THE ROLE OF THE SUPERVISORY AUTHORITY 2/4/2004

Introduction

Today I will be looking at the role of the supervisory authority and in particular the role that a supervisory authority or regulator can play in the sustainability of the entire pensions system. Much of what I have to say will relate to the Pensions Board which is the Irish regulator, however I will also refer to some of the other regulatory regimes such as in the UK and here in the Netherlands.

Obviously, with the advent of the EU Pensions Directive, regulation and supervision of pension schemes can no longer be solely a national issue. The pan-European issue is going to have to be considered at length by regulators and supervisors and will have a real impact on how they operate and the plans they make for the future. This is an issue I will also deal with. I will cover some of the impact we see it having in Ireland and also consider the possible wider impact.

Why

It is always good to start at the beginning, so I suppose the first question is why do we need a regulator? As regulators have become a permanent fixture in so many parts of modern life you could almost ask the question, why would you not have a regulator?

Regulation is necessary for two reasons. Firstly, regulation is the means by which unequal relationships between parties can be controlled. These inequalities can occur in the level of knowledge or power that one party possesses in relation to another.

The second reason is when the system being regulated is of such a fundamental nature to society that any failure in the system would undermine society in general. In order to provide stability and confidence a regulator is established to ensure that the system does not fail.

The pensions system falls into both of these categories. Firstly there is an unequal balance between the providers and participants in the system. By participants, I mean the ordinary citizens who happen to be members of pension schemes or are making provision for themselves. Individuals generally do not come armed with much, or indeed any, prior knowledge of how the system works. This is not surprising as traditionally pensions were something that were arranged by an employer. The individual spent his or her life working with an employer, retired when they reached a certain age and then got paid a pension which was based on their salary and was enough to help them enjoy retirement for the few years before they died. There was no need for the individual to have a detailed knowledge when the system was that simple.

Today it is no longer so simple. There are many complications that have emerged over the years. Individuals no longer spend all of their life working with the one employer. The one age that everyone retires at is disappearing. They no longer always get a pension based on their salary. What they do get may no longer be enough to enjoy retirement and they do not die after a few years. So people need to be better informed. That is difficult in an environment riddled with different systems, different tax implications, a labyrinth of charging structures and commissions, not to mention a plethora of advisers and consultants. Part of the goal of any regulatory regime is to ensure that this whole confusion is made simpler for individuals. It allows them to feel more comfortable about their own pension and to be better informed about what they, as individuals, require to ensure that they can enjoy and not endure their retirement.

The second reason is to provide a level of confidence in the system. Pension provision is a big business that ties up a lot of financial assets. Also tied up with these assets are individuals’ futures. Modern society demands that someone is looking after these. Regulators and Supervisors are often referred to in the media as watchdogs, guardians or even as police. That is how society likes to believe that the system is safe. An associated aspect is the fact that a lot of tax reliefs are allowed through the pension system. Governments are understandably concerned that these are effectively regulated and that there is no scope for abuse of the tax system.

Many regulators were established as a direct result of a failing in the system. The Irish regulator, The Pensions Board was established in the early 1990s as a result of the failure of some high profile schemes in the 1980s to provide benefits following the collapse of the employer.

OPRA was also established in the UK following the Maxwell scandal.

While there is never any certainty that a regulator could have prevented these events or could do so in the future, their existence is society’s way of trying to ensure that events like this do not recur and of fostering public confidence in the system.

Wider Role

While regulators do tend to have primarily a policing role they can often have a wider role in the sustainability of the system. The Irish system is a good example of this. I will give you some background to the development of the Irish regulatory system and the Pensions Board.

Firstly I will look at the legislation that is in place. Irish occupational schemes are generally trust based and are subject to trust law. Trust law tends to be case based rather than legislation based and has evolved over time. The basic tenet of trust law, which is particularly relevant to pension schemes, is the “prudent man” principle.

The trustees of a scheme are charged with duties and responsibilities in relation to the beneficiaries of the scheme. The basic principle is that they always act in the best interests of the beneficiaries. The “prudent man” principle requires that they take the same care as ordinary prudent persons would take in managing the affairs of other people for whom they feel morally bound to provide. The full definition is that “a fiduciary must discharge his or her duties with the care, skill, prudence and diligence that a prudent person acting in a like capacity would use in the conduct of an enterprise of like character and aims.”

Whether or not trustees adhere to their duties as established in trust law is a matter for the Courts. The Pensions Act, 1990 establishes in primary legislation certain duties and responsibilities of trustees. The Act, which also established the Pensions Board, was the first pensions related legislation passed in Ireland. There have been 2 major amendment Acts in 1996 and 2002.

The Act establishes rights of members (for example, rights on leaving service) and duties on trustees (for example requirements to produce scheme accounts). It is a substantial body of legislation and provides the legal framework within which schemes must operate.

The Act also established a regulator which until 1990 had not existed. As I have already mentioned, the need for a regulator was established due to the failure of some schemes in the 1980s. So, what are the principles of regulation to which we operate?

The first is to maintain a balance between necessary regulation and unnecessary cost. I have already explained why regulation is necessary. However the cost of regulation should be proportionate and should therefore not jeopardise the sustainability of the system.

In particular, in Ireland and in the UK, regulation needs to have regard to the voluntary nature of the plans. There is no gain in having a superb, watertight regulatory system if the cost of complying with this is such that the system itself will be made financially unsustainable.

Our system of regulation has regard to the trust based system and the role of trustees. It is the trustees who have the primary responsibility to ensure compliance with the legislation in force. This allows us to have a relatively light regulatory regime with appropriate checks and balances to ensure that trustees are complying with their duties. This contrasts for example with the approach adopted by the Dutch regulator the PVK which has a much greater detailed level of involvement in the way individual schemes or plans are operated. This does not necessarily reflect any great ideological difference between how the different regulatory regimes should operate. Rather the different approaches reflect how the different systems work. For example Ireland and the UK each have over 100,000 schemes. It would be impossible to have a detailed level of involvement in so many schemes. In contrast, the Netherlands has a small number of very large schemes where detailed involvement is possible.

We also place a lot of emphasis on disclosure of information to the members of arrangements. We believe that this encourages members to have a greater level of awareness of the workings of their schemes. In some cases as a result of the disclosure or indeed lack of disclosure those members can alert the regulator to problems with an arrangement.

Proper disclosure and regulation can help to facilitate choice. In particular where all providers work to the same standards there is a more level playing field between providers. It also promotes pension security which is one of the primary functions of the Pensions Board.

We view ourselves as a pro-active regulator. We conduct audits of schemes in order to check their compliance with the legislative requirements. We also frequently meet with the scheme providers in order to feed back to them any issues we encounter and to ensure that they have adequate compliance functions, although we do not have any formal regulatory role with those providers.

We also have reporting or “whistleblowing” requirements in our legislation. A report to us as regulator is required by any of the parties involved in a scheme where there is fraud or material misappropriation of the assets of a scheme. A report must be made where this is about to occur, is occurring or has occurred. This allows us to concentrate on cases that are likely to impact on members’ entitlements.

The aim of the Board as a regulator is to secure compliance without recourse to legal action unless necessary. Our legislation does grant quite wide-ranging legal powers to the Board, for example removal of trustees and the power to prosecute trustees and/or employers. Quite often the mere existence of those powers can ensure that an issue is rectified without the need to use the powers. We are however prepared to take prosecutions and have recently prosecuted the trustees of two schemes and have some further cases due soon.

Functions

The functions of the Pensions Board are set out in the legislation. They include the following:

. to monitor and supervise the operation of the Act and pensions development generally,

. to issue guidelines on the duties and responsibilities of pension trustees and codes of practice on specific aspects of their duties,

. to encourage the provision of appropriate training for trustees and to advise the Minister on standards for trustees,

. and to advise the Minister on the operation of the Act and all pensions matters.

As you can see, these are very wide-ranging functions and give the Board a number of different roles which are broader than a pure regulatory role.

Our Board is comprised of consumer representatives, pensioner representatives, representatives of government departments and of the main participants in the pensions industry, for example pensions lawyers and accountants, pension schemes and providers. The Board works on a consensus basis and for that reason the area of pensions has not been a political football in Ireland. Indeed the most recent substantial body of legislation, the Pensions Amendment Act 2002 received all party support when it went through our Parliament.

The Pensions Board also has a policy role which involves advising the Minister about pensions matters generally. This is a very broad role but, we believe, a crucially important one. The advice can be initiated by the Board or the Minister can request the Board to advise her on particular matters. We believe that the policy role is complementary to the regulatory role. They work well together and help to drive each other forward. As a regulator we feel the policy role is important as it allows us to have an input in the shape of regulation. As we have that input from an early stage it should ensure that we can pre-empt any issues that arise as a result of any new regulations. As a policy maker we can utilise the practical day to day experience gained in the regulation side.

We also have a guidance and training role. We provide a lot of publications, for example, information leaflets for scheme members on various aspects of schemes. We also accredit trustee training courses. We provide a legislation service which consists of consolidated versions of the Pensions Act and all the regulations. We provide a trustee handbook which outlines the responsibilities of trustees and provide guidance notes for trustees. We also answer general queries from the public and have a comprehensive website.

Our pensions development role involves us in the shaping of policy on a macro scale. In 1998 the Pensions Board published a report as part of the National Pensions Policy Initiative – Securing Retirement Income. This report has been the key driver of the development of pensions policy in Ireland over the last 5 to 6 years.

One of the key outcomes of that report was the identification of the need to encourage pension take-up in Ireland. It is estimated that 50% of the workforce have pension provision. It is a stated aim of the report and of the government that this is increased to 70% of the workforce. Various measures have been taken to try and achieve this aim. The most significant has been the introduction of a new pensions product, the Personal Retirement Savings Account. This is designed to be a flexible, portable and personal pensions product. All employers are obliged to make such products available to their employees where there is no alternative pensions provision so effectively we have mandatory employer access to private pension provision.

The Pensions Board is currently running a National Pensions Awareness campaign to try and increase individuals’ awareness of pensions and the need for pension provision.

It is sometimes suggested that the development role somehow conflicts with the regulatory role. As I have already said we find that the two are complementary and each naturally shapes the other.

As you may be aware the UK plans to introduce a new regulator this time next year which will replace Occupational Pensions Regulatory Authority (OPRA). One of the criticisms of OPRA has been that it was too rigid and slow to change or adapt when necessary. One of the reasons for this would seem to be that OPRA was removed from the development of policy and legislation. As a regulator it therefore had to enforce legislation that it had no role in shaping or input in drafting. It is interesting the “new kind of regulator” that is envisaged for the UK is much closer to the model we have in Ireland.

Funding

Returning to the theme of the role of the regulator in the sustainability of the system, I thought it might be particularly useful to examine the issue of funding of defined benefit schemes. This has been a big issue in most countries, particularly over the last two years due to the falls in the assets of schemes and the continuing increases in the liabilities. I am sure that everyone is acutely aware of the reasons for these and I will therefore concentrate on the impact and the different approaches being taken to deal with that impact. Obviously the real impact is that many schemes do not have sufficient assets to cover their liabilities at this point in time. Schemes and particularly sponsoring employers will argue that they do not necessarily need to have sufficient assets to cover their liabilities at this point in time as they do not have to pay for their liabilities at this point in time. Members, and indeed regulators, feel more comfortable if there are sufficient assets to cover their liabilities at this and indeed all points in time.

Irish Approach

The legislation in Ireland requires that every 3 ½ years a defined benefit scheme must certify that its assets would be sufficient to meet its liabilities if the scheme were to wind up at a specific date. Where the assets would not have been sufficient the trustees must submit a funding proposal which would ensure that it would be able to meet its liabilities at the date the next certificate was due (i.e. a maximum of 3 ½ years).

The Board was concerned that this could mean that schemes which were viable on a long term basis would have to pay additional contributions to ensure they could meet their liabilities on wind-up and, that rather than do this, schemes would be closed. For a scheme which is in no danger of winding-up, it seems unreasonable to have to pay additional contributions to cover the possibility of something that is not going to happen. Obviously for the regulator the difficulty is in knowing which schemes are or are not going to wind-up.

Having deliberated on the issue, the Pensions Board proposed a change in legislation which would allow the Board to consider a longer time period for the scheme to meet the funding standard. This change was implemented in legislation in 2003.

This is an example of an area where a reasonable balance has to be found. The Board could have taken the view that there should be no flexibility with the possibility that we would be left with no schemes. We believe that the action we have taken is proportionate to the scale of the problem that exists and that this response is in the overall interests of members of defined benefit schemes. That said, we are also aware that it may not turn out to be in the interests of members of a particular scheme. However we felt that the worst thing we could have done would have been to do nothing. Therefore the regulation has been adapted to ensure the sustainability of the system.

During the deliberations we considered whether we should focus on the solvency of the sponsoring employer as well as the solvency of the particular scheme. However we felt that was moving too far from our role as a pensions regulator and furthermore were not comfortable that we had the appropriate expertise and resource. We also felt that, as the trustees have a fiduciary duty to the members, they should undertake that role of ensuring that the solvency and commitment of the employer is examined.

UK Approach

As you will probably be aware, the UK has embarked on a different path in relation to dealing with insolvent schemes by establishing a Pension Protection Fund. This has been the Government’s response to particular experiences of schemes in the UK.

As I mentioned earlier the Minimum Funding Standard in Ireland is based on the position at wind-up of a scheme and is designed to ensure that a scheme could meet its liabilities on wind-up. As such it is a relatively stringent standard. The UK has been operating the Minimum Funding Requirement (MFR) which is not a wind-up standard. However many members of UK schemes were shocked to discover that, although their scheme had met the MFR, on actual wind-up there were insufficient assets to pay their benefits. Furthermore as pensioners ranked first in the priority order, in that their benefits had to be secured, many of the active members received little or no benefits.

This has been the case for a number of high profile scheme wind-ups. One can understand the shock and anger that these individuals feel when they find out that despite having paid into a scheme for almost 40 years they are entitled to little or no benefit. When this comes at the same time as having lost their jobs it is not surprising that is has developed into such an issue.

Therefore, the UK Government has decided to establish the Pension Protection Fund (PPF). The intention of the PPF is to ensure protection for scheme members and to give employers the reassurance they need to carry on being involved in pension provision.

The PPF will ensure that when a company with a defined benefit scheme becomes insolvent and the scheme is not fully funded that the members will receive the core of the benefits they are entitled to. The PPF will be funded by a levy on schemes. This levy will include a risk rating linked to the underfunding of the scheme and other risk factors. The intention of this is to try to ensure that well run and well funded schemes do not subsidise less well run and less well funded schemes.

It will be interesting to see how this will work in practice. The PPF is similar to the system in place in the US with the Pension Benefit Guaranty Corporation which has had a mixed experience.

Netherlands Approach

Those are two distinct methods of dealing with the issues caused by the underfunding of schemes. The Dutch regulator has taken a different approach by requiring the schemes to raise the buffer that they require schemes to hold so that the assets available are greater than the liabilities. There are many regulators who are envious of such an approach although I understand that envy wasn’t one of the reactions of the schemes themselves. Again my understanding is that this approach was a reaction to the experiences and circumstances of the Dutch system. This approach reflects the fact that the obligation on the employer is to pay the contribution whereas the obligation on the scheme is to pay the benefit. This is slightly different from the Irish system where the obligation on the employer is to pay the contribution that is necessary to fund the benefits. As the scheme has no access to any funds other than those provided by the employer the PVK believes it is prudent to ensure that the scheme maintains a reserve in order to be able to cater for instances such as decreasing assets and increasing liabilities.

Directive

It is interesting to look at the differing approaches particularly in, perhaps, three of the most similar systems in Europe. The fact that such diverging approaches are taken by the regulators in similar systems does pose some interesting questions regarding the operation of the European Directive on the Activities and Supervision of Institutions for Occupational Retirement Provision (commonly referred to as the IORPS Directive). In particular it raises questions as to the possibility of regulatory arbitrage. What if a scheme does not like the PVK’s approach and feels the Pensions Board would be an “easier” regulator for their particular circumstances? It is possible that a multinational employer could decide that one country’s style of regulation better suits its particular needs and could therefore decide to relocate all its funds to that member state. It is even possible that a member state could ensure that its regulatory regime was structured in order to be attractive to such schemes!

This is a live issue for regulators. There are a number of factors that work to prevent this. Firstly, the Directive itself does allow the imposition of particular requirements on schemes that propose to operate cross-border. Secondly all the countries and regulators are currently examining the ramifications for them of the imposition of the directive. There are areas within the directive that may require a change in the role of particular regulators. I can certainly see areas that will have implications for the work that we currently do in the Pensions Board.

There is also a lot of work to do at EU level to ensure the smooth transposition of the directive into national law. The Committee of European Insurance and Occupational Pension Supervisors have set up a number of working parties including an IORPS Working Group to look at these issues.

Many of the regulators throughout the EU have formal and informal contact and do talk to each other. That does not say that issues will not arise and that schemes will not spot opportunities that suit their scheme. Indeed this is the whole purpose of the Directive in the first place.

However the challenge for the regulators and supervisors is to ensure the integrity of the schemes, provide protection for members and ensure the sustainability of the system. It must give sponsors, schemes and individuals the encouragement and confidence to participate in the system. Otherwise the system will not be sustained at any level, national or European. While this primarily relates to the second pillar system it also has an effect on the first pillar system. Many countries are now looking to strengthening the second pillar provision in order to relieve some of the strain on the first pillar. In order to do this they need to ensure that the second pillar has, I believe, a credible, robust and practical supervisory and regulatory system in place.