Less than two months to go before IORP II is effective. To what extent are Dutch pension funds prepared for the new legislation? What will the impact of IORP II be? And to what extent is the new directive even necessary in the Netherlands?
22 Nov 2018
In recent years, the increase in invested assets (EUR 1362 billion) and the decrease in the number of pension schemes have increased the schemes' responsibility, just as that of their trustees. In addition to that, over the past 20 years laws and regulations have increased exponentially. This has had repercussions on various policy areas of pension schemes. In order to improve the quality of pension administration throughout the European Union, IORP II (Institutions for Occupational Retirement Provision) has been drawn up.
Will IORP II have an effect on the Dutch pension sector?
Pension administration in the Netherlands is indeed already at a high level. The importance of IORP II for the Netherlands is therefore relatively limited. However, a number of policy areas will be recalibrated. The IORP II directive describes the quality of pension administration in much more detail than current Dutch legislation prescribes. In particular in terms of governance and risk management. I expect IORP II will strengthen these policy areas.
Pension administrators in other countries probably need to make much greater efforts to comply to IORP II. The harmonisation of legislation on supplementary pensions across the European Union was drawn up to stimulate cross-border pension provision.
IORP II is expected to be implemented on January 13, 2019. To what extent are pension schemes in the Netherlands prepared for the implementation, do trustees take the impact of IORP II serious enough?
At the moment there seems to be sufficient attention for IORP II. However, we do see that - particularly in the case of smaller pension schemes - the focus is mainly on the minimum requirements they must meet in the short term. We see that the schemes' main focus is currently on correctly implementing the key positions.
The attention paid to other components, i.e. investment policy (ESG), remuneration, communication (communicating on the basis of scenarios, and attainable pension) and the higher objective of improving the governance system (adequate interpretation of risk management on the basis of the 3 lines of defence model) is still relatively little.
In your opinion, where is the focal point of IORP II; the key functions, ESG or risk management?
In my opinion, IORP II focuses on adequate execution and effective risk management. In the Netherlands, almost all attention is currently on the key functions. The higher objectives IORP II aims for are less of significance for Dutch pension schemes because almost all of them are already in practice. But Dutch pension schemes should focus more on improving their communication to their members, and restore the confidence in the pension sector.
With the implementation of the new directive, Dutch pension schemes should also pay more attention to ESG, implementing it into policy and its impact on asset management.
The Dutch government is leaning to the notion that the ownership of the risk management function and the internal audit function cannot be outsourced. What are the consequences of this for pension schemes?
It is true that DNB (the Dutch National Bank, and therefore the Dutch government) has higher standards than the minimum requirements on certain aspects of IORP II. However, the draft legislation seems to come closer to the IORP II guideline. If the intended optimal separation of functions is enforced into final legislation then that will lead to higher costs, but undoubtedly also to better risk management. Pension schemes will need to find a balance between saving on costs and increasing risk management.
Many boards do not yet see how they can give an effective interpretation to the internal audit function. Proposals that use external parties for the audit function are often considered to be expensive.
If a pension scheme chooses to outsource the ownership of the key functions (risk management and internal audit), the government's position is that the pension scheme should provide clear explanation why DNB’s and the Ministry of Social Affairs’ recommendation is not followed. Outsourcing the ownership of these key functions will require more administrative attention.
All factors taken into consideration, the cost impact of IORP II will be relatively low, depending on the pension schemes’ approach to fill the key positions. Bottom line, IORP II will strengthen pension schemes. Small pension schemes, provided they make good use of the legal possibilities within the proportionality principle, must also be able to find suitable solutions with a relatively limited increase in costs.
Are pension schemes putting excessive focus on elements of IORP II?
Perhaps the implementation of the risk management system is taken more seriously than IORP II requires. But it is a good thing if pension schemes put extra attention to risk management.
IORP II includes the communication on ESG. What will be the impact of that?
From a certification point of view (prudent person), it will be assessed whether new ESG policy has been formulated clearly and whether it complies with amended legislations, whether this policy has been adequately written down, and whether this policy is sufficiently monitored (which is also a task of the risk management function). IORP II sets new standards for ESG policy. ESG must soon receive sufficient administrative attention.
Does the imminent implementation of IORP II has an impact on pension schemes’ ESG investment policy? Do pension schemes have formulated anything on ESG?
ESG is gradually receiving more attention. In the beginning ESG was mainly about pension schemes telling what they do, now they tell more on why they do it. And where previously the focus was on excluding certain investments, this is gradually shifting towards impact investing.
Many pension funds have an ESG policy. I do not think that IORP II is the direct reason for pension funds to draw up an ESG policy. However, IORP II has renewed schemes’ focus on ESG. Perhaps that new attention will accelerate development of ESG policy.
Do you think that the stimulus for cross-border pension provision will have an impact on the Dutch pension sector?
For the Netherlands, the cross-border pension provision means that the "execution of supplementary pension" can be exported. However, due to major differences in fiscal and social legislation, the export opportunity seems limited. Because of the high safety standards, including a low actuarial interest rate, Dutch pensions are relatively expensive. There are still major hurdles to be taken for an employer to execute the pension scheme cross border. Dutch employees seem to prefer the security that the Dutch system offers. The impact on cross-border pension provision will therefore be limited.
In the Netherlands, most of the supplementary pension provision is managed by occupational pension schemes. It is difficult or impossible for them to export their services. In a European context, the more important question to ask is whether the system of average premium can be sustained. You can also discuss whether an occupational pension scheme is a social institution. But these questions cannot be answered based on the outlines of the IORP II directive.
The export risk is greater for occupational pension schemes. But when it comes to DC schemes, we at Milliman do not only see risks but also opportunities.
You indicate that there are two types of ambition levels for pension schemes: a high and a low level of ambition. Could you indicate, roughly speaking, what the current situation is in the pension sector? Which ambition level do pension schemes prefer?
We see that most smaller schemes and some mid-sized schemes opt for a low level of ambition and focus primarily on the minimum requirements to comply with legislation and regulations, using the proportionality principle. The bigger funds often ask themselves: "what adjustments must we make to our governance and risk management system in order to be both compliant with legislation and regulations, and to do justice to our desired level of ambition of IORP II and the chosen design criteria?”