When we talk about pensions, we are talking about our future and our families. In terms of financial products, only a mortgage or health insurance policy has the potential to conjure up such powerful emotions.
And that’s why the European Commission has to think very carefully about how it approaches its proposed revisions to the Institutions for Occupational Retirement Provision (IORP) Directive.
It appears that the Commission remains committed to basing this work on the insurance law Solvency II, which, when it comes into force, will govern how much capital insurers must hold against risk.
This is a source of real concern and not just for the European Private Equity and Venture Capital Association.
This week seven other major organisations joined Invest Europe in making a joint statement warning of the possible unintended consequences this course of action could lead to.
Asset managers, trade union representatives, employers and employers, businessmen and pension industry experts all agreed that basing IORP revision on Solvency II could be disastrous.
Why did so many different people from different groups and sectors, even those sometimes thought of as having opposing points of views, come together in this way?
Because pension funds are not insurers and they need to be treated differently and because using Solvency II as the foundation for IORPs will not only hit pensioners, it could slow down an already stagnating economy and hinder the recovery from the financial crisis.
The controversial and long overdue Solvency II law actually punishes insurers for investing in long-term, growth-promoting sectors like private equity and venture capital.
The way the capital requirements are calculated does not take into account the diversification benefits of investing in a portfolio of funds that in turn invest in many companies or that the PE managers are experienced, active owners.
Invest Europe has carried out research that proves this positive effect these benefits bring.
Simply put, insurers have to set aside excessive amounts of capital. That is cash that could and should be available to Europe’s SMEs or long-term infrastructure product s like roads or wind farms.
Under Solvency II, capital requirements are calibrated to corresponds to the value at risk over a 12 month period. This means that liquidity is more important than how much capital is at risk.
Under a similar system, pensions managers would have to change their investment strategies, turning away from traditional long-term growth assets in favour of short-term, lower returning investments.
Pensions are by nature long-term with long term liabilities – so it simply does not make sense to push the industry towards short term investments.
The investment risk could actually rise as funds will be strong-armed into having less diverse portfolios.
The cost of pensions would rise as the funds would have to set aside too much capital while no longer be making the same returns, causing, for example, defined benefit schemes to close their doors to new members.
Pension schemes have used private equity funds to invest 53 billion euros in European companies over the last four years.
A lot of that cash has gone to small and medium sized enterprises –the engine of economic recovery.
83 percent of private equity backed companies are SMEs, which boost the real economy spurring growth, investment and job creation, as well as providing tax revenues.
If it continues down this path, the commission could jeopardise economic recovery and make it harder to ensure that pensioners can fund their retirement.
And that explosive mix could well prove to be political dynamite.