Radical changes to pensions landscape on the horizon

Reducing something to an acronym or set of initials can often disguise its power and potentially disruptive and destructive impact. TNT is one example and IORP II could well be another, as far as small pension schemes are concerned at least.

The European Union directive on the activities and supervision of institutions for occupational retirement provision or IORPs (IORP II), came into force in the EU on January 12th, 2017, and was due to be transposed into national law in Ireland by January 13th, 2019, but has been delayed because of Brexit and other factors.

No one could argue with the directive’s aims, which include enhancing pension scheme governance and improving outcomes for members. But the side-effects may be far reaching for those smaller schemes.

The transformational nature of the directive was acknowledged by the pensions regulator, Brendan Kennedy, in a recent statement. “Irish occupational pensions are about to undergo the most significant changes in at least a generation,” he said. “The purpose of these changes is to improve outcomes for members of Irish pension schemes. At present, there are well-run pension schemes, which achieve good member outcomes, and which will have little difficulty in adapting to the new obligations. However, there are too many schemes that are not run to the standard that members are entitled to expect. It should not be a matter of luck for a member how well run their scheme is. Furthermore, given the significant value of pensions savings that can be built up by retirement age, there is no justification for the standard of care for pensions savings being any less than it would be for any other type of savings.”

The directive provides for EU-wide pension scheme standards including an effective system of governance, covering areas such as fit and proper standards for trustees; the appointment of key function holders for risk management, actuarial and internal audit; written policies on risk management, internal audit, and, where relevant, actuarial and outsourced activities; and new standards relating to communications with members and potential members.

Those standards will place an increased compliance burden on schemes of all sizes. "The impact will be quite low for a certain profile of scheme," says Irish Life head of products Shane O'Farrell. "A lot of the larger occupational schemes have the size and resource to meet the new regulatory bar being set. For many smaller schemes the regulatory bar will be set so high that they won't be able to exist in their current form. Many of them will move into master trusts. We are still waiting to hear what schemes will be included but the indications are that all schemes will be covered."

Declan Maher, head of corporate pension and risk with Bank of Ireland Wealth Advice and Distribution, notes some of the implications of that higher bar. "The introduction of independent functions under IORP II such as risk management and internal audit will be significant," he says. "While some of these functions currently exist for large pension schemes, the roles may be carried out by the same persons, which could lead to conflicts of interest. Creating separate functions may therefore require investment and additional personnel, which would significantly increase costs and prove challenging, particularly for smaller schemes.

In addition, the requirement for audited annual accounts is currently required only for large schemes with more than 100 members, but post IORP II it will be an expected requirement for all schemes, leading to extra accounting and audit costs for those smaller schemes.”

Rationalisation and consolidation are inevitable outcomes, according to James Campbell, head of legal consulting and knowledge management with Mercer Ireland. "At the end of 2018, Ireland had approximately 160,000 employer-sponsored pension schemes. Each of these schemes, irrespective of its size, is likely to be subject to the full range of new regulatory requirements. The new requirements could be particularly challenging for smaller schemes. The Government has said that it does not intend to exempt smaller or one-member schemes from the scope of the new legislation. We anticipate there will be a period of extensive consolidation and rationalisation, with many employers perhaps opting to close their schemes and transition them to an alternative arrangement, such as a multi-employer master trust, where all compliance and management obligations would be fully outsourced."

One-member schemes

This is not necessarily a desirable outcome, says Joe Hanrahan of Brewin Dolphin. “I don’t think anyone is opposed to the quite laudable principles contained within the directive,” he says. “But to say that one-member schemes should be treated the same as a 500-member scheme seems to be disproportionate. The directive itself says its application should be proportionate. The Association of Pension Trustees of Ireland has said that one-member schemes should get some sort of derogation.”

The investment restrictions placed on schemes will also have a disproportionate impact on smaller schemes, he claims. “Under article 19, pension-scheme assets should be invested predominantly in regulated markets. That also strikes me as disproportionate. There has to be a place for other sorts of investment. A lot of people buy a property instead of investing in a pension. What’s wrong with having a property in a pension? Small self-administered pension schemes and executive pension schemes in particular will be affected. Part of it appears to be anti-consumer when the stated objective is to improve outcomes for investors. It may be appropriate for 500-member schemes, but you can’t say they are the same as one-member schemes.”

On the increased cost burden, Hanrahan believes it may have more far-reaching consequences than rationalisation. "A number of firms have made submissions to the Pensions Authority on the additional costs. How proportionate is €3,000 or €5,000 for an annual audit for a small scheme? That might mean them choosing not to set up a scheme at all."

The overall outcome is likely to be positive, however. “For current and future members of occupational pension schemes, the reforms should ultimately prove to be very positive,” says James Campbell. “The directive was part of the European Union’s overall response to the financial crisis at the end of the last decade, and the measures it introduces will build important protections and safeguards into pension-scheme management. The new governance, risk-management and internal-audit standards should, over time, result in improved benefit protection, which in theory should lead to improved benefit outcomes. We also anticipate there should be an improvement in the quality and frequency of pension-scheme information provided to members.”