The design of European supervision of pension funds

In this paper we focus on the second pillar, that of employment-based pensions. The primary function of occupational pension schemes is to provide employees with a retirement income. There are many ways in which these occupational pensions can be organized. The key differences relate to the way such pensions are financed, whether the pension promise contains any guarantee, the way the guarantee is secured, and the level of risk sharing among stakeholders. The key purpose of this paper is to explore the optimal design of European supervision of occupational pension funds, given the wide variety of pension schemes. Supervision on these occupational pensions is carried out by national supervisory bodies, using regulatory frameworks that may differ by member state, as seen fit for each specific situation.

The European Commission has put forward the aspiration to further harmonize supervision on a European level. The Commission has issued a call for advice (Commission 2011) asking the European Insurance and Occupational Pensions Authority (EIOPA) on how to achieve this goal. Given the abovementioned differences, harmonization will prove to be a challenge, and it may even impact the way pension schemes are designed. EIOPA has developed the concept of a ‘holistic balance sheet approach’ as the way to achieve as much harmonization as possible (EIOPA 2011). There are still many complexities that need to be addressed before harmonization can be achieved using the holistic balance sheet approach.

In addition to a single harmonized framework for all different occupational pension systems throughout the European Union, we propose a supervisory framework that is consistent in the methods and instruments used, but that is still tailored to the specific characteristics of each individual pension system. We propose a method of clustering pension schemes along three dimensions, and we discuss the various supervisory instruments that can be used for each cluster in order to achieve the goals of supervision in a consistent manner. A harmonized regulatory framework at a European level will be implemented through legislation in each member state. This raises the question of how much freedom is left for individual countries to shape the regulatory framework and how to tailor it to specific situations. This is the subject of further study.

The paper is organized as follows. In Chapter 2, we discuss the various differences in occupational pension systems. Six pension scheme clusters will be identified. We note that these six clusters can all be described along three axes: the pension benefit, the method of financing, and the level of risk sharing. This leads to a ‘cube’ of pension systems in which six of the eight corners can actually be used. This classification is used for further analysis of the way supervision can be structured.

In Chapter 3, we start by stating that the main objectives of supervision are related to assessing financial health, risk management, disclosure, and governance. A prerequisite for good supervision is providing the right information in order for the supervisor to be able to assess these four areas. We therefore continue with an overview of instruments that are available to provide the supervisor with this information.

In Chapter 4, the concepts developed in the first chapters are combined by assigning to each pension cluster a group of usable and useful instruments. We argue that such a framework leads to instruments being consistently applied over different pension schemes in order to provide all the necessary supervisory information. Such a framework leads to convergence of pension supervision where possible. Finally, given the relevance of the subject and to provide the European Commission and EIOPA with an alternative use of the holistic balance sheet framework, we discuss this framework in greater depth. We recommend a holistic balance sheet approach as it can be a useful instrument for funded, collective schemes, including collective DC plans. But the approach also offers some challenges before it can be made readily available. One way to achieve this is to introduce the holistic balance sheet approach for designated pension funds and as an internal model. In that way practical experience can be gained and the challenges resolved, before the approach is widely introduced in pension supervision.