Bringing order to a fragmented pensions landscape

The transposition into Irish law of the Institutions for Occupational Retirement Provision (IORP) II directive at the end of April represented a game changing event for Irish pensions, says PwC pensions partner Munro O’Dwyer.

Ireland has more than 100,000 pension schemes, the majority of them one-person arrangements, and the net effect of the new rules could be to reduce that number to less than 200.

That rationalisation will be prompted by the increased regulatory obligations and costs imposed on pension schemes. IORP II 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; a requirement for annual audits for all schemes; and new standards relating to communications with members and potential members.

It also removes the derogation that allowed one-person schemes to invest in unregulated markets such as property and to borrow for the purpose of investment.

This is just another step in an ongoing regulatory process. “In April, the European Insurance and Occupational Pensions Authority issued two opinions on charges and long term risk assessment by defined contribution schemes,” O’Dwyer notes. “This demonstrates that IORP II is simply a single stage on a long-term journey towards European harmonisation of pension regulation. Ireland has a long way to go.”

Ireland was the last country in Europe to transpose the directive into domestic law, over two years past the 2019 deadline.

Need for reform

“There is broad consensus around what needs to be done. The delay in transposition was likely due to our incredibly fragmented pensions landscape,” he says.

Ireland is disproportionately challenged when it comes to pensions regulation. “We have just 1 per cent of the population, but are home to about 50 per cent of all pension schemes in the EU. There are lots of reasons for that. There have been no real barriers to setting up a pension scheme which has led to a proliferation of small schemes. We now have a complicated mix of personal plans, personal retirement savings accounts (PRSAs) and occupational schemes and the rules don’t dovetail that neatly.”

A large number of these schemes are in trust structures that require trustees and sponsoring employers and quite complex administration. “Ultimately, for a small economy, you end up with a landscape that is very challenging to regulate. IORP II will help to tidy up that landscape.”

Potential benefits

And while there will be disruption, the potential benefits are widely appreciated. “The policy position is that smaller schemes incur disproportionately larger administrative costs as fixed costs are shared among fewer people,” O’Dwyer explains. “The new rules will be transformative for Irish pensions. That said, the rules bring significant additional requirements, in terms of both the cost of compliance and risks of non-compliance.”

We will end up with a much smaller number of much better regulated and run pension schemes

The regulatory bar has been set higher than ever before. “IORP II and its forerunner contain lots of principles on how to run best in class pension schemes. I don’t think anyone disagrees with them. Very simply, we will end up with a much smaller number of much better regulated and run pension schemes. That will be a really positive outcome. The challenge is how to get there.”

While one-person schemes will be affected by the removal of the investment and leverage derogation, O’Dwyer believes new requirements imposed by IORP II will have the greatest impact overall.

“The new governance requirements will raise the cost of running a small scheme to a point where it is potentially not viable” he points out. “The impact is not simply around small schemes – for larger schemes with €100 million and over in their funds, they are assessing the impact of IORP II and concluding that while they want a high quality pension scheme for their employees they don’t want the risks associated with complying with the new regulations. Pension arrangements are largely outsourced now in any event, and there is significant interest in exploring how that outsourcing model might be extended.”

There are two main options open to employers. The first is to move every scheme member on to a PRSA, which has some disadvantages. “PRSAs are outdated in terms of the legislation that underpins them,” O’Dwyer notes.

Master trust

The other option is a master trust. A scheme of schemes where a pension provider offers a single vehicle containing multiple pension schemes, it offers economies of scale when it comes to compliance with new regulations.

It is quite plausible that master trusts will become the dominant means of providing pensions in Ireland

“A master trust has a single trustee board which would be expected to have significant experience and expertise. The trustees will select the administrators and the investment managers who they believe are most appropriate for the members of that master trust and who will deliver the best outcomes for their pension savings. The potential for better outcomes for members is clear,” O’Dwyer says.

It may be possible for larger employers to engage with master trusts on the investment choices. “There can be some flexibility, depending on the scale of the employer and their appetite to influence investment options,” says O’Dwyer. “What employers want are high quality pensions for their staff. If they can delegate that to an expert third party at a lower cost and lower risk, that is very attractive. For smaller employers, the advantage for them is having the comfort of knowing they have best in class governance and expertise available to them. It is quite plausible that master trusts will become the dominant means of providing pensions in Ireland.”

Existing schemes will have a transition period to decide whether to comply with the new rules or move to alternative arrangements. “The Pensions Roadmap sets out that all existing pension schemes will need to demonstrate compliance with IORP II to the Pensions Authority. The penalty for non-compliance is potentially the withdrawal of tax relief. Employers will not want to take the risk of going to the Pensions Authority and having the tax relief withdrawn.”

Individual firms

The remaining question is how individual firms will oversee their staff pension schemes within a master trust structure. “Employers want to maintain oversight, and are setting up pension committees to meet regularly with the master trust provider and ensure it is communicating effectively and that the investment performance and administration are in line with expectations. Key is that governance is maintained, but with none of the compliance risks.”

IORP II is going to impact every employer with a pension scheme. “We are seeing evidence of a clear appetite in the market for master trusts. People are considering a landscape with a vastly reduced number of pension schemes, and the regulatory standards that could apply as a result. They are seeing IORP II not simply as a further regulatory change, but as the trigger for a decision around how they provide pensions to staff into the future.”

Discover more at pwc.ie