested, given a long life expectancy.
The European Commission affirms that it will ensure consistency between these standards and the ones applicable to other investment and retirement products, such as Undertakings for the Collective Investment in Transferable Securities (UCITS) and PRIIPs. It will also need to ensure consistency with any forthcoming proposals in the area of personal pensions, where EIOPA has already put forward detailed recommendations regarding disclosure and communications.
Other Measures to Increase Investor Protection
In addition to transparency and disclosure, the IORP II proposal contains other important measures to strengthen investor protection by raising the integrity and resilience of pension fund operations:
- IORPs will be required to name a single depositary, with responsibility for the custody and record keeping of assets — under a regime broadly equivalent to the one applicable to alternative investment funds and UCITS. For defined contribution funds, the requirement applies strictly, since the risks are borne directly by the end investor, while each member state may choose whether to require a depositary in defined benefit funds.
- The directive contains a number of measures aimed at raising the standards of governance and risk management, thus promoting best practice. Notably it includes the requirement to perform a “risk evaluation for pensions” on a regular basis. As part of this evaluation, the IORP will need to estimate the margin for adverse deviation from target solvency requirements, taking into account short- and long-term risks, as well as any potential support available from its sponsor (as a sort of stress testing exercise).
- Finally, the directive requires prudential supervision to be prospective and risk-based. Member states need to equip supervisors with the tools to monitor and review the governance system and the risks faced by IORPs. National supervisors should perform stress tests to identify problems at an early stage and have the authority to require IORPs to take remedial measures.
Since the directive applies both to defined benefit and defined contribution pension funds, these requirements will apply in a different manner depending on the presence of a sponsor and the distribution of risks between sponsor and end investors. For funds offering guarantees, the European Commission would like to propose a framework for prudential capital requirements, given the cross-border externalities that could arise in case of significant failures to meet commitments with beneficiaries. There is, however, no precise time-horizon for this initiative.
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