Pensions naturally focus on the future. As the era of defined benefit (DB) pension plans winds down, however, that future has been cloudy for participants, employers and pension funds. The clarity provided by the Pan-European Personal Pension (PEPP) regulation released in June, however, points toward sunnier days for an alternative solution
PEPPs might become a new normal, providing a meaningful pension alternative and a path to an estimated European capital market of €700 billion (per a 2017 EY report for the EU Commission).
At one time, DB plans dominated, due to expanding economies and an expectation of stable growth that made these plans both possible and desirable. Those ongoing commitments were also challenging, however. Even 20 and 30 years ago, pension plans in the U.S. and Canada started moving toward a defined contribution (DC) model, instead of defined benefits. This transformation took longer in the Netherlands due to different social welfare structures, but was ultimately prompted by dramatic declines in interest rates about a decade ago.
While the risks seemed manageable when the discount rates were 7 or 8%, you can imagine the effect as the discount rate dropped to 4%, then 3%, then 2% and even, with applicable market circumstances, to around zero. Guarantees simply became too expensive for many employers, while pension funds struggled with their coverage ratios and to maintain full funding and perspective on indexation.
Additional headwinds came from our changing society. We are seeing more self-employment, diminishing the prospect of employer contributions. Research in the Dutch market carried out by Netspar shows that the younger generations are also not very keen on solidarity with older generations, preferring to organize their own pension system via an individual pension accrual. We also see more internationalization, especially in cross-border working relationships within the European Union (EU). If you have ever tried to carry out a cross-border pension value transfer, you know it’s time consuming and complicated, and therefore not often applied.
As DC plans became more common there was some movement in the Dutch market for insurance companies to set up (independent) Premium Pension Institutions (PPI). While the pressure to generate a guaranteed benefit was gone, the administrative costs and requirements, and the lack of standardization between countries increased the appeal of the simpler, more flexible PPIs.
The PEPP solution
A PEPP is a new individual pension savings product with a number of attractive advantages established by the PEPP regulation. These include standardization of the core product features such as transparency requirements, investment rules, and the ability to switch plans or between investment options. As the “Pan-European” part of the name suggests, these standards apply across the EU and can be offered as part of the EU Passport. PEPP products are supervised by the European Insurance and Occupational Pensions Authority (EIOPA) and the relevant local authority.
PEPPs are a basic pension savings solution, providing long-term capital accumulation for creating an income on retirement. They can be offered collectively by an employer or a trade union, or purchased individually from asset managers, insurance companies, banks or – except for inter alia the Netherlands – a pension fund. There is enough flexibility within the regulations for providers to tailor products that fit their business model and market. They can also be purchased and administered digitally from anywhere in the EU. Their lack of complexity, and strong consumer protections, make them a good alternative savings program for smaller employers to offer. The products are competitive and savers can contribute to the same PEPP even if they change residences to another EU state.
While PEPPs are focused primarily on savings, and don’t feature the insurance protection connected with traditional pensions, disability and term life coverage may be easily added to the scheme. It should be emphasized that PEPPs are designed to complement, not replace, existing public and occupational pension systems. Nevertheless, they should help reach the large portion of the market currently not enrolled in a pension plan, which some estimates place as high as 25% or more of Europeans between ages 25 and 59. In addition to providing individual financial security, channeling more savings into long-term investments is expected to increase the depth and liquidity of the capital markets, stimulating growth and more jobs.
Why is this important?
While different countries are still at work elaborating on the tax rules, this is the time for providers (of all kinds) to think about the attractiveness of this market and the partners they need to align with to take advantage of these opportunities.
The DB pension business models are at the end of their life cycle. Asset managers, insurance companies, banks, trade unions, even pension funds are looking for alternative solutions, as are consumers. Meeting these needs in this time of dynamic change means embracing new ways of thinking, connecting, communicating and organizing customer engagement, all to further the market's enduring and fundamental purpose: to provide financial security in an insecure world.