The excitement in the pension fund industry caused by the potential introduction of consolidation vehicles to help schemes that cannot afford the gold standard of an insurance company buyout is in danger of being crushed by the lobbying efforts of ... the insurance industry.
While killing consolidation will obviously be a negative for those thousands of schemes for which a buyout is not on the horizon and the millions of pension scheme members whose benefits have a low degree of security, it is also worrying for the pension industry as a whole.
The arguments being advanced by the insurance industry are eerily reminiscent of the long-running argument with the European Insurance and Occupational Pensions Authority as to whether Solvency II should apply to pension funds.
With the support of the U.K. government and The Pensions Regulator, the pensions industry in the U.K. managed to push back the proposals by EIOPA. So it is worrying that a U.K. regulator has picked up the EIOPA baton — and the evident dangers it poses to an industry charged with managing £1.6 trillion ($2.1 trillion) of assets to ensure the safe retirement of more than 10 million people.
The Prudential Regulatory Authority, the division of the Bank of England that regulates the solvency of insurance companies in the U.K., published its response to the consultation by the Department for Work and Pensions on consolidation on Feb. 5.
The PRA's response includes a number of troubling statements for the pension fund industry. In effect, the economic similarity of the benefits provided by a pension scheme to an annuity, and the fact that in the consolidation market the sponsor will be a profit-making entity, are combined so, in essence, a consolidation vehicle is an insurance company and should be regulated in exactly the same way.
Given that the overwhelming majority of pension schemes are sponsored by profit-making entities, this runs the risk of pushing the EIOPA argument to its logical conclusion that defined benefit schemes should be regulated as insurance companies.
While it is not necessary to remind the pension industry what this would mean for U.K. companies, it is worth considering, once again, the financial implications of such a change.
The assets held by the pension industry are expected to cover about 87% of benefits on an ongoing basis with about £200 billion to be contributed by employers over the coming years to restore full funding.
This might sound like an eye-wateringly high number but is widely seen as generally affordable. Last year alone, the sponsoring employers standing behind the U.K.'s largest 360 schemes made an extra £14 billion in special contributions.
However, if this consultation meant pension schemes were to be treated like insurance companies, employers would have to fund the liabilities to a Solvency II level of technical provisions, ring-fencing capital. A rough calculation suggests £800 billion would not be an unrealistic assessment of the cost to U.K. corporations.
Clearly, pension schemes are not insurance companies. Pension scheme funds are held in trust by trustees for the beneficiaries and not owned or controlled directly by a profit-making third party.
The security provided to a pension promise is not set by the PRA but driven by an employment bargain with the employees: A more secure promise from a stronger employer means the benefit promise is worth more to the member.
Consolidation was proposed to help those schemes where the benefit promise is made by an employer that is not strong, where benefit security is weak and the risk of a claim on the Pension Protection Fund is high. By bringing new money into play to support these pension promises, consolidators can better protect benefits promised to members which are currently imperiled.
Pension schemes are different from insurance companies in that they are managed by trustees with the protection that trustees will always want: the gold standard for their members to whom they answer. They will not agree to be consolidated unless it is demonstrably in the best interests of their members.
Of course, consolidators need to be strongly regulated by The Pensions Regulator, and buyout should remain the gold standard.
But concerns over regulatory arbitrage can be managed, not by making the regulation the same, but by precluding those schemes where buyout is a realistic, medium-term outcome.
That would restrict consolidation to those cases for which the weaker, non-insurance, promise from the consolidator is substantially better than they would hope to achieve otherwise.
In short, a silver standard open only to those who currently have a bronze standard but have no hope of achieving the gold standard.
Richard Jones is a principal at Punter Southall Group Ltd., London. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines, but is not a product of P&I's editorial team.