CORRECTED TRANSCRIPT OF ORAL EVIDENCE
To be published as HC 1911 -ii

House of COMMONS

Oral EVIDENCE

TAKEN BEFORE the

Work and Pensions Committee

EU Pensions Policy

Monday 23 April 2012

Karel van hulle and Ralf Jacob

Evidence heard in Public Questions 65 - 126

USE OF THE TRANSCRIPT

1.

This is a corrected transcript of evidence taken in public and reported to the House. The transcript has been placed on the internet on the authority of the Committee, and copies have been made available by the Vote Office for the use of Members and others.

2.

The transcript is an approved formal record of these proceedings. It will be printed in due course.

Oral Evidence

Taken before the Work and Pensions Select Committee

on Monday 23 April 2012

Members present:

Stephen Lloyd (Chair)

Harriett Baldwin

Andrew Bingham

Karen Bradley

Glenda Jackson

Brandon Lewis

________________

In the absence of the Chair, Stephen Lloyd was called to the Chair

Examination of Witnesses

Witnesses: Karel Van Hulle, Head of the Insurance and Pensions Unit, Directorate-General for the Internal Market and Services, and Ralf Jacob, Head of Unit for Active Ageing, Pensions, Healthcare, and Social Services, Directorate-General for Employment, Social Affairs and Inclusion, European Commission gave evidence.

Q65 Chair: Welcome to this afternoon’s session. Thank you, Mr Jacob and Mr Van Hulle. I know that we are on a fairly tight schedule because I am told by our office that you really need to be out of the door by six o’clock, so we will crack on. Before we start, I would be very grateful if each of you could give a very brief introduction of yourselves and your responsibilities, and then we can get on with the session. Mr Jacob, could you start?

Ralf Jacob: Thank you very much for inviting us. I would like to apologise first of all on behalf of my Director General, Koos Richelle, for not being able to come in person. I am in charge of the unit dealing with active ageing, pensions, health and long-term care in the Directorate-General for Employment, Social Affairs and Inclusion of the European Commission.

Q66 Chair: Thank you very much. Mr Van Hulle?

Karel Van Hulle: Good afternoon. Thank you also for inviting me. I am speaking also on behalf of my Director General, Jonathan Faull, who could not be here today. I am in charge of insurance and occupational pension funds at DG Internal Market and Services.

Q67 Chair: Thank you very much for that. I shall start off by looking at the White Paper proposals initially, and then we will be getting on to the solvency issue and a number of other key things, as quickly as possible. Just to set the scene: the White Paper highlights the challenge of ensuring adequacy and sustainability of pension provision in the context of increased longevity. In your view, what does the EC see as the key reforms that member states need to make to improve pension provision?

Ralf Jacob: The White Paper takes up two policy proposals that were developed in the annual growth surveys of 2011 and 2012. These proposals concern, on the one hand, measures which would improve the balance between time spent working and time spent in retirement over the individual life cycle. On the other hand, we are aiming at promoting a greater contribution to pension incomes from supplementary schemes such as occupational pension schemes. These measures fall largely into the responsibility of the member states, so the purpose of the White Paper is to show first of all what could be a common shared vision for more sustainable and adequate pension systems in the less favourable contexts of demographic ageing and the unfavourable economic environment. It also tries to set out what could be the European Union’s contribution to help member states implement the necessary reforms. That is basically the purpose of the White Paper.

Q68 Chair: Mr Hulle, do you want to add anything to that?

Karel Van Hulle: I think it is a very good representation of the White Paper.

Q69 Chair: As you know, in the UK we already have a robust regulatory system. We are also now taking steps-which I am sure you know from the Chancellor’s announcement a few weeks ago-to increase the state pension age, restore the state pension provision, and introduce automatic enrolment. There are therefore an awful lot of things going on at present in the UK. On the back of that, are there any further steps that in your judgment the EC would regard as necessary for the UK to take to improve the pension system, bearing in mind the three or four steps that we are actually taking at present?

Ralf Jacob: These steps are very much in line with the recommendations in the annual growth survey and in the White Paper itself. You may remember that following the annual growth survey of 2011, country-specific recommendations in the area of pensions have been issued to a majority of member states, and the UK was not one of them, because the reforms that you just mentioned go very much in the right direction, from the Commission’s point of view.

Q70 Glenda Jackson: You speak of the annual review; what does it show and how long term is it? Are we talking about the length of time we will live post our being contributing workers?

Ralf Jacob: The document I referred to is the annual growth survey, which is a new instrument in the context of the Europe 2020 strategy for growth and employment, which every year reviews the situation and identifies policy priorities. Among the policy priorities that were identified was pension reform, which is considered important for making public finances sustainable. In the sovereign debt crisis we have seen that sustainable pension systems are critical to ensure the sustainability of public finances overall, and we are looking at the sustainability of pension systems in a longer term perspective over the next decades.

I should mention here that our colleagues from the Economic and Financial Affairs department are working together with the Economic Policy Committee to prepare a new set of long-term projections of public spending on pensions and other areas of social protection in order to establish to what extent there are risks to the sustainability of public finances. We therefore adopt a long-term perspective; the annual growth survey is really a reflection of the latest trends, but in that context we identify long-term reform needs.

Q71 Glenda Jackson: How long is long?

Ralf Jacob: As far as pensions are concerned, our time horizon is 40 to 50 years, depending on what we are looking at: financial sustainability, adequacy; here we are looking at a 40-year time horizon.

Q72 Chair: On the back of that, the EC acknowledges that it does not have the legislative powers in relation to the design of member states’ pension systems. What mechanisms, therefore, can the EC use to encourage member states to take the actions that it regards as necessary-other than Solvency II, which we will be going on to in a minute-from the White Paper perspective?

Ralf Jacob: We have instruments, such as the open method of co-ordination, that foster mutual learning. The member states are facing very similar problems. Some countries have already come up with interesting solutions; others are still looking for solutions. We want to facilitate this process of mutual learning. We want to make it possible, for instance, for other countries to look at what is happening in the UK, with reform such as the NEST1 scheme, and we want, vice versa, also to make it possible for the UK to look to other countries, if there is such an interest. We use, for instance, the PROGRESS programme, which can be used to fund mutual learning activities such as peer reviews and specific projects that can be designed by policy makers in the member states in order to benefit from the experience in other countries. Then we have financial instruments, such as the European Social Fund in particular.

We stress in the White Paper the need to accompany pension reform measures, which aim very much at raising the pensionable age, with measures that enhance the employability of people, otherwise people will drop out of the labour market early and will only suffer a cut in their pension entitlements because they cannot make it up to the higher statutory retirement age. Here we can propose the use of the European Social Fund in order to enhance the employability of older workers in particular. These, then, are some examples of instruments that we can mobilise at the European level.

Q73 Chair: However, on the longevity issue, all politicians, across every country in the EC at the present time, are trying-with varying degrees of success-to face up to the challenge around longevity, which is an opportunity on one hand, but obviously a challenge from a pensions perspective. I have two specific questions on that, and I would be keen to get your take from an EC across-the-piece perspective. First off, I think we all accept that longevity means that the pension age needs adjusting. As I said, countries are dealing with that differently, though we all accept the need for it. Within that, though, what proposals do you have for dealing with some of the demographic challenges, which will clearly have a greater impact on different professions and trades? If I am a hod carrier, a brick carrier, it will obviously be that much harder for me to do that at 64 than it would be if I was a secretary, for instance. What learning have you picked up thus far across the EC? Perhaps you have some interesting ideas about that.

Ralf Jacob: We have recommended the restricting of access to early retirement schemes, and that may be regarded as unfair for those people who started their working lives very early and who have worked under very arduous conditions, and whose health may be severely impaired long before they reach the official retirement age. This is something that needs to be taken into consideration, but there are different ways of dealing with it, and some ways are better than others. One of the worst ways I can think of is to have lower retirement ages for an entire sector or an entire profession without taking into consideration the actual health impact of working in that sector on individuals. We need to have a different approach, perhaps targeted more at individual needs, and for that we can have invalidity schemes that deal with those cases.

Q74 Chair: I shall interrupt there, because that is a really interesting point. Your expertise would say the solution is not that one whole particular sector-for instance brick carriers or what have you-therefore retires early, but that we have to focus on individual cases and therefore provide some specific benchmarking that allows us to measure that. How would you do that in individual cases?

Ralf Jacob: Most countries have invalidity pension schemes, which would assess the individual health status, and award a pension if that is needed. I will develop these thoughts a little bit further if I may. The very first thing to do, of course, is to make sure that nobody has their health ruined by working. Health and safety should come first as a way of dealing with these issues. It is good news that fewer people nowadays are working in sectors or professions that have such ruinous effects on their health. Secondly, there is the option of career management. You may be able to do certain arduous jobs during a certain phase of your life, but one should not assume that everybody has to do the same profession up to the end of their professional life-up to the age of 68 or wherever the pensionable age is set.

Career management can help a lot. People can do one kind of job that requires a lot of fitness up to a certain age, and they can then move to a different type of activity. This needs to be supported by social protection schemes. Rather than having a specific social protection scheme that applies to one profession or to one sector and allows people to withdraw from the labour market at a sector- or profession-specific age, it would be better to facilitate mobility from one activity to another.

Q75 Chair: Is that advice that your department would be feeding through all the different regions within the EC?

Ralf Jacob: This is not yet official advice that is laid down in policy documents, but these are the kinds of solutions that we want to explore in co-operation with the member states in which mutual learning could be brought to bear.

Q76 Glenda Jackson: On the issue of career management, what happens to the pension contribution? I am thinking of examples within my constituency, where I see people who may have been in management or something similar get to a pensionable age and then stack shelves in a local supermarket, because they would sooner do that than be bored at home. Their pension contributions from the supermarket are nowhere near what their pension contributions were when they were in middle management. Is portability the right word for this, when the pension pot goes into the next stage of the career?

Ralf Jacob: There are presumably different arrangements. Nobody should be penalised retrospectively for moving to a less well-paid job, though sometimes this happens in pension systems, where the pension level may be determined by your final earnings. However, this is becoming increasingly rare. More common nowadays are pension schemes that look at average earnings over the entire career, or you have defined contribution schemes, so that it does not really matter that during the final years of your career you have lower earnings. We really need to think-and this is also mentioned in the White Paper-about second career labour market opportunities for people who have finished their main career but want to stay in the labour market, though perhaps with a lower involvement.

Q77 Chair: The majority of the other EC countries are either already using average earnings pension schemes or moving to average earnings. Is that correct?

Ralf Jacob: I would not go so far as making that kind of affirmation. This is something we would have to check; we would have to go through the overview of social protection schemes that we have, the so-called MISSOC tables. I could come back to you on that.

Q78 Chair: I would be grateful for that. I would be quite curious to see how many of the EC countries are currently using average earnings, and how many are moving toward average earnings.

Ralf Jacob: Okay. We will do that.

Q79 Chair: Good, thank you. One more question before we go on to section two, which is crucial. This Select Committee has highlighted that people need to have confidence in the security and reliability of return of occupational pensions if take-up is to increase. What measures would the EC like to see national governments introduce to increase public confidence in pensions?

Ralf Jacob: Here we do not have any readymade recipes for success. Again, this is one area where we would promote mutual learning. There are different ways of running successful occupational pension schemes. One way that seems to be very successful in a number of countries, such as some Nordic countries-Denmark, Sweden and the Netherlands-is schemes based on collective bargaining. These schemes tend to be broader in scope, covering entire sectors-so not just linked to one employer-and there seems to be strong support and trust in these schemes. Then, when you have employer-run schemes, one way of strengthening confidence is to make sure that these schemes are well protected in the event of the insolvency of the employer. Here the UK has made some progress, notably following the Robins court case, which was based on a Directive on the protection of workers’ rights in the event of the insolvency of their employer, which contains one article on the protection of occupational pension rights.

Q80 Chair: What, then, is your take on NEST and what the coalition Government are doing with auto-enrolment, following on from the previous Government, and NEST being effectively underpinned by the Government?

Ralf Jacob: One issue that we raise in the pensions White Paper is the need to increase coverage of pension schemes. Many of the occupational pension schemes in particular-but also this is mostly the case for third pillar schemes-are voluntary in nature, so people can choose whether they contribute to such schemes. As people tend to be somewhat short-sighted about pension entitlements, and do not realise how much of a savings effort is needed over the entire career in order to get a pension, it is important to consider either mandatory membership in occupational schemes-and that tends to be the case with those schemes based on collective bargaining-or to use devices like the one you developed for the NEST scheme, which requires people not to opt in but to opt out. It will be very interesting to see how successful that scheme is, and I think this could provide useful inspiration for some reforms in other countries.

Q81 Chair: Would it therefore be fair to say that the other EC countries are watching what we are going to be doing with auto-enrolment and NEST very closely?

Ralf Jacob: I cannot say whether they are actively watching, but we would be very happy to provide opportunities for the UK to share its experiences in the peer review programme, for instance. However, I suppose it is still early days. In one or two years it could be a good moment for organising such a peer review, where other countries could then look at what is happening here and try to ask some questions that would allow them to decide whether this experience will be transferable to their own circumstances.

Chair: That is a very DG answer, if I may say so. Thank you.

Q82 Brandon Lewis: Why does the EC want to increase the capital requirement for pension funds?

Karel Van Hulle: First of all, let me say that the debate that might result in the possibility of increasing capital requirements is just starting. What we are trying to do is to build a system whereby pension funds would better take account of the risks of the pension pots. We see that sometimes numbers are being put out-600 or 800 billion in any currency-which is very surprising, because the Commission has not made any proposal. I wonder, therefore, on what basis these amounts are being calculated. The fear of capital increases comes from the fact that we have a system today whereby we live in low-interest environments. Sometimes pension liabilities are calculated at a discount rate that is rather high. If you brought the discount rate closer to the market discount rate, your technical provisions would increase, and that might result ultimately in capital increases.

However, again, we are in early days. We are looking at the possibility of having more comparability between the situations of pension funds across member states. That is one of the reasons why there is sometimes confusion, because people always presume that an occupational pension fund in another member state is exactly the same. It is not. The UK occupational pension funds are different from the Dutch or the German pension funds, so we need to take that into account.

Q83 Brandon Lewis: That is good to hear. Can you expand a little bit when you say "take that into account"? There are many people who argue that in the UK system, for example, there is not a need for that because of the structure and the protections that we already have-TPR and PPF2, for example. However, equally there is a perception that there is an attempt to try to treat pension funds in the same way as insurance companies, when obviously it is a whole different structure. You have commented there on looking at the individual states, and in the Chairman’s question earlier there was a comment on the EC looking at things on an individual basis. What kind of reassurance can you give that the EC will look at and take into account what is going on in particular member states such as the UK, where there is a strong view that this simply is not a requirement that is needed?

Karel Van Hulle: Let me first of all say that no decision has been made by the Commission to propose an extension of Solvency II like that to pension funds. There is no decision to apply that system-the regime that would apply for insurance undertakings, which is still not finally regulated-to pension funds. What guarantees can we offer? The first thing that the Commission did was to ask the supervisors-EIOPA, the European Insurance and Occupational Pensions Authority, based in Frankfurt, which also combines the pension supervisors-to provide advice to the Commission on how to deal with this diversity that exists between the member states. We have pension funds, for example in the Netherlands, that bear their own liabilities; they carry their liabilities on their balance sheets. They are ultimately responsible for paying out to the members of the pension fund. That is different from the situation in the UK, where you have sponsoring employer support.

EIOPA has advised the Commission to examine this concept of a holistic balance sheet. They say, "Let us try to compare these Dutch pension funds, for instance, with the UK pension funds," and in the UK you would then have to consider the sponsor covenant and the Pension Protection Fund guarantees, which in a holistic balance sheet could qualify as assets and thereby reduce the liabilities and therefore reduce the capital charges. That is an idea that EIOPA has put forward that would allow us to better compare occupational pension funds across member states, which today, by the way, is very difficult, because we do not have harmonised rules on financial reporting on pension funds. To take the pension funds’ financial statements today and to read them across is very difficult. EIOPA’s idea is interesting, and we are looking at that, and it is obvious that, if we are going to make a proposal, we will test, and that is what we did for the insurance industry. We went through five quantitative impact studies. We are now thinking, on the basis of EIOPA’s advice, about what sort of elements we should put out to test, which is a challenge, because, as I said, the comparability of the data is very difficult.

Q84 Brandon Lewis: With that in mind, therefore, as you said, one size fits all would not work across member states.

Karel Van Hulle: It is not possible.

Q85 Brandon Lewis: Exactly. With people’s fear that, for example, in the UK, as I said, we already have protection in the way the system works that does not require Solvency II and that kind of need to increase capital for the pension schemes, are you saying therefore that if that was found to be the case, and the view here was backed up, that simply would not happen, and there would be a system that treats different member states according to their system differently, in order to suit the pension systems that they have and not ruin their own pension market?

Karel Van Hulle: That is exactly right. That is what we call the economic risk-based approach. We have to see where the risks are. What are the true liabilities? On your point about comparing this with insurance undertakings, when we were discussing this with stakeholders we realised that there is a lot of confusion about an insurance contract compared with a pension promise. A pension promise is not a hard promise, because it results from a contract between the employer and his employees. To the extent parties can change that, I would argue that is very different from an insurance contract, where you sign a contract for X number of years. Of course, that will have consequences in terms of capital buffers on the way you treat it ultimately from a solvency perspective.

Q86 Karen Bradley: We had an evidence session on this topic a few weeks ago with stakeholders from the UK pension industry, and by that I mean that social partners such as the CBI and TUC were represented-it was not just the pension industry. They said that the Solvency II changes represent, and I quote, "the single biggest threat to UK defined benefit schemes" and that the change would have "an immediate catastrophic impact on the stability of European financial markets". How would you respond to those comments?

Karel Van Hulle: Let me first of all say that the problem with defined benefit schemes has nothing to do with Solvency II. The problem with defined benefit schemes results from the fact that we have longevity-people live longer-and that the return on investments is lower than it used to be. This means that, from a financial perspective, to guarantee a defined benefit today costs more than it used to in the past. That is the reason why we have seen-not only in the UK, by the way, but also in other member states-people move away from defined benefits. When I say that people are moving away, that is an agreement between the employer and his employees, and so they close certain schemes. That is a market-driven event.

Will the introduction of Solvency II to pension funds be so dramatic for the sector, and for defined benefits in particular? Again, we are not aiming at treating pension funds exactly the same as insurance companies. We have to find out what the similarities and the differences are. If there are similar products-and I take as the best example defined contribution schemes-there is a lot of comparability between a defined contribution scheme and a unit linked business in insurance, and there is no reason why you should treat these differently. However, to the extent that your pension promises, as I said, something that the parties can change, to the extent that you have a sponsor covenant or a pension protection scheme, you can read these things differently from what would apply normally in an insurance undertaking, which is a private business that stands in for its own liabilities. I would not agree, therefore, with that statement, which I think is exaggerated. Again, the numbers that I see quoted are not based on any specific proposal.

Q87 Karen Bradley: We are talking about the CBI, an employers’ organisation, and the TUC, an employees’ organisation, who are at completely different ends of the spectrum in terms of the groups they are representing. The degree of consensus in the evidence session we had was phenomenal, and I have never seen such consensus in any panel of witnesses at an evidence session. Why are they thinking in this way? Why do they have this view?

Karel Van Hulle: I believe that we saw a similar situation when we organised a public hearing in Brussels on 1 March, where the employer and employee sides were also very much in consensus on this issue. I think first of all there is fear. People are afraid for their pensions because of the situation today, the financial crisis, the uncertainties we have. It is therefore normal that people are afraid, and when you are afraid you say, "We don’t want to change." I believe what is important today-and this is also a lesson we got out of the public hearing in Brussels-is to go and look at the facts. We need to know and calculate what the consequences are of certain hypotheses that we would like to test. That is the first thing that we can do. Once we know the facts and the numbers, then we can hold a clear debate, because for the moment, as I said, people put hypotheses on the market that have not been proposed or tested objectively.

Q88 Karen Bradley: What information do you therefore feel is lacking in the UK pension system that you would need in order to say, "Actually, the UK pension system works very well-we don’t need to touch it"?

Karel Van Hulle: I think that as far as the UK is concerned in this debate, what would be very interesting for us, and we have contacts with the National Association of Pension Funds and The Pensions Regulator to do that, is to apply this holistic balance sheet, which is an EIOPA idea-the Commission did not come forward with that. Let’s test that. Let’s calculate that in practice, and then compare the UK with the Netherlands and with Germany, based on the same comparable data, and then we will know much more. However, for the moment that has not been done, and I think that is the first step to take.

Q89 Karen Bradley: Are you getting similar concerns raised in other member states?

Karel Van Hulle: We do have similar concerns, but possibly for other reasons. If you take the Netherlands, for example, they introduced a risk-based solvency regime for their pension funds a number of years ago. In the midst of the financial crisis they saw that of course the hypotheses that they had tested in the past were no longer possible, because the returns were not as high and the liabilities had increased. So they decided to lower the promises that were given to the employees.

In the Netherlands, therefore, the fear is that if we are starting this debate at the European level, that could influence their regime, which they introduced a number of years ago. However, again, in the Netherlands, the same message is being passed that they should participate in this exercise, this impact study, and the pension funds and the Government in the Netherlands are very well disposed to help us in this respect.

Q90 Andrew Bingham: You have made the point that the Netherlands have taken action. In this country we have the Pension Protection Fund, and various other things all around defined benefits. These two nations take up 85% of defined benefit schemes across the EU, so the two countries largely affected by this have taken action within their own states, yet you still feel that you should press ahead with this Solvency II.

Karel Van Hulle: Again, why are we aiming at this reform? The reason why we are doing it is, particularly on the solvency side, due to the fact that the present pension funds Directive, the IORP3 Directive, refers to occupational pension funds that apply defined benefit schemes that guarantee promises, referring to Solvency I, which is a system that applies today for life assurance companies. Solvency I will be abolished by Solvency II once it enters into effect. The question then is, why would one keep the guarantees for pension funds, guarantees that are considered not to be sufficient-Solvency I-and therefore we are changing to Solvency II? Why would you want to keep those guarantees for the members of pension funds while you give a better protection to policyholders? That is the question. In order to answer that question, we have to see, if we move away from Solvency I for pension funds, the system that exists today-

Chair: Forgive me, we need to go and vote. We will be back as soon as humanly possible.

Sitting suspended for a Division in the House.

On resuming-

Q91 Chair: Can we resume the meeting, please? Thank you very much and apologies for that. It is one of those things. There are still a number of key issues that I want to get through, and I know that time is of the essence.

I shall just ask one supplementary, following the direction of the questions that my colleagues have been asking. I am sure that one of my other colleagues, Glenda Jackson, will also have a question on this. The anxiety around Solvency II is obviously very clear to you, not just from the sector in the UK but across the board-from the perspectives of both employers and employees. I would like to ask one supplementary on the back of the answers you have already given. Have you any idea of an ETA, a timetable, for when you think you will be in a position to put forward these proposals? A lot of people in the UK pensions industry, employers and trade unions are obviously very anxious.

Karel Van Hulle: From the consultations with EIOPA, the public hearing and further conversations we have had with stakeholders, the Commission is very conscious that this is a topic that is technically difficult. When I say technically difficult, when you look at a holistic balance sheet, which is a new idea-even actuaries have to learn how it works-it is not something that you just take out of the books. It is therefore both technically difficult and also very sensitive politically. I come back to what I said earlier: people are anxious because it is about their pensions, and they want to know and do not want to see risk. That is why the Commission wants to prepare very carefully.

We have not yet made our mind up on the technical specifications that we will give to EIOPA to do the first test. You can imagine that it is very important to develop these technical specifications, and we also want to consult about that. We do not want to be seen as people who do these things without proper consultation. We are, therefore, still working on that, and once we have done that, we will then give these technical specifications to EIOPA, after consultation on that, and then EIOPA can carry out a first field study for a number of member states that have already said that they are prepared to participate. That takes time, and we are working on that. It is on our work programme for this year. We will see how far we go and how far we get in the development of these technical specifications.

Q92 Chair: Thank you for that-I appreciate it. If I can just push: do you have any idea at all of an anticipated time for the first stage-is it one month, 12 months, 18 months-to get the model, so to speak, to EIOPA, so that they can do the modelling?

Karel Van Hulle: As I say, it is very difficult, because it is technically not evident. We are carrying out consultations, and we have to reflect properly on that, so at this stage it is difficult for me to give a specific date for that.

Chair: Yes, I realise.

Q93 Harriett Baldwin: The United Kingdom, broadly speaking, does not follow the insurance-based approach that many other European countries follow, and the National Association of Pension Funds and the Minister have all expressed a view that this could be the death knell for the defined benefit schemes that we have in this country. If the uncertainty around how Solvency II might apply to pension funds continues, is it possible that one result of this consultation might be that you could rule out this applying to the United Kingdom?

Karel Van Hulle: The first thing that needs to be done, together with the National Association of Pension Funds and The Pension Regulator, is to see how a system based on a holistic balance sheet could work for the UK. I cannot give you an answer as to whether it will or not, because I have not done it yet. We need to find technical ways of calculating, for instance, sponsor covenants or the pension guarantee fund. What does that mean in terms of a solvency regime? That needs to be developed. I am sure I can count on The Pension Regulator and the National Association of Pension Funds to co-operate on that. Only after we have carried that out will we be able to make a comfortable statement, as you said.

However, the objective is, of course, that we establish a solvency regime for the whole of the European Union that brings out more comparability, looking at the economic substance, and taking account of the difference between a pension promise and an insurance contract. In that sense I can already tell you, and my Commissioner has said it on several occasions, that a read-across of Solvency II, which is designed for the insurance industry, will not apply to pension funds. That is the reason why, when we made our proposal for Solvency II in 2007, the Commission decided to exclude the pension funds from the scope of application of Solvency II, which was not the view of several member states, who were in agreement with that. Also, in the European Parliament, the Parliament asked the Commission to make it our job also to look at where we are now with Solvency I for the pension funds, and how it looks now that we have gone through the Solvency II exercise.

Harriett Baldwin: Thank you. I will ask a lot of questions about the holistic balance sheet in a moment, but now I will hand back to the Chair.

Q94 Brandon Lewis: Listening to your answer there brings me back to what I asked at the beginning. I am not sure we have had a direct answer to it. I will try again. We made the point that we have heard all this evidence from UK organisations that are normally on different sides of the argument-Government officials, the TUC, business and industry; whoever it happens to be on either the employers or employees side-all saying that this is the wrong thing for this country. Surely you should be able to say or agree that, if that is proven correct and if they are able to argue that case properly, this would not apply in this country. You are not suggesting that, if that were the case, the EC would want to go ahead with something that would damage the UK pension industry to that degree-or are you saying that? At the moment you are avoiding answering that question at all.

Karel Van Hulle: I apologise if I did not answer that question. I intended to answer it. It is for the moment not possible to say that what we intend will damage the UK pension regime, because we have not made a proposal, we are doing calculations, hypotheses, and we are trying to work out technical specifications. Once we have done that we will know more about what this looks like in terms of the UK system. That applies equally to Germany, the Netherlands, to Belgium, or to other member states.

Q95 Brandon Lewis: I will try again. Are you saying you are sure you would not end up putting forward a scheme that would damage the UK pensions industry?

Karel Van Hulle: I would be surprised, reading these statements about this 600 billion of additional capital, if that materialised.

Q96 Brandon Lewis: I understand that, but that is not what I am asking you. It is a pretty simple yes or no. Are you able to say that you will ensure there is not something put in place that would damage the UK pensions industry?

Karel Van Hulle: The objective of this reform is not to damage the pensions industry. On the contrary, it is there to make sure that occupational pension funds can thrive, because the Commission believes-and this is what my colleague also said-that occupational pension funds are an essential feature of pension provision throughout the European Union. We need options, and therefore the objective can never be to have a system that is to the detriment of the pension funds.

Q97 Brandon Lewis: In an individual member state.

Karel Van Hulle: In an individual member state.

Q98 Glenda Jackson: You are reviewing all the pension systems in all the member states. How long is this process going to take? Do you know?

Karel Van Hulle: We are not reviewing the pension systems. We are trying to develop technical specifications that allow us to introduce a risk-based solvency regime in the pension fund sector, which does not exist today.

Q99 Glenda Jackson: However, you do require the information for the existing schemes in the individual member states, and I am wondering how long the process of gathering that information will take.

Karel Van Hulle: Some of that information has already been gathered by EIOPA, and they developed their advice on the basis of that information. However, it is true to say that we still need more information.

Chair: Forgive me Glenda-I shall interrupt for a moment. That is a very good point. I was asking earlier if Karel was able to tell us exactly when the next stage would be before he was able to pass over to EIOPA. He felt that he was not able to give a precise answer, but we covered that quite comprehensively, important as it is.

Q100 Karen Bradley: From the meeting that we held a few weeks ago, I think there is a great deal of unrest and uncertainty. People want reassurance. Once you have been through your process of reviewing all the pension schemes, looking at what happens across Europe and coming up with a holistic balance sheet, if at that point, when the Commission puts forward its proposals, the UK still says, "This will be absolutely catastrophic to both our pension schemes, our pension industry, our pensioners and the market," would you still press ahead and insist that the UK implement it?

Karel Van Hulle: The Commission will do its work very thoroughly, and before we make a proposal we will make sure that it makes sense and that it is a workable system, not only for the UK but also for other member states. That is exactly what we are trying to do. It is not the intention of this reform to aim at any specific member state or at any particular industry. The objective is to have a system that can replace Solvency 1 and that is also workable for pension funds.

Karen Bradley: Thank you.

Q101 Andrew Bingham: Therefore if it is not workable in the UK, you would not impose it on us over here.

Karel Van Hulle: If it is not workable, the Commission would have to reflect on whether it should make this proposal.

Q102 Andrew Bingham: Does "reflect" mean yes or no?

Karel Van Hulle: It is ultimately for the Commission to take that decision, but if the Commission sees that this is an area where what is presently on the table is not workable, I cannot see that we would press on with that subject.

Chair: Good. Thank you. You can appreciate why we focus so hard on the whole issue of Solvency II. I am sure you understand that.

Q103 Glenda Jackson: It is really a follow-on from the last question. Commissioner Barnier has said that "a real single market for occupational pensions means lower costs for employers" and "more choice and security for workers". Where is the evidence that a single market in pensions is a) achievable, and b) that it would be beneficial for the United Kingdom?

Karel Van Hulle: The main objective of the pension funds Directive was to open up the market in Europe. Before we had this Directive, it was not possible, in most member states, for pension funds to invest in anything other than their own country’s state bonds. It was not possible previously for a UK undertakings to operate with a pension fund in another member state. This was, therefore, a main objective of this Directive. What we have seen is that only 87 cross-border schemes have been developed since then. On the basis of that low number, people have argued that the cross-border element is not really relevant. We would disagree with that, because we have to see why we only have 87 cross-border schemes.

We have only 87 cross-border schemes because there are a number of uncertainties and a certain lack of clarity in the present Directive. For instance, if a UK undertaking sends an employee to work in Belgium, let’s say, the question is: can this person still belong to the pension fund of which he was a member in the UK, or is that to be considered as a cross-border operation? If it were to be considered as a cross-border operation, the liability would have to be fully funded, and that would make this very complicated. Therefore, we have already argued that cross-border business does not necessarily mean that expats have to leave their adherence to their national pension funds because they work in another member state. This is an area where I believe there is a need for clarity. Cross-border operations can also further help UK citizens if pension funds become more efficient by combining their operations. That element of the single market is something that we believe has not been sufficiently tested. More efficiency in running the pension funds should also ultimately result in lower costs for pensions.

Q104 Glenda Jackson: With respect, the Commissioner made a fairly categoric statement. Given that you have already told us that our pension system is different, much more different, from pension schemes throughout the rest of the European Union, where is your evidence that a single market would be of benefit not only to the European Union but to the UK?

Karel Van Hulle: Similar questions were put to us when we were talking about telephone fees, bank account charges and so on.

Q105 Glenda Jackson: They are the details that have to do with specific schemes that are in existence at the moment. You raised the issue of a British employer sending someone to work in Belgium. That individual would probably be on a very high salary, and that would not apply to someone who was just a day worker. The issue of the gap between people who have secure pensions and people who do not have pensions at all is large, not only in this country but across the whole of the European Union. My question to you is still this: where is the evidence that the proposed changes would be of benefit to employers and employees, and to the European Union and the UK pensions industry? You do not seem to have any evidence.

Karel Van Hulle: We believe that if we were to remove some of the existing barriers, we would create potential, and that potential will make people use these benefits in order to develop a better system and to use the single market.

Q106 Glenda Jackson: Your removal of barriers, however-and forgive me if I am making a too-hasty conclusion here-is, as we have heard, what both sides of the social equation here, the TUC and the CBI, regard as a basic fundamental threat that will destroy our pensions industry and the market. Apart from hope, where is the evidence?

Karel Van Hulle: Well, we have to create a potential first.

Q107 Glenda Jackson: How do you do that, though, if there is not uniformity of the model?

Karel Van Hulle: We are not pleading in favour of a uniformity of model, because the systems are different. We have to make sure that the contradiction between the models is not such that they are a barrier to cross-border operations.

Q108 Glenda Jackson: That does not constitute evidence, with all due respect, as far as I am concerned. To repeat what I and others have already said, UK business, pensions and employee organisations have already pointed out, as you have, that there are only 84 cross-border schemes in the EU, and that they are mostly between the UK and Ireland, where there are similar pension and tax regimes. They believe that there is no real demand from employers or employees for increased cross-border provision, and that requiring it would prove extremely costly for all employers, while benefiting only a minority of employees. How do you respond to that view?

Karel Van Hulle: We believe that if we can reduce some of the impediments that apparently make it difficult to have cross-border schemes, we might have more situations where pension funds would outsource some of their activities, and this could also be beneficial for the UK, which has a lot of expertise in terms of financial services. If we reduce these impediments, then pension funds would be more likely to seek that opportunity to work more efficiently, to combine their resources and to outsource some of their activities in a way that could render those activities more efficient.

Q109 Glenda Jackson: Would you regard that as being fair competition? I can think of large companies that could do that. I could think of smaller companies, which provide very good services, that would not be able to. Is that really fair competition?

Karel Van Hulle: I think that in today’s environment it is very important to be as efficient as possible in financial markets, and it is obvious that smaller pension funds will outsource some of their activities to insurance companies, and that is already happening. They will also benefit from that opportunity.

Q110 Glenda Jackson: You are, then, actively addressing the issue of fair competition in this whole area.

Karel Van Hulle: Definitely yes.

Q111 Glenda Jackson: Thank you. You have touched on the issue of greater efficiency; presumably they would save money, and there would be greater transparency. If this comes about, what are the other benefits of such cross-border schemes, as far as you can see at the moment?

Karel Van Hulle: I think that their comparability will help also the efficiency in the markets. We have a system today whereby pension funds operate pretty much in a national environment. We have no comparability in the data between the pension funds. If we manage to improve that situation, it will also help pension funds to learn from each other’s experience, to compare themselves with each other, and to better see whether they are doing a good job at delivering their promises to their members.

Q112 Glenda Jackson: However, despite what we have been saying about our pensions industry, which I endorse, we have seen within our own pensions industry that they were in many instances rather slow in many areas to go out and attempt to increase their markets. Changes have been brought about in this country where they have stepped up to the plate in many ways. Given the disparity between pension schemes across the European Union, how are you going to ensure that it is a practical effect, and not simply people creaming the market, where the costs for both employers and the security for employees is maintained and improved?

Karel Van Hulle: Again, that is linked to the system of supervision. It is obvious that we set the rules but then we need proper supervision, and that, of course, is part of the new framework, where the supervisor looks at how the system works. For the moment it is very difficult for EIOPA to compare the situation between different member states, because the systems are very different and the data are not comparable. We hope that if we have more commonality in how we calculate pension liabilities across the board, how we take care of things like sponsor covenants and the like, it will be also easier for supervisors to operate the market in a way that is ultimately to the benefit of the members of the pension funds.

Q113 Glenda Jackson: Are they the supervisors in the individual member states, or is it a European Union supervision?

Karel Van Hulle: No, it is EIOPA, which is an agency that combines the national supervisors and, of course, has the important task of seeing to it that the supervision across the board in the European Union is done in a way that is equivalent and comparable from member state to member state. Today, that is very difficult, particularly in the area of pension funds.

Q114 Andrew Bingham: I will try to be quick, as I think we want also to talk about this holistic balance sheet before we finish. The portability issue has been bandied around for 20 years and it has never got anywhere, basically due to the different pension tax regimes of the different member states. Do you really think it is realistic to try to resurrect it now, or indeed, given the present circumstances in the world, do you even think that it is desirable, or do you think we are just wasting our time?

Ralf Jacob: Portability is an issue for me, if you will allow me. You are right: portability has been discussed for slightly over 20 years, but I think you are not completely right when you say that nothing has been achieved. A few things have been achieved under the UK presidencies, by the way. There is one Directive from 1998 which requires pension schemes to treat people who move across borders in an equal way to people who move within a country. That is not something that has changed the world radically, because in most cases there was no such discrimination, but it was a first guarantee to make sure that cross-border mobility cannot be penalised as far as occupational pension entitlements are concerned.

Then under the 2005 UK Presidency the Commission made another proposal that focused on the acquisition of pension rights-basically trying to shorten vesting periods-tried to improve the preservation of dormant pension rights, and tried to give people the right to transfer their pension rights into another scheme. The negotiations in Council proved very difficult, and it was decided in 2007 to drop the transferability aspect and to focus, in an amended proposal for a Directive, on the acquisition and the preservation of occupational pension rights. This Directive is still on the table of the Council, and we now have two options. One is to try to resume negotiations on the basis of that Directive, but taking into account the different legal context since the coming into force of the Lisbon treaty. The other option would be to table a new proposal.

The Green Paper consultation that we carried out showed that what is in the 2007 proposal is more or less what the pensions constituency expect. They do not want to go for a more ambitious approach, by including transferability again, for instance, in the scope of the proposal, and they did not propose that any other new policy issues be covered in the proposal for a Directive. Our feeling is, therefore, that we should try to resume negotiations, and we are starting to discuss with upcoming presidencies, in particular with the Cypriot Presidency, whether this can be put on the agenda of the Council.

Q115 Andrew Bingham: Is there any evidence that the current arrangements act as any block to free movement of labour?

Ralf Jacob: It is not just a question of whether this is an obstacle to the free movement of labour. It is also a question of whether people who move are penalised in an unacceptable way in terms of their pension entitlements. We would be very hard-pressed to come up with any evidence or estimates of how much more mobility we would get if the proposal for a Directive was adopted. Mobility is relatively low, and personally I would not expect mobility to explode as a result of the adoption of the Portability Directive. However, there is a fundamental issue of ensuring that people who make use of the right of free movement are not penalised with regard to their pension entitlement. We need to complement what we have achieved for statutory social security schemes with an instrument that covers occupational pension schemes, especially if we say at the European level that occupational pension schemes have to play a greater role in providing adequate pensions in the future.

Q116 Andrew Bingham: Picking up from what Glenda said earlier and what you have just said yourself, there does not seem to be a huge amount of evidence to back this up, does there? In terms of the objectives, they are, to quote, "to ensure transparency and good governance". What sort of governance problems have you got in mind-are they something you have identified? Then moving on from that, have you seen any governance in UK schemes that has given you concern? There are therefore two parts to the question.

Ralf Jacob: Governance issues, if I remember correctly, were raised in relation to third pillar schemes, where we aim at improving the information and protection standards through voluntary codes. This would mean that there would not be any serious interference with national practices in this particular area. As far as occupational pension schemes are concerned, we want to work together with the Pensions Forum to develop a code of good conduct to improve the functioning of occupational schemes.

I could not present you with a detailed analysis of what might be wrong with UK second and third pillar pension schemes. I would also say that it is not necessarily the role of the Commission to make in-depth assessments of such schemes, which remain primarily the responsibility of the member states. However, what we wanted to do is to give member states, in particular those that are less advanced in terms of developing such schemes, an opportunity to learn from the experiences of other countries, and the experience of the UK will be extremely valuable in that context.

Andrew Bingham: I am quite keen that Harriett gets in, because this holistic balance sheet that we keep hearing about deserves further probing.

Chair: You mentioned it a few times at the beginning.

Q117 Harriett Baldwin: We wanted to ask a little bit more about what the Commission means by the holistic balance sheet. You obviously see that as a mechanism to compare and contrast how the pension system works across 27 member states. Obviously on the asset side of the equation you will value the assets that are held; you want to try to value in some way an employer’s covenant; you want to try to value the protection provided by schemes like the PPF in the UK. Those are hard things to value. Possibly not impossible things to value, but certainly hard to value. On the liability side, you obviously need to show what the schemes’ liabilities are, and you say that you want to use the risk-free discount rate to value those. I am just curious to know: what is the risk-free discount rate in the eurozone at the moment? Tell me what the risk-free discount rate is in Greece?

Karel Van Hulle: I can assure you that a decision on the use of which discount rate to use is a very important one, and it has not been taken.

Q118 Harriett Baldwin: Is it the German five-year then?

Karel Van Hulle: I can tell you that we will have to do a lot of market research before we decide that, because we are talking about very long-term liabilities, and therefore the exact percentage of the discount rate is very important.

Q119 Harriett Baldwin: Some would argue that there are countries in the euro at the moment that are not solvent, and you are trying to use their discount rate to value the pension promises that they have made in those countries. Will the end result of this holistic balance sheet be that you have a gaping hole in the funding for European pension liabilities? It is going to be a very painful-looking balance sheet, isn’t it?

Karel Van Hulle: Again, we have not decided what discount rate we will use. That is very important, because there are different possibilities. If you change the system, there is also the question, whichever system you introduce, of what you do with the back book of the pension liabilities of the past. That is something that has also created some anxiety, particularly in the UK. You will have to have a transitional regime, which probably would have to go on for many years. I am talking not about 5 years but about 10 or 20, maybe even 30 years, because you have this very important back book, and if you have a new system, this can only apply to the new liabilities, but you cannot change the old liabilities overnight. That is therefore an important element that we will consider in developing this holistic balance sheet.

Q120 Harriett Baldwin: I submit to you that there is no 30-year risk-free rate for valuing the Spanish pension balance sheet, and that a better term might be "hole-istic" balance sheet, to do a British play on words, because it will just show that the system in Europe is really full of holes. Not only are there going to be many pension promises that are not valuable and not affordable, but people are not even prepared to lend to governments for this length of time in Europe at the moment.

Karel Van Hulle: However, we cannot escape the duty to calculate the liabilities. In order to create a system that is comparable we need to agree on which discount rate to use. If you look at the present situation, which is disharmonised, you will see that sometimes pension funds will use a discount rate for the calculation of their liabilities that is very different from the market rate. The question is, in terms of the protection of the members of the pension fund, is that the right approach? Is that not an understatement of the liability, and ultimately, if you understate liabilities, what is then the consequence in the long term, particularly for the new members? That is an issue that was raised at the public hearing, which is the inter-generational issue. We have a system today that might work well for a while, but will the new employees be able to have their pensions paid in the long term? That is why the definition of that discount rate is very important, and we need to agree on that.

Q121 Harriett Baldwin: I think, however, that we can also agree, even without doing the work, that it is going to show a huge hole.

Karel Van Hulle: It will show a huge hole if you apply it backwards to the existing pot of liabilities. That is why I say you need a transitional regime, and that is something that everybody agrees on. These are such long periods: the build-up phase and the pay-out phase in pensions can run up to 60-70 years, so in that sense you really need to find a solution for how to deal with the back book. If we do that, I think the debate will be very different.

Q122 Chair: I would agree, but this is a slightly existential debate. Can I go back to timing, which I was asking about on a different subject earlier? Are you able to give any estimated time line of when it will be clear to the different EC countries exactly what a) the discount rate is and b) what makes up a holistic balance sheet? Do you have any idea of time lines?

Karel Van Hulle: At this stage I cannot give you a specific time line, because as I said, we are now thinking about the technical specifications for the first quantitative impact study. We have to decide the discount rate for it. We have to decide what should be tested, and depending on the criteria you use, of course you get a different result. That is why we need to work through that very carefully, which we are working on, and then we need to consult on it. Then we see what the results of the consultations are. What are people going to say about it? That is the uncertainty about the timing.

Q123 Harriett Baldwin: However, to go into the timing, if you cannot agree which discount rate to use-and I submit that there is no appropriate risk-free rate to value a lot of these liabilities-how can you complete an accurate impact assessment? We certainly have had witnesses in our inquiry who believe that the timetable for the impact assessment is really very short, and that the proposed changes will affect millions of people’s pensions and could potentially have very significant adverse macroeconomic consequences. How then can the impact assessment be done, given the timetable and the lack of certainty about the holistic balance sheet?

Karel Van Hulle: What is important is that we do the preparatory work well-that is the first thing-and the timetable will follow from that. However, we have to do our preparations well. The Commission will not come up with a proposal that is not well thought through, in the sense that we need to test, and perhaps we need to test two or three times-I do not know. We have to start the exercise-that is the first thing we have to do-and the timing will follow from that.

Q124 Harriett Baldwin: Again, to go back to my Chairman’s question, what I am hearing here is that the timetable you are working towards is going to be very difficult to be realistic in terms of the number of iterations that will have to be done for both the impact assessment and the quantitative impact survey. Given that it all stems from the holistic balance sheet approach and the challenges there are in terms of dealing with that, can we ask again about the timetable, and whether you think that the timetable for the whole reform is realistic? Given the question-marks that it raises for our whole defined benefit industry and the concerns that we have that this shadow of uncertainty about future regulation can be almost as damaging as the regulations themselves, can we get some sense from you in terms of the timetable, particularly with regard to the initial consultation and whether it might exempt the UK?

Q125 Chair: Under two years or over two years. I appreciate that it is hard, but we are trying to pin you down, even if it is just to say whether it is under two years. Can you give us any sense at all?

Karel Van Hulle: Are you asking me when the project will be finished?

Chair: No, the first stage.

Q126 Harriett Baldwin: You are currently in a consultation period. An acceptable outcome of the consultation-I do not know if I speak for the whole Committee but I sense that I do-would be to say that the UK, because it has a very different, non-insurance based regime for pension provision, would be possibly left out of these Solvency II regulations. When can we expect the response to the consultation, for example?

Karel Van Hulle: My answer to that would be the following. It is very important that all member states, particularly those that have an important pension fund sector, which is the UK, participate in this exercise. We have to learn from those member states how to do that, and the others are looking at you. At this stage, we sometimes see the reaction "We would rather not". What is now very important is that we start to work together to do the calculations and then to take the conclusions that follow from those calculations. That is the phase in which we are now, and we will do these consultations and will come out with these draft technical specifications as soon as is practicable. However, as you rightly said, it is a technically difficult subject, and that is why you must understand that the Commission does not want to jump into the water without testing the temperature. We need to know what we are going to propose; we will consult on that and then EIOPA will do the testing.

Chair: I am going to draw a line there because it is coming up to the time. I appreciate you both coming in; it has been very clear, and I am sure you both picked up how important these issues are to the UK. Before I finish with the final formality, I will share a line with you that we have all heard from really quite sensible groups of people-that is what has been for me very relevant to the whole concern around here, both from the employers’ and employees’ perspective. I have heard people use the line: "If the EC get this wrong with the proposals around Solvency II, it could be the final nail in the coffin of defined benefit schemes." I am sure that you will take that away with you; as I am sure you already know, it is a matter of profound concern to us. On that note, thank you very much for coming; I appreciate it and I hope that you catch your train.


[1] National Employment Savings Trust, part of the structure for the new automatic enrolment-workplace pension arrangements

[2] The Pensions Regulator and the Pensions Protection Fund

[3] Institutions for Occupational Retirement Provision

Prepared 27th July 2012