Addressing the pensions sector’s challenges
By Gabriel Bernardino, Chairman of the European Insurance and Occupational Pensions Authority (EIOPA)
Demographic changes, aging populations and significantly increasing life expectancy, paired with a challenging economic environment with historically and persistently low interest rates, bring pensions back on the agenda of policymakers and governments in Europe and in most developed and developing countries.
The outlook on the sustainability of pension promises, from state, occupational funds or private savings, is anything but comforting. Recent serious corporate failings showed the impact on the safety of individuals’ future retirement income in case of significant underfunding of pension funds.
In 2017 EIOPA carried out a stress test of Institutions for Occupational Retirement Provision (IORPs), assessing the resilience of a representative sample of European pension funds to a severe, yet plausible, ‘double hit’ market scenario. It was noticeable that the challenging market environment has took its toll on the sector and has put funding positions of Defined Benefit/hybrid IORPs under severe pressure, resulting in substantial shortfalls even under pre-stress conditions. The Defined Contribution IORP sector would experience a drop in asset values in the adverse scenario, reducing the individual accounts of Defined Contribution members and, if the scenario persists, leading to significantly lower future retirement income. Sponsors of over a quarter of IORPs might face severe challenges meeting their obligations, so the pensions sector’s vulnerabilities could spill-over to the real economy either through the adverse impact on sponsors and/or on beneficiaries through benefit reductions. Whilst national recovery mechanisms mitigate the short-term effects on financial stability, in the longer-term the burden of restoring the sustainability of pension promises will affect disproportionately younger generations.
Further, the pension sector with its long-term obligations and its matching long-term investment horizon is most affected by risks stemming from unsustainable asset classes and bears a social responsibility to assess Environmental, Social and Governance (ESG) factors. EIOPA sets high expectations on the effective implementation of the IORP II Directive’s provisions enhancing the risk management and investment governance with regards to ESG. In the future IORP stress test EIOPA will explore the best way to include risks from investing in ‘brown’ or stranded assets, as well as risks from climate change. The on-going shift from Defined Benefit to Defined Contribution, accelerated by the low-interest rates and the pressure on sponsors, and supported by recent pension reforms in Europe, shifts the burden on investment decisions and investment risks on members of pension funds. Therefore, the provision of relevant information to members and beneficiaries, together with appropriate governance structures for pension funds, tailored to Defined Contribution structures, are high up in EIOPA’s strategic business priorities for 2018.
To find relevant solutions to the challenges European pensions face, one needs to seriously appreciate the different starting points of the European Member States: there are a number of countries that do not have any – or only a few – occupational pension funds, some of the countries have fairly young pension markets and state or occupational pensions rely on employers and employed citizens contributing to the systems, whereas the workforce is increasingly mobile and is more and more characterised by unconventional careers.
That is why EIOPA is convinced that a Pan-European Personal Pension product (PEPP) is a promising legislative initiative, and if successfully implemented it will be a tangible improvement for the European citizen. Personal pension products often have suffered from being perceived as too costly, too in-transparent and too complex to make them a savings option for the majority of consumers, and in particular for those with limited available income to save for future retirement income. PEPP is designed to be a safe, transparent and cost-effective long-term retirement savings product that will offer pensions savers new opportunities to strengthen their future retirement income within a European personal pension framework. It is a powerful tool to encourage personal pension savings for individuals and to enable important long-term investments. The building blocks of PEPP, in particular the standardised elements shall ensure to reap economies of scale and help to increase transparency and consumers‘ trust. Further, it will provide a level playing field for providers, encourage competition, increase trust among consumers and cater for the European labour market. The PEPP will not replace existing national personal schemes, but will be a complimentary regime alongside national regimes.
The European pensions sector is under pressure to address urgently its challenges and to promote sustainable pension promises. EIOPA believes that a tool set of efficient risk management, improved funding, tailored systems of governance, a proper assessment of sustainable finances – together with the introduction PEPP, will contribute to make European pensions future proof.