COMMISSION OF THE EUROPEAN COMMUNITIES 
Brussels, 10.06.1997 
COM(97)283 final 
Supplementary Pensions in the Single Market 
A Green Paper 
(presented by the Commission) 

Supplementary Pensions in the Single Market 
CONTENTS 
INTRODUCTION AND EXECUTIVE SUMMARY I 
CHAPTER I THE DEMOGRAPHIC AND ECONOMIC CONTEXT 1 
A. Current demographic trends I 
B. Budgetary implications of demographic changes on state pension arrangements I 
C. Current structure of pension provision 2 
D. Conclusion 8 
CHAPTER II RETIREMENT PROVISION AND EU CAPITAL MARKETS 9 
A. Size of EU pension funds 9 
B. How EU pension and life insurance funds are invested 9 
C. Returns on pension funds assets 10 
D. Impact of differences in rate of return 11 
E. Can higher returns be achieved without undue risk ? 11 
F. How could EU capital markets absorb future increases in EU pension funds and life insurance 
investments ? 13 
CHAPTER III APPROPRIATE PRUDENTIAL RULES FOR A SINGLE MARKET 15 
A. Role of supervision of pension and life insurance funds and fund managers 15 
B. The effect of excessive rules on pillar 2 pension fund investments 15 
C. Rules on pillar 3 life assurance investments 17 
D. Should there be similar EU rules for pillar 2 and 3 schemes 18 
E. Fund managers 19 
F. The way forward 19 
CHAPTER IV FACILITATING THE FREE MOVEMENT OF WORKERS 22 
A. General considerations 22 
B. Obstacles to free movement of persons relating to supplementary pensions 22 
C. Possible approaches 26 
CHAPTER V THE IMPORTANCE OF TAXATION FOR SUPPLEMENTARY 
PENSIONS 28 
A. General considerations 28 
B. Avoiding double taxation 29 
C.\ The case for a common approach 30 
TABLES 
Table I Coverage Levels - Pillar 2 
Table II Pension fund assets - total and as a percentage of GDP (1993) 
LCL 
Table III Assets of life assurance companies - total and as a 
percentage of GDP (1995) 
Table IV Distribution of pension funds (pillar 2) assets, as % of total assets (1994) 
Table V Distribution of life assurance assets (pillar 3) as % of total assets (1994) 
Table VI Differences in rates of return of equities compared to bonds 
Table Via Real rates of return (% pa) (1967-1990) in domestic currency 
Table VI b Excess returns of equities over bonds (% pa) (1981-1995) in domestic 
currency 
Table VI c Real return (% pa) from US, UK and Belgian Markets 
Table VII Pension funds 1984-1993. Average rates of return, volatility, relationship of 
return to risk 
Table VIII Stock market size. Domestic equity (1996) 
Table IX Summary of national regulations on pension fund portfolios (pillar 2) 
Table X EU rules on investment by life insurance companies (pillar 3) 
Table XI Summary of national regulation of life assurance companies (pillar 3) 
Table XII Assets of group life schemes as a percentage of pillar 2 pensions assets (1994) 
Table XIII Pension funds v life assurance 
Footnotes 
/ 6 
INTRODUCTION AND EXECUTIVE SUMMARY 
The provision of pensions is a fundamental aspect of social protection in the European 
Union. This is made clear in the Commission's communication on Social Protection1 
ihc present paper seeks to build on that communication by developing a number of 
ideas relating to certain aspects of supplementary pension provision. Currently there 
are 4 people of working age to support each pensioner in the EU. By 2040, there will 
be 2. This prediction is the result of greater longevity and the decline in birth rates in 
Europe. The average number of births per female in Europe has declined from 2.5 in 
1965 to 1.8 in France and the UK to less than 1.5 in Germany, Italy and Spain. This 
phenomenon is not confined to the EU but is also found to a greater or lesser extent in 
most developed countries. 
Statutory state pensions in the EU are mostly paid by the state out of current revenues 
("pay as you go"). There are at present in general no earmarked investment funds for 
state pensions. If current policies towards pensions are not changed, there will be an 
inevitable increase in state spending on pensions to pay for the increased number of 
pensioners. At the moment state pensions account for 10% of GDP. Without changes 
in policy this will increase significantly by 2030. It will be difficult for Member 
States to meet these increased demands in view of the already high level of public 
spending in the EU and their commitment to budgetary rigour. 
Several Member States have already initiated reforms to ensure the sustainability of 
state pension provisions, and further reforms are being considered. Currently state 
pensions (pillar 1) account for the bulk of pension payouts (88%), but the need to 
maintain levels of income in retirement is likely to result in greater reliance being 
placed on the other main sources of supplementary retirement income: 
• pension schemes linked to employment (pillar 2); 
• pension schemes taken out by individuals, usually with life insurance 
companies (pillar 3). 
The Commission clearly recognises that policies in relation to pillar 2 and 3 
supplementary pension schemes discussed in this paper are by no means a panacea for 
the difficulties which demographic change is expected to raise. Member States' social 
security systems will continue to provide the bulk of pension payouts, with the 
emphasis on social solidarity within and between generations. 
Consistent with the principle of subsidiarity, it is for Member States to decide on the 
role they wish each of these three sources of pension provision to play in providing 
retirement income. They can alter the balance between the sources directly, by 
changing the rules for state pensions or by making work- related schemes compulsory, 
or indirectly, through fiscal incentives. But given the existence and likely growth of 
funded supplementary schemes, the Green Paper explores how the Single Market can 
enable these schemes to operate more efficiently. 
In contrast to state schemes, most pillar 2 and 3 schemes are funded: that is to say 
they are backed by assets which are invested to provide future pension payouts . 
Even though the contribution of these schemes to total pension payout is currently 
relatively small, the funds invested to meet future pension liabilities are enormous: 
in 1993 there were 1 200 bn ECU invested on behalf of supplementary schemes; of 
the 1 600bn ECU of life insurance assets, a small but significant proportion represents 
pension provision. 
They are likely to continue to grow in tne ruture. tiven it pillar i schemes in all 
Member States only grow to half the current coverage in the Netherlands and the UK 
(the Member States with the highest coverage at the moment), these funds would 
increase to 3 000 bn ECU. 
The growth in these funds is one of the possible elements in maintaining the level of 
retirement income. They present an opportunity for the EU economy; the Green Paper 
asks how these benefits can be delivered through the EU capital market, particularly 
in the light of the positive impact of the introduction of Economic and Monetary 
Union. At present, employment and life assurance linked pension schemes in most 
Member States invest a large proportion of their assets in domestic government bonds. 
In view of the commitment of Member States to financial stability, it is likely that the 
capacity for growth in government bonds will be limited. This means that the supply 
of equities and private sector bonds is likely to grow if the increase in available funds 
is to be taken up by the EU capital market. The EU capital market will be 
transformed as a result, in particular, of the increase in supply of long term capital. 
This could have with beneficial effects on EU industry and infrastructure. 
Some of the rules currently imposed by Member States as part of their prudential 
supervision of these funds seem to go beyond what is objectively necessary and 
prevent the freedom of movement of capital in the Single Market. Clearly, prudential 
supervision is required to ensure that pension funds and life assurance companies can 
meet their future pension liabilities. This supervision must not be weakened. One of 
the objectives of the Green Paper is to consider how the security of benefits can be 
maintained, removing the current disproportionate restrictions whilst allowing a real 
Single Market in pension funds to develop for the benefit of pensioners and future 
pensioners. From the evidence it seems that alternative methods of supervision can 
provide equivalent security. These alternative methods would have two additional 
advantages: 
they would be compatible with the free movement of capital and would 
encourage the expansion of the EU capital market. Such a market would be 
more liquid than individual national markets; and 
they would allow pension funds to invest a greater proportion of their assets in 
a variety of long term financial instruments such as equities, in line with the 
structure of their liabilities. This strategy could increase returns on the 
investments of pension funds because these instruments have generally carried 
a higher rate of return than government bonds. 
id 
The last point could be significant. It is possible that some EU pension funds could 
increase their current rate of return by diversifying and taking advantage of a Single 
Market for investment. Even a relatively modest increase in the rate of return over a 
typical working life could make a great difference to either the pension payout or the 
contribution necessary to finance a given pension. The lowering of the cost for 
companies of financing a given pension would have a positive impact on job creation. 
The Community is committed to improving employment in the Union. This 
commitment is borne out by the Commission's Confidence Pact and the employment 
strategy agreed at the Dublin European Council. 
It should be clear that this Green Paper does not seek to endorse the investment by 
pension funds in equities or any other assets. It believes however that fund managers 
should be given the freedom to invest in the assets they consider the most appropriate 
for their particular pension fund and that this freedom should be exercised within a 
Single Market. This freedom cannot, of course, be absolute, but should be based on 
prudential rules and subject to supervision. The Commission is committed to 
ensuring that there is no reduction in the protection of pension funds. Prudential 
considerations are all the more important for equities given the greater volatility of 
these assets in the short term. The Commission is looking at alternative methods of 
supervision that are consistent with the Single Market. 
This Green Paper also stresses the need to confirm the right of approved investment 
fund managers to offer their services in other Member States. This would not only 
give managers themselves the advantages of a Single Market, but the increased 
competition could be expected to reduce costs and encourage managers to improve 
their performance. The effect would be to increase the returns on investment, for the 
benefit of members of pension schemes. 
Supporting the mobility of workers within the Union is a fundamental Community 
objective. Yet whilst arrangements relating to statutory pensions exist to facilitate free 
movement, there is no Community legislation on mobility in the context of 
supplementary schemes. Supplementary pension arrangements can pose a significant 
obstacle to labour mobility. This can be the case currently for moves within a Member 
State; the same is true, to an even greater extent, for moves to other Member States. 
The issue of migrant workers' supplementary pensions was considered in the report of 
the High Level Group on the freedom of movement of workers chaired by Mme 
Simone Veil, which concluded that action was needed to permit migrant workers to be 
treated on an equal footing with workers who move jobs within a Member State. This 
Green Paper considers the way forward. 
Taxation plays an important role in pension provision and scheme design, providing 
privileged treatment at the level of contributions, fund income and capital gains, and 
benefit payments. There are regulations in place to control how these fiscal privileges 
are used. However, they can be an impediment to a Single Market, both for 
occupational and life assurance related arrangements, and can hinder the mobility of 
workers. The Green Paper therefore asks what initiatives are called for to make 
progress in this area. 
Ill U 
The Commission believes the ideas discussed in this Green Paper can make a 
significant contribution to addressing the question of maintaining income in 
retirement and to reducing labour costs. Even if action must also be taken in other 
areas, in particular with regard to reform of state systems mobility of workers and 
taxation, the Union cannot afford to miss the opportunity that a change in policy 
towards the investment of pension and life assurance funds offers. This paper does not 
however attempt to deal with consumer protection issues (such as advice or mis-
selling) except in the context of prudential regulation. 
The Commission invites comments from the Member States, the European 
Parliament, the Economic and Social Committee, the Committee of the Regions, the 
social partners, economic operators, representative organisations, consumers and all 
other interested parties on the issues raised in this document. Responses to the paper 
are requested in writing no later than 31 December 1997, to: 
The Director General - DG XV 
European Commission 
Rue de la Loi 200 
B-1049 Brussels 
Fax: (+32 2) 295 65 00 
Internet address: John.Mogg@dgl5.cec.be 
IV 
(* 
Chapter I THE DEMOGRAPHIC AND ECONOMIC 
CONTEXT 
A. Current demographic trends 
1. The demographic structure of the European Union is changing considerably. The 
dependency ratio (i.e. the ratio of the elderly to the population of working age) is 
increasing in most Member States and has already reached historically 
unprecedented levels. Over the last few decades two major demographic changes 
have taken place which lie behind the expected increase in the dependency ratio: a 
decline in the fertility rate and an increase in life expectancy. Although the long 
term effects of the ageing process on public budgets are rather uncertain and 
depend on the way the economy and society adapt to the process, there is likely to 
be significant pressure for an increase in public expenditure in the years ahead. 
Much of the pressure will fall on public social security pension schemes, which 
account for by far the most significant proportion of pensions in Europe, since 
expenditure on them is highly dependent on the age structure of the population. 
Similar demographic pressure is evident in the US and Japan. 
2. The consequences of these changes are considerable . The combination of fewer 
births and longer life expectancy means that over time the ratio of those who have 
retired to those working will increase considerably. At present there are four people 
of working age to support each pensioner through social security contributions. By 
2040 it is expected that on average those four people will have to support two 
pensioners. In some Member States the ratio will be even more unfavourable. 
B. Budgetary implications of demographic changes on state pension 
arrangements 
3. The effects of these developments will be gradual. The Commission has 
conducted a survey of projections carried out in the Member States of future 
expenditure on state pensions over the coming decades . The survey focuses 
on the most recent projections assuming current legislation, i.e. incorporating 
reforms already announced. The conclusions are as follows. 
• Over the period 1995-2030 as a whole, the weighted average of pension 
expenditure to GDP ratios in the 11 Member States for which projections up to 
the year 2030 are available will increase by 3 percentage points (under 
favourable assumptions) and up to 4 percentage points (under unfavourable 
assumptions). Expenditure pressures will be relatively strong in several 
Member States which have not yet substantially reformed their pension 
systems (Belgium, Denmark, Ireland, Luxembourg, the Netherlands), but also 
in some Member States which have already introduced substantial reforms 
(Finland, France, Germany). Expenditure increases are expected to be fairly 
3-
limited (under favourable economic scenarios) in Italy, Portugal, Spain, 
Sweden and in the United Kingdom. 
• By the year 2030, in several Member States (Belgium, Finland, France, 
Germany, Italy, Luxembourg and the Netherlands) the ratio of pension 
expenditure to GDP may be in the range of 15% to 20%. Expenditure should 
be lower in Denmark, Spain, Sweden (in the 10% to 15% range), and in 
Ireland, Portugal and the United Kingdom (below 10%) . 
4. At present, approximately 88% of all pensions paid in the EU are accounted 
for by state pensions. In turn, these pension costs represent a significant 
proportion of GDP - approximately 10% . Therefore any increase in total pay­
out on pensions by Member States will have an impact on budgets.. Because of 
reforms already undertaken by most Member States., generally only 
demographic trends now contribute to the increase in pension expenditure as a 
proportion of GDP. 
C. Current structure of pension provision 
5. In line with the principle of subsidiarity, it is for each Member State to decide 
on a national structure for pension provision that is in keeping with its 
particular needs. The relative importance of the three pillars in each Member 
State will therefore vary considerably, and will depend on the legal structure 
covering pension provision and the extent to which other factors come into 
play, such as the availability of tax relief. Equally, the nature of these pillars 
can be widely different. For example, in Finland pillar 1 consists of the 
statutory state pension scheme and the statutory occupational pension scheme 
which is partially funded . In France there is a very significant compulsory 
pillar 2, which is administered on a pay as you go basis. In the UK, there is a 
compulsory earnings related top up pillar 1 scheme, whilst pillar 2 
arrangements are not compulsory at a national level. In Germany, Austria, 
Luxembourg and to a lesser extent Sweden, a significant proportion of 
supplementary pensions is provided through unfunded employers' book 
reserve schemes. In contrast, the setting up of book reserve schemes is no 
longer permitted in Spain. 
6. Overall, employees in the EU rely for income provision in retirement on a 
number of sources. In broad economic terms, they can be described as follows. 
•illar Hat-rate, social security pensions (pay-as-you-go) 
earnings related, defined benefit (pay-as-you-go / funded) 
Pillar 2 occupational pension schemes (pay-as-you-go / funded) 
Pillar 3 life insurance based (predominantly) pension savings plans 
The following table shows the extent of the current reliance on pillar 1 schemes. By 
comparison pillar 2 schemes make up only 7% of total payments. 
EU wide pay out sources in % of total pay-out (1994 - excluding Austria, Finland and 
Sweden) 
Type of Scheme 
Pillar 1 I 88.8% 
PAYG," 
Pillar 2 7% 
Funded, book reserve, insured plans 
Pillar 3 
Personal pensions 0.9% 
Other 
Means tested, guaranteed income scheme, poor .'>..>°<> 
relief programmes 
Source: EUROSTAT 
7. Pillar 1 
This is the basic state scheme, in which participation is generally compulsory. 
Schemes are financed on a pay as you go basis, where current workers' 
contributions are used to fund the pension payments of retired people. These 
pension payments are guaranteed by the state, and the scheme is administered 
by a public institution. Pension benefits are calculated on the basis of a 
formula fixed in advance and are usually dependent on years of service. 
Pension income in retirement is usually indexed to inflation or to current 
wages. The link between contributions made during working life and benefits 
received after retirement changes substantially from system to system. Ar-b 
Basic schemes in some Member States will provide for a pension which bears 
no relation to income during working life. In such systems there may be an 
earnings related pillar 1 scheme to top up pensions; contributions will depend 
on earnings, and benefits will be calculated by reference to those earnings1*. 
Advantages: 
Near universal coverage. 
Solidarity within and between generations. • 
• 
• Alleviates poverty in old age and avoids for individuals some of the 
financial problems associated with longevity. 
Promotes social welfare. 
• 
• No discrimination for labour mobility, between jobs both within a Member 
State and between Member States. 
Insurance against inflation; avoids the consequences of investment risk. 
No selling costs. 
Disadvantages: 
Vulnerable to the risk of population changes which can make current levels 
of benefit unsustainable. 
As pay as you go schemes have no underlying fund, they are vulnerable to 
rule changes. Governments may decide to change the basis on which 
benefits are calculated, thereby creating uncertainty about adequacy of 
benefits in the future. 
Where funding is through social charges, this can distort the labour market, 
through a perception of a tax on jobs. 
No scope for individual flexibility in the contribution cycle. 
8. Pillar 2 
Table I shows the current situation of coverage of supplementary pillar 2 
schemes. The variety of approaches in the Member States is illustrated by an 
example: in France the compulsory pillar 2 scheme is pay as you go and 
coverage is approximately 90% of those in private sector employment, making 
up 21% of all pension payments, whilst in Italy coverage of supplementary 
schemes is 5% of private sector workers and constitutes 2% of total pension 
payout. In the Netherlands, pillar 2 schemes account for almost a third of all 
pension payments. 
Pension schemes in this category are generally linked to employment or the 
exercise of a profession (an 'occupational scheme' or 'industry wide scheme'). 
Membership of these schemes is limited to those working in particular sectors, 
industries, professions or companies, and will be created as a result of 
agreement between the social partners or by reference to, for example, 
standards in a particular industry. Pillar 2 schemes are administered by private 
institutions, and benefits are not guaranteed by the state. Contributions are set 
by reference to income, and payment of contributions is generally shared by 
employers and employees. With notable exceptions \ pillar 2 schemes are 
generally funded, with contributions accumulated and invested in order to 
provide benefits in the future, rather than to pay benefits to those who have 
already, retired. The analysis in this section focuses on funded schemes. The 
link between contributions and benefits is closest in defined contribution sch 
ernes which provide benefits dependent solely on the return on assets invested. 
Returns on a member's slice of the fund will depend on investment choice, and 
ultimate pension benefits will depend on the value of the member's fund at the 
time of retirement. Funded defined benefit schemes, on the other hand, retain 
vestigial traces of solidarity, in that they allow for some redistribution of 
income among the members of the scheme. In defined benefit schemes the 
employer will effectively guarantee a level of benefits relating to the income of 
the employee at or near retirement. 
Advantages 
Some link between contributions and future benefits in particular for 
defined contribution schemes, allowing workers to distinguish between 
contributions levied for pension provision and general taxation levied to 
pay for other welfare benefits. 
Largely resistant to demographic change. 
Defined contribution schemes: benefits linked directly to investment fund 
performance. 
Defined benefit schemes: employer's guarantee protects against falls in 
asset values. Some solidarity is also retained. 
Voluntary arrangements do not distort the labour market. 
Disadvantages 
Coverage is not universal in all Member States. 
In some member States vesting periods (during which an employee will not 
have accumulated sufficient years of service in order to be entitled to a 
pension) are very long. 
Resistance to complete pooling of risks, so difficult to achieve equal 
treatment between men and women. (For example, if the pension is paid as 
a lump sum, this can lead to lower annual payments due to the greater 
longevity of women.) 
Defined benefit scheme: the approach to valuation of benefits of early 
leavers can discourage worker mobility between firms both within a 
Member State and between Member States (see Chapter V below). It can 
discriminate against those who take a career break. It has also been 
suggested that there could be a disincentive to employing older workers. 
Defined contribution scheme: investment risk is taken by the scheme 
member. 
Defined benefit scheme: where the employer provides a guarantee, the 
insolvency of the employer will remove that guarantee, making the scheme 
vulnerable to fluctuations in investment values (though the scheme is ring 
fenced and separate from the employer's own funds). 
• Liabilities in salary linked defined benefit schemes depend on external 
factors such as inflation and, in particular, salary movements. 
• Compulsory schemes may distort the labour market. 
• No guarantee against the effects of inflation. 
• Investment returns may not match expectations. 
9. Pillar 3 
Pillar 3 schemes may be used to supplement the first or second pillars, or both. 
They have many of the characteristics of defined contribution pillar 2 schemes, 
although participation is not related to employment or the exercise of a 
profession, and is arranged individually by contract directly with a product 
provider, generally a life assurance company. An individual's contributions are 
accumulated and invested, and the resulting fund in used subsequently to 
provide pension benefits for the individual. 
Advantages 
• If investment performance of the underlying assets is good, this can lead to 
improved pensions. 
• Flexibility regarding contributions. It can accommodate career breaks and 
periods of part time work. 
• Resistant to demographic change. 
• Neutral regarding changing jobs. 
• If the scheme is a life assurance pension policy, the policyholder will be 
able in principle to benefit from the freedom of provision of services under 
the Third Life Assurance Directive, and so select an arrangement from a 
provider established in any Member State. However, regulatory and tax 
aspects, which may have an impact, are considered in Chapters IV and V. 
Disadvantages 
• Investment returns may not match expectations. 
• No guarantee against the effects of inflation. 
• No solidarity between and within generations. 
• 
• Cost: selling costs are generally high compared with first and pillar 2 
schemes. 
Success depends in part on tax breaks. 
Risk of individuals' being sold inappropriate products. 
10. Group schemes 
Life assurance providers play an important role in pension provision. This can 
be through personal pensions, as described above. Equally, life assurers can 
provide management of group pension funds on behalf of pension scheme 
trustees. Such an arrangement falls under the pillar 2. A further option is for 
the scheme trustees to ask a life assurer to administer the scheme on the basis 
of a group arrangement. This is a "group scheme", and also comes within the 
pillar 2. Yet another variation is the group personal pension scheme, which, 
though organised through an employer, is a collection of individual personal 
,. . 14 
pension policies . 
11. Recent Member State reforms 
Several Member States have in the last decade or so introduced reforms to 
reduce the impact of demographic change on public pension provision. These 
reforms have been achieved in a variety of ways. In order to try to maintain the 
level of benefits, certain Member States have implemented an increase in 
social security contributions. However, given the already high contribution 
rates in most Member States, containment of spending is likely to be the 
primary instrument used to guarantee sustainability. There have already been 
steps towards decreasing benefits. Such steps include changing benefit 
indexation formulae, e.g. from a link with earnings to one with prices; 
increasing the retirement age and thereby the years during which contributions 
are paid, and reducing the number of years during which a pension will be 
receivable; reducing the proportion that pension benefits bear to income during 
working life (the replacement rate); calculating earnings related benefits on 
earnings over a long period rather than on the final year's earnings; reducing 
incentives to early retirement. 
12. A different approach is for a funded state scheme to be developed to run 
parallel to the state pay as you go scheme. In Sweden statutory pension 
contributions are paid currently to the pay as you go scheme; however, once 
new legislation is implemented 2% will have to be paid into a statutory funded 
scheme. A more substantial systemic reform in the financing of public pension 
schemes would be a transformation from pay as you go to funding. Although 
this has been widely discussed, there are difficulties in implementing it in the 
case of developed and mature public pension systems such as those prevailing 
in the EU, not least the crystallising of future liabilities already 'bought' by 
non retired workers. This issue is discussed in the Commission's 
Communication on improving social protection in Europe . 
13. One option that is being considered, and indeed the process has already begun, 
is that Member States might gradually introduce conditions which are more 
conducive to the development of private funded supplementary schemes. The 
level of contributions is nevertheless unlikely to fall dramatically because; not 
only will it be necessary to pay the pensions of those already in retirement, but 
the role of state pay as you go systems will remain a fundamental part of the 
social structure of the Union. Private funded schemes are well established in 
several Member States including the UK, the Netherlands, Denmark and 
Ireland. Recent legislation in other states, such as Italy and most recently 
France, provides an opportunity for further developments in this area. 
14. In essence, increased reliance on second and third pillar funded schemes would 
imply a partial shift in responsibility for retirement income provision from 
governments towards employers and employees, and towards individuals. 
Economic considerations point to the desirability of pension systems (the 
combination of both state and supplementary) which incorporate both pay as 
you go and funded elements, as these are subject to different risks and returns. 
However, as the importance of supplementary pensions increases as a 
percentage of total retirement income, it will be increasingly important for 
governments to provide a secure environment for the efficient operation of 
supplementary funded schemes. The role that the Single Market can play is 
explored in the next chapter. 
D. Conclusion 
15. Demographic changes in all Member States have prompted consideration of 
their effect on the funding of state pension schemes. Continued reductions in 
benefits and restrictions in pension eligibility to help to ensure the viability of 
public, pay as you go, schemes is one option many Member States are already 
implementing, though there are further steps to take.. But this will have a 
negative impact on total retirement income levels. For this reason the trend 
towards the development of funded second and third pillar schemes is 
expected to continue. 
It must be clear however that the development of funded schemes in the EU 
will not of itself provide a solution to the current problems of pay as you go 
systems. The sustainability of these schemes can only be achieved through 
further internal reforms. Funded schemes can facilitate the reform of pay as 
you go systems by offering benefits that compensate for a reduction in benefits 
from pay as you go schemes. 
Chapter II RETIREMENT PROVISION AND EU CAPITAL 
MARKETS 
A. Size of EU pension funds 
16. The total assets in the EU of pillar 2 pension funds amount to 1 198bn ECU, of 
which the UK accounts for the largest share (717bn ECU or 65% of total) 
(Table II). In fact, the two Member States with the biggest funds, the UK and 
the Netherlands (261bn ECU), together account for 89% of total assets of EU 
pension funds. The pension funds of other Member States are relatively small 
in comparison. This is a reflection of the fact that they are either not funded, 
pay as you go or based on book reserves, or have a very low coverage (see 
Table I). The importance of UK and Netherlands funded schemes is reflected 
again when they are expressed as a percentage of national GDP (79% and 88% 
respectively), with other Member States falling well below this figure. The 
EU average is 20 % of GDP. For comparison, US pillar 2 pension funds total 3 
546bn ECU (60% of GDP) and Japan 1 800bn ECU (45% of GDP). 
17. The total assets of EU life insurance companies are nearly 50% higher than 
pillar 2 pension funds - 1 600bn ECU (Table III). This figure includes pillar 3 
pension policies but is made up principally of all life insurance savings 
schemes (that are not specifically designed for providing a pension) and life 
cover without a savings element (e.g. linked to a mortgage). Again the UK has 
the biggest funds (564bn ECU - 67 % of GDP) followed by Germany (380bn 
ECU - 21 % of GDP), France (317bn ECU - 30 % of GDP) and the 
Netherlands (138bn ECU - 46 % of GDP). The tax incentives given by each 
Member State are a factor in determining the size and growth of these funds. 
18. Predictions of the likely growth of pension funds and pension related life 
assurance funds are difficult. Much will depend on the rules obliging 
employers to provide cover (pillar 2) and on the encouragement given through 
tax breaks (pillars 2 and 3). At the moment pillar 2 schemes cover 22% of the 
EU working population and only account for 7% of total pensions paid to 
those covered by such schemes. Even if pillar 2 schemes in all Member States 
only grow to half the coverage of the Netherlands and UK (the Member States 
with currently the highest coverage but still growing) these funds will increase 
to 3 000 bn ECU. If they grow to have the same coverage as the Netherlands 
and UK they will reach 5 000 bn ECU. Similarly, given a favourable tax 
environment, the funds of pillar 3 schemes could also grow rapidly as more 
people decide to increase their reliance on individual pension schemes. 
B. How EU pension and life insurance funds are invested 
19 Pension funds and life insurance companies make investments in order to meet 
future obligations. The pattern of investment varies considerably between 
Member States. The UK and, to a lesser extent, Ireland stand out because of 
the high percentage of assets in equities (80% and 55% respectively, which 
compares to the US with 52%) and low percentage of bonds (see Table IV). 
However, funds in most other Member States rely much more on fixed income 
securities, mainly government bonds (e.g. 75% in Germany, 67% in France), 
and much less on equities (11% and 14% respectively). In all Member States 
real estate investments and short term placements are relatively small. The 
patterns of foreign to domestic assets also vary considerably. Most Member 
States' funds invest less than 10% in foreign assets. The UK and the 
Netherlands stand out, with 30% and 25% of their assets being non-domestic. 
20 The pattern of actuel investment for the assets of life insurance companies is 
similar to that of pillar 2 pension funds (see Table V). Most assets are in fact 
held in domestic fixed income securities (mostly government) (e.g. Germany 
75% of total, France and Italy 70%). Assets held in equities are much less 
important (e.g. Germany 5%, France 18% and Netherlands 12%). The UK is 
an exception with nearly 50% in domestic and over 10% in foreign equities. 
The reliance on fixed income securities in the UK is much less (25% of total). 
C. Returns on pension fund assets 
21 Many studies show that over the longer term equities have tended to have a 
higher rate of return than bonds (see Table VI), though this is not inevitable for 
the future. The investment strategy of a pension fund or life insurance 
company and the portfolio balance between equities, bonds, real estate and 
short term placements are principal determinants of the rate of return on 
overall assets. Because of the greater volatility of equities, any figures on rates 
of return are sensitive to the period over which these returns are measured. In 
the short term, therefore, equities could be outperformed by bonds, or could go 
down in value. Nevertheless, it is believed by some observers that because of 
the higher returns associated with equities over a long period, and because 
pension funds require investment over the long term, there is scope to increase 
the rate of return on some EU pension and life assurance funds, which 
currently hold a high proportion of government bonds, by increasing the share 
of equities in their investment portfolio. 
->o It is difficult to get unequivocal evidence on this potential for higher equity 
holdings to increase returns. Any period selected is arbitrary. However over 
the period 1984-93 (Table VII) pension funds in the UK and Ireland, with 
important equity holdings, had high real rates of return (10,2% and 10,3% 
respectively). Member States with around a third of their assets in equities had 
lower real rates of return (Sweden 8,1%, the Netherlands 7,7%, Belgium 
8,8%). The Member States with the lowest proportion of equities in their 
investment portfolio and a high percentage of government bonds had the 
lowest returns (Germany 7,1%, Spain 7,0% and Denmark 6,3%, the latter 
partly as a result of the tax on real interest rate). Other sources over other 
periods do not however give such clear results. 
D. Impact of differences in rate of return 
23 The previous section showed significant differences in the real rate of return of 
EU pension funds and life insurance funds - with over 6 percentage points 
difference over the period 1984-1993 between the worst and best performers. 
In a funded scheme, returns need to be sufficient to deal with the effects of 
salary inflation over the long term. An increase in the annual rate of return of 
say 2 or 3 percentage points can make an enormous difference over a working 
life and should not be underestimated. 
Assume the target is a fixed supplementary pension of 35% of salary on the 
basis of a 40 year working life. If the real rate of return on assets is 6%, the 
cost is 5% of salary: all other things being equal, if the real rate of return is 
4%, the cost is 10% of salary, and if the real state of return is only 2% the cost 
is 19% of salary. Low rates of return on pension funds and life insurance 
assets will therefore mean: 
either much higher contributions from employers and employees: this will 
affect the indirect costs of labour, and therefore have an adverse impact on 
the EU's job creation ability; 
or much lower pensions for the same contributions and therefore more 
pressure on government spending in pillar 1. 
It should be stressed that the Commission is not advocating any particular 
investment strategy for pension funds. It is the role of the fund managers to 
determine the best investment strategy for the ultimate benefit of pensioners, 
subject only to appropriate prudential supervision. This Green Paper is 
exploring the role the Single Market can play in the future to maximise the 
investment possibilities of fund managers whilst maintaining adequate 
prudential control. It discusses whether the current rules of prudential 
supervision in some Member States are disproportionate in that they go 
beyond what is objectively necessary to ensure the security of funds, and at the 
same time prevent the development of a real Single Market in pension funds 
for the benefit of pensioners and future pensioners ( see Chapter III). First, 
however, it examines some of the asset management and supervisory 
techniques that are consistent with a Single Market in pension funds. 
E. Can higher returns be achieved without undue risk ? 
24 Because their liabilities are long term, pension and life assurance funds can 
afford to take advantage of the generally higher returns offered in equities and 
long term placements. However, it is recognised that equities entail a higher 
risk than bonds, especially government bonds, and that long term bonds 
present a greater risk than short term bonds . 
25. Clearly, it would be unwise to pursue only high rates of return without any 
concern for the risk involved. Many of the regulations in the Member Stales 
focus on prudential controls designed to reduce risks to which funds are 
susceptible. 
26 Advocates of modern risk management techniques suggest that such 
techniques allow managers to control risk while investing in assets with 
greater volatility but higher rates of return. These techniques aim to capture 
the return from the risk premium of equity while avoiding excessively high 
levels of volatility. In evaluating risk and making asset allocation decisions, it 
is more appropriate to focus on the relationship between assets and liabilities, 
and not solely on assets. For example funds would tend to make assets 
progressively liquid to match the date the liability is due - this avoids the 
effects of last minute bear markets or interest rates rises. Thus different 
pension funds (e.g. young schemes with many contributions relative to pay­
out, or old schemes with large pay-outs relative to contributions) should in all 
likelihood adopt different investment strategies because their asset/liability 
profiles are different. In this way they can maximise returns at minimum 
increased risk. 
27 In essence, asset/liability management (ALM) seeks to concentrate portfolios 
on long term assets with the highest returns, compensating for the increase of 
risk by pooling across assets whose returns are imperfectly correlated 
(diversification). Thus one asset with a high return but which is risky (i.e. 
volatile) may be offset by another high return but risky asset, if these risks are 
not positively correlated. 
28 It is argued that diversifying assets is in fact a prudent approach, because over 
concentration in any one asset can increase risk and reduce rates of return. 
Even government bonds can fluctuate with changes in interest rates and 
inflation expectations. Consequently, over concentration of a portfolio on 
assets such as government bonds, that are regarded as "safe", can actually 
increase risk in comparison to a diversified portfolio, without obtaining higher 
returns . Investment in a selection of imperfectly correlated markets will 
provide managers with a spread of diversified investments, and reduce 
potentially the risk of over concentration in assets denominated in one 
currency. One commentator concludes: 
"Restrictions imposing arbitrary limits on asset holdings by type of asset, 
country or currency distribution run contrary to the prudential principle 
because they severely limit risk diversification. This constraint forces pension 
funds to assume more risks, while sacrificing return, and to conduct 
investment policies that are detrimental to their members in the long run ". 
29 This approach to asset/liability management is the basis of the "prudent man" 
management and supervisory technique used in some Member States. They 
judge the financial viability of the pension fund or life insurance company by 
assessing the match between its financial assets and its liabilities over the 
expected life of the scheme, taking into account relevant considerations such 
as the type, size, development and rate of funding of the scheme, and the 
volume and nature of the fund's liabilities. When applying such asset/liability 
management principles, managers will also work within any investment 
principles imposed by, for example, the trustees or board. It is not a laisser 
faire supervision. On the contrary, it imposes on supervisors the obligation to 
ensure that the respective roles of manager and trustee/custodian/depositary 
are fulfilled in such a way as to ensure, in turn, that scheme members' benefits 
are secure. 
30 The role of the supervisory authorities would need to be more dynamic if a 
qualitative approach to the investment of pension fund assets were to be 
pursued. Quantitative yardsticks would be much less prominent. When 
examining the financial health of a fund, supervisors would focus separately 
on its short and long term liabilities and on its investment horizon, the rate of 
funding in relation to liabilities and the need for the particular liability 
structure to be matched with an appropriate asset structure through an 
acceptable asset/liability management approach. 
F, How could EU capital markets absorb future increases in EU pension funds 
and life insurance investments ? 
31 The development of funded supplementary schemes in the EU will increase 
the amount of financial assets available for investment. This growth will be 
very significant, but gradual. This section explores what advantages the 
creation of a real Single Market could have in increasing liquidity and 
reducing costs for pension funds. It also examines the structural changes in EU 
capital markets likely to come about as a result of increased investment by 
pension funds. 
32 The supply of government bonds is unlikely to match the growth in financial 
assets of pension funds. 
Other vehicles for investment include principally equities and corporate bonds. 
These can be expected to play a greater role in the EU capital market in the 
future. In the US market capitalisation is much greater in relation to GDP (US: 
68%; EU: 32%) (see Table VIII) and the increase over time in pension fund 
assets has been successfully taken up by capital markets to provide adequate 
pensions. 
Because Ell pension funds will have to find new investment outlets, private 
sector equity could, gradually, become one of the likely outlets for many 
funds. However the privatisation of state owned enterprises is likely to 
represent a relatively small proportion of the market as a whole. In addition, 
EASDAQ and stock markets for small company shares in a number of 
Member States could supplement conventional issues of equity available for 
pension and life insurance fund investment. Other new equity might also be 
issued by EU firms replacing to some extent the traditional sources of 
corporate finance in Europe. 
An additional area for development in the EU, as an alternative in appropriate 
circumstances to equities, is the corporate bond market. The market for 
corporate bonds is underdeveloped in the EU by comparison with the US, 
where the market is more than 7 times larger. If the US experience is mirrored 
in the EU, it may be expected that the market for corporate bonds will increase 
markedly in size. 
33. Capital markets will adapt to take up these funds. Some of this capital may go 
outside the EU, though normal asset management practices would result in 
most of these remaining inside the EU . However if Member States capital 
markets are kept separate, they will be less liquid and be less able to take up 
successfully these funds. Therefore barriers to flows of capital which are not 
objectively justified on prudential grounds, will reduce the efficiency of this 
process. The Investment Services Directive has already removed many of the 
barriers to the functioning of EU capital markets. In addition stage 3 of 
Economic and Monetary Union will help this process by eliminating exchange 
risks for investors investing in securities issued in the currencies of 
participating Member State. Other obstacles, such as transaction costs and 
delays in implementing investment decisions, will also be reduced by a single 
currency, and should contribute to increased investment activity. Chapter 111 
examines remaining prudential rules, applied by Member Stales, that are an 
impediment to freedom of capital flows and asks whether they are objectively 
justified. 
34 Competition between financial institutions and between financial centres in the 
EU, together with the growth in financial assets available for investment, will 
lead to improvements in the EU capital market by reducing costs and 
increasing liquidity. This will be reinforced by EMU, which provides the 
opportunity for further development of an EU-wide capital market. 
Question: The Commission seeks views on the analysis in this chapter. 
14 
Chapter III APPROPRIATE PRUDENTIAL RULES FOR A 
SINGLE MARKET 
A. Role of supervision of pension and life insurance funds and fund managers 
35. It is clear that pension and life insurance funds and the managers of these 
funds must be subject to prudential supervision. Consumers (i.e. future 
pensioners) must be protected in an area where they have little knowledge. 
Supervision must ensure that fund managers execute their fiduciary duties 
correctly. The regulatory approaches towards pension funds differ widely 
between Member States. In some states they are covered by regulations 
specific to pension funds; in others, they are regulated on the same footing as 
life insurance companies. This means they are subject to the same minimum 
solvency requirements, rules as to technical provisions and investment 
restrictions and other provisions as life insurance companies. 
36 Whilst national regulations differ, there are commonalities in approach. 
• A requirement for pension funds to be authorised or approved by a 
competent authority. 
• Authorisation or approval could be dependent on fulfilling certain 
criteria, such as the suitability and approval of managers of pension 
funds and custodians/depositaries/trustees of the funds' assets; the legal 
form of the fund. 
• A requirement for prudential supervision of the fund, including regular 
reporting rules and powers of intervention by the supervisory authority. 
• Minimum prudential rules on the investment of members' 
contributions, in particular requiring that they be invested prudently. 
Question: Do interested parties agree that these points provide an 
appropriate basis of regulation? 
B. The effect of excessive rules on pillar 2 pension fund investments 
37. There are no specific EU harmonization rules relating to the investment by 
pension funds of their assets beyond the principle of, and general rules relating 
to, the free movement of capital '. These are intended to guarantee to all 
investors, including pension schemes, the freedom to invest where they wish in 
the EU. The Treaty permits" investment restrictions to be imposed if these 
can be justified on prudential grounds. Member States may not use this 
exception to the freedom as a means of discriminating against foreign assets, 
nor as disguised, non-prudential restrictions introduced for other reasons. 
!5 
21 
Further, the Treaty prohibits any 'privileged access' by central, regional or 
local government to financial institutions, including pension funds, through the 
imposition of minimum investment requirements, except on prudential 
grounds. The Commission is in the process of taking action against Member 
States that discriminate for non-prudential reasons against foreign assets. 
38. Many Member States have restrictive rules that generally fix the maximum 
percentage of a fund that can be held in a particular asset or currency (see 
Table ÎX). Germany is an example of such an approach. It fixes the following 
maximum asset levels: 30% equity, of which a maximum of 6% may be non 
EU equities, 25% EU property, 6% non-EU bonds, 20% overall foreign assets 
and 10% self-investment limit. Pension funds in Member States with such 
quantitative rules tend to hold a high proportion of assets in government 
bonds. 
39. Member States' rules defining the appropriate supervision can have the effect 
of frustrating the Single Market and the investment advantages it can bring. 
The Commission believes that in many cases they go beyond what is 
objectively necessary to maintain adequate prudential supervision. There are 
other prudential rules and techniques that are consistent with a Single Market 
and maintain equivalent prudential security. In particular, Member States' 
prudential rules relating to investment portfolios can have the effect of 
obliging pension and life insurance funds to invest a large proportion of their 
assets in domestic government bonds. Even so the actual investment pattern of 
investment by pension funds in several Member States has in effect not 
reached the limits fixed by the rules. For example in Germany pension funds 
only invest 6% in foreign assets (maximum allowed 20%) and 11% in equities 
(maximum allowed 30%) . 
Question: The Commission would like to know how far quantitative 
restrictions limit in fact the investment strategy of pension funds, particularly 
in Member Slates where the maximum permitted proportion of equities is not 
reached. 
Will these restrictions begin to have a greater impact on investment policy if 
as is predicted, funds available for investment increase considerably in the 
future and the opportunity for investment in government bonds is restricted by 
lack of supply? 
40. In the past the Commission has twice put forward a specific interpretation of 
- 2^ 
the Treaty rules tor pension funds: first, in a draft Directive that was 
withdrawn because the amendments proposed by Member States would have 
legitimised restrictions on pension funds rather than liberalised them; 
secondly, in a Communication "\ which was annulled recently by the 
European Court of Justice on the basis that the Commission intended to 
27 
impose new binding obligations on Member States . 
The Commission believes the objectives of the withdrawn Directive and the 
Communication still need to be pursued, in a broader context: in fact all the 
16 
more so in view of the increasing awareness of the need to reform pension 
systems with a view to ensuring their sustainability. These policy objectives 
may be summarised as follows: 
freedom for fund managers who are authorised in accordance with the 
Investment Services Directive, the Second Banking Directive or the 
28 
Third Life Insurance Directive to offer services all over the EU; 
freedom to invest assets of pension funds under the "prudent man" 
principle; diversification of assets, including diversification into assets 
denominated in currencies other than that in which the liabilities of the 
institution are established; removal of any requirements on pension 
funds to invest in or refrain from investing in particular categories of 
assets, nor to localise their assets in a particular Member State, 
otherwise than on justified prudential grounds. Any restrictions 
imposed on prudential grounds must be proportional to the objectives 
they may legitimately pursue . 
41 It is not anticipated that removing restrictions would open the floodgates to an 
alternative style of fund management. Fund managers would take time to 
adapt to a new investment strategy; in addition, there is evidence of home 
country bias as well as the normal prudential policy of keeping the bulk of 
assets in the same currency as the liabilities. Thus despite the absence of 
restrictions on foreign equity investment, the proportion of such investment is 
only around 25%-30% in those Member States with the most liberal 
investment regimes. A further observation in this context is that- fund 
managers very often do not currently take advantage of the investment 
freedom they do have, so a rush towards equities appears unlikely. 
Question: Do interested parties agree that the approach to EU supervisory rules 
described above could provide adequate prudential security at the 
same time as offering the advantages of the prospect of higher returns 
within the framework of a real Single Market for pension funds? 
C. Rules on pillar 3 life assurance investments 
42. In contrast to pillar 2 schemes, where there is no specific EU harmonisation, 
the rules for pillar 3 life insurance schemes are harmonised under the Single 
Market provisions' . Once a life insurance company is authorised and 
supervised in one Member State, it effectively has a European passport and 
can sell its products in other Member States. A level playing field for 
competition between insurance companies in different Member States is 
established and consumers are protected. 
43. The relevant EU rules for investment by life insurance companies are given in 
fable X31. Of particular significance are the following: 
- investment shall be based on the prudent man principle; 
17 
- Member States may not require insurance companies to invest in particular 
categories of assets, and 
- Member States cannot oblige an insurance company to keep more than 80% 
of its assets in a currency matching its liabilities. 
A minority of Member States have a flexible approach to supervision, and 
insurance companies in such Member States hold a high proportion of assets in 
equities, including foreign equities. Most Member States however adopt a 
quantitative approach to supervision, similar to the approach they follow in 
respect of pillar 2 pension funds (see Table XI). In fact in such Member States 
most insurance company assets are kept in domestic fixed income securities 
(Germany 75%, Spain 55%, France 68% and Italy 70%), despite the scope 
under the rules to invest in equities and foreign assets (equities or bonds, for 
example) to a greater extent. 
Question: The Commission would like to know how far life insurance 
funds in Member States that impose quantitative limits are in fact restricted or 
are likely to be restricted in the future in their investment strategy by national 
rules. It also asks whether the quantitative limits imposed by Member States 
should be changed along the lines described in section B for pillar 2 schemes. 
D. Should there be similar EU rules for pillar 2 and 3 schemes ? 
44. This Green Paper has examined the prudential rules concerning the 
investments made by pension and life assurance funds (i.e. the assets side of 
the balance sheet).The question also arises as to whether pension funds should 
be subject to rules similar to those that exist for life assurance on the liabilities 
side of the balance sheet - in particular is there a need to harmonise the 
technical provisions and the 4% solvency margin of own funds \ This is 
especially the case where they are in direct competition, in particular where 
employers use life assurance companies to provide employment related 
pensions (pillar 2) in the form of "group schemes" which are subject to the 
33 
harmonised rules for pillar 3 schemes (see Table XII). 
As regards this point, the organisation representing European insurers (Comité 
Européen des Assurances - CEA) argues that pillar 2 pension schemes should be 
subject to-the equivalent prudential rules whether they are managed or operated 
by a pension fund or life insurer. The Commission considers there are four 
options: 
Option I: make funds of pillar 2 schemes subject to the rules currently 
applied to group life schemes 
Option II: adapt the current rules on the solvency margin for group life 
schemes to the framework currently applied to pillar 2; 
IK 
Option III: define new common EU standards for both pillar 2 
schemes and group life assurance. The Commission would be 
interested to hear any concrete suggestions; 
Option IV: accept the differences that currently exist because de facto 
they do not lead to significant distortions of competition. 
Question: Before making up its mind the Commission seeks the view of 
interested parties. 
E. Fund managers 
45. Authorised fund managers are already entitled to sell investment services 
throughout the EU on the basis of the Treaty as well as of harmonised 
criteria . These fund managers are also entitled to offer their services to 
manage pension funds across borders. Restrictions on this freedom can act as a 
barrier to improving returns on investments, and infringe Treaty freedoms 
relating to the free provision of investment management services in the Single 
Market35. 
46. Efficient management of a pension portfolio implies an appropriately 
diversified investment strategy, which can require external specialised advice. 
Pension schemes need to be able to call on advice and management services 
from the most appropriate source, which might be from a manager established 
in another Member State. A fund manager in another Member State might be 
more aware of non domestic investment opportunities both within the EU and 
outside it. There should be no impediment to a pension scheme's ability to 
call on such services. The Commission also considers that increased 
competition could lead to lower management charges or more efficient 
management of these funds. Even a one percentage point annual cost 
advantage or efficiency gain over a working life is an enormous saving. 
Question: The Commission seeks views on this point, and asks also 
whether any current impediments provide actual barriers to the cross border 
provision of services by pension fund managers. 
F. The way forward 
47. This Green Paper has suggested that changes may be desirable to the rules 
governing the prudential supervision of pension and life insurance funds. If it 
is decided to make these changes the question arises as to the most efficient 
instrument to carry them out. There are several possibilities. 
Option 1. Rely on introduction of euro. This option would reduce the 
impact of currency matching requirements lor participating Member States. 
Any assets in a participating Member State would automatically be in a matched 
currency. Such an approach requires no additional legislative or enforcement 
effort on the part of the Commission. However this approach would not solve 
19 
the problem of any unjustified quantitative rules that limit investment in certain 
classes of assets (e.g. equities) so de facto obliging investors to buy 
(government) bonds. It would not help solve the problem for funds located in 
Member States not participating in the euro with either currency matching or 
quantitative limits. However, this approach could be combined with the second 
option. -
In parallel to the introduction of the euro Member States might also make 
unilateral changes to their national regulations in order to facilitate more 
efficient pension fund management. Such changes would be a matter for 
Member States, and would depend on their perceptions about what is 
appropriate for their particular situation. 
Option 2. Apply current Treaty freedoms. This option would rely 
simply on the obligations created by the current Treaty freedoms relating to 
movement of capital and to the provision of services. The Commission could 
issue guidelines as to how it interpreted these basic freedoms for the investment 
of pension and life insurance funds and fund managers to offer their services. It 
would then examine for each Member State both its general rules and decisions 
in individual cases, to see if they were justified on prudential grounds. Where 
the rules or decisions were not justified, the Commission would be obliged to 
start infringement proceedings under the Treaty. The case law would then 
develop to show the practical interpretation of Treaty rules. Such an approach 
however has certain disadvantages: 
it would take time for the practical application of the basic legal 
principles to become clear; 
it could lead to legal uncertainty. This is particularly so because case 
law could easily identify clearly abusive cases but would have greater 
difficulty in deciding marginal cases where the border between justified 
and unjustified prudential restraints is not a simple bright-line test; 
there is a risk that interpretation derived from case law, which is based 
on an adversarial procedure in individual cases, would become rigid. It 
might not allow for sufficient change and flexibility in the rapidly 
evolving and technical area of financial supervision. 
Option 3. Adoption of a Directive. An alternative approach would be 
harmonisation by a Directive setting out basic principles. It would allow the 
interpretation of Treaty provisions in this technical financial area to be worked 
out in cooperation with all partners. A Directive could incorporate mechanisms 
for cooperation between the Commission and national supervisors to interpret, 
and update in line with changing circumstances, the practical application of 
basic Treaty freedoms for the supervision of pension and life insurance funds. 
The publication of an opinion, arising from such co-operation, on interpretation 
and application of the Directives could lead to transparency and certainty. This 
approach has been tried before, unsuccessfully. The difficulties of obtaining a 
consensus between Member States on Community legislation in this area are 
20 
clear; it is possible that the heightened interest in the role of funded 
supplementary schemes might lead to a greater consensus. 
Question: The Commission seeks the views of interested parties. 
21 
Chapter IV FACILITATING THE FREE MOVEMENT OF 
WORKERS 
A. General considerations 
48. Article 51 of the EU Treaty requires Community legislation to be adopted in order 
to remove all barriers in the sphere of social security which impede a genuinely 
free movement of workers. 
On the basis of this Article ', the Community has already adopted legislation 
(Regulations 1408/71 and 574/72 ), which removes obstacles to cross-border 
mobility of workers in the field of statutory pensions. This legislation does not 
apply to supplementary pension schemes. 
More and more qualified and highly qualified people make use of their right to 
free movement. For this category of people, supplementary pension schemes 
contribute substantially to their social protection. 
B. Obstacles to free movement of persons relating to supplementary pensions 
49. In its Communication of July 199T , the Commission started a discussion at 
Community level on the role of supplementary pension schemes and their impact 
on free movement. 
As a follow up to this communication, the Commission services have explored on 
several occasions, in conjunction with the representatives of Member States, 
Social Partners and pension funds, how to remove obstacles to cross-border 
mobility of employed and self-employed persons in the European Union in -the 
field of supplementary pensions. 
Given the specific nature of many supplementary pension schemes and their 
extreme diversity at national level as regards their origin, their occupational and 
material scope, as well as their legal and technical forms, the current coordination 
system created for statutory schemes does not seem to be the appropriate 
instrument to address the problems. A more flexible approach is required. 
50. In February 1996 the Commission decided to ask a High Level Panel on Free 
Movement of Persons chaired by Mme Veil to deliver an opinion inter alia on the 
measures to be taken in order to eliminate the obstacles to freedom of movement 
of workersr which arise in the context of supplementary pensions. 
The panel presented its report in November 1996. It came to the conclusion that 
legislative action at Community level is necessary but that it should be confined, at 
least initially, to a three-pronged approach, encompassing the following elements: 
22 
a) Preservation of acquired rights for members who cease active membership of a 
supplementary pension scheme as a consequence of moving from one Member 
State to another at least to the same extent as for members ceasing membership of 
the scheme but remaining within the Member State in question. 
This specific point is inspired by a basic principle of Community law, namely that 
of "equal treatment". This means that a worker who leaves a supplementary 
pension scheme in order to work for another employer in another Member State 
should not lose the rights already acquired in the first scheme which he would 
have had preserved had he/she changed employer while remaining in the same 
Member State. 
b) Cross border payments: Member States should ensure the application of another 
fundamental principle of the Treaty (free movement of capital and payments) by 
taking measures in order to permit payments in other Member States of all benefits 
due under supplementary schemes. 
c) Measures allowing workers temporarily seconded by their employer in another 
Member State to remain affiliated to the supplementary pension scheme in the 
country in which they were previously working. To this effect all obstacles to 
cross border affiliation should be eliminated. 
As a first step towards dealing with the obstacles to free movement arising in the 
area of supplementary pensions, the Commission intends very soon to present a 
proposal for a Directive concerning the aspects highlighted by the High Level 
Panel's report. This has already been announced in the Commission's 
Communication on improving social protection in the European Union. 
51. The Commission is also considering the usefulness of establishing a Community 
Pensions Forum, as suggested by the High Level Panel. This Forum would be 
constituted by representatives of the Member States, the Social Partners and 
pension funds. Its purpose would be to explore the possibilities for solving the 
outstanding problems for mobility in the context of occupational pensions. For 
instance, by bringing together the different interest groups, it could serve to find 
solutions to the problem of non-recognition of pension schemes as between the 
Member States. In general, its task would be to advise the Commission on the best 
way to overcome the remaining obstacles to free movement. 
52. As has been indicated above, there remain, however, a number of obstacles to free 
movement, other than those which will be dealt with by the proposal for a 
Directive. The problems identified can be summarised as follows: 
• burdensome qualifying conditions for acquiring supplementary pension 
rights, including long vesting periods; 
• difficulties with transferability of vested pension rights from one Member 
State to another; 
• tax difficulties linked to acquiring pension rights in more than one Member 
State; 
• the specific disadvantage of changing schemes arising in the case of a worker 
other than a seconded worker who goes to work only temporarily in a 
Member State other than that in which he/she has been building up pension 
rights. 
53. Qualifying conditions for acquiring rights 
The acquisition of vested rights often takes place after several years of 
employment in a company (ten years under German law) and sometimes only at 
the time of retirement. Any job change before the acquisition of a vested right 
implies that no occupational pension will be paid in respect of this period of 
employment. Some pension schemes cover however all employees of a given 
industry (e.g. construction industry). In this case job changes within the industry 
and within a given country will not be penalised by the loss of pension rights. 
Cross-border job changes, however, do involve a switch to a new pension scheme. 
This can therefore be considered as an obstacle to the cross-border mobility of 
labour. 
54. The reason for this is the negative impact on free movement of lengthy vesting 
periods, either because a worker hesitates to leave his original employer for fear oï 
losing the rights he/she has been building up, or because he/she is reluctant to 
move to a Member State where lengthy vesting periods are the rule because it will 
take too long to build up the right to a pension. For example, an Italian or Spanish 
migrant worker in Germany may have to stay 10 years with the same employer in 
order to obtain an acquired right under an occupational pension scheme in this 
country. 
55. Difficulties with transferability of vested pension rights from one Member State to 
another including the lack of approved mechanisms for recognising pension 
funds. 
On the question of transferability, there are at present obstacles to transferring 
acquired rights to a scheme in a Member State other than that in which they have 
been constituted. These obstacles may take the form of legal regulations or of 
scheme rules. 
If a job leaver has obtained a vested right it will be necessary to decide what to do 
with this right. Two possibilities exist: rights can be preserved in the pension 
scheme in which they were acquired, and the job leaver will be able to draw a 
pension from this scheme once he/she retires. The alternative, if the nature of the 
scheme allows, is to pay out a capital value representing vested rights. This capital 
value can then be used to buy a deferred annuity from an insurance company or be 
paid into the new pension scheme, provided of course the new scheme accepts the 
transfer. 
24 
56. Capital transfer seems to be a straightforward solution in the case of funded 
pension schemes, but is not normally used in the case of book reserve plans and 
pay-as-you-go schemes, neither of which set aside financial assets to back up 
their pension promises. Many job changers therefore have only one option, i.e. 
39 
that of preserving their rights in the previous pension scheme . In either case -
transfer or preservation - future pay rises will not normally be taken into account 
as they would be after an uninterrupted career with the same employer. 
Frequently, not even expected price or average earnings rises are taken into 
account for the calculation of transfer values. As a result, there is a tendency for 
scheme leavers not to get their fair share out of a pension fund. 
Calculation of transfer values which penalise scheme leavers and inadequate 
preservation of "dormant" rights are severe obstacles to labour mobility. 
57. Tax difficulties linked to acquiring pension rights in more than one Member State. 
Although direct taxation is largely within the competence of the Member States, 
Member States must exercise their powers consistently with Community law. In 
this regard, it should be noted that Article 48 implies not only the abolition of any 
discrimination based on nationality but also the suppression of any national 
measure likely to impede or render less attractive the exercise, by Community 
nationals, of the fundamental freedoms guaranteed by the Treaty. Chapter VI 
below deals more generally with taxation issues. 
Workers who wish to exercise their right to free movement within the Union may 
come up against tax obstacles when trying to transfer accrued benefits (where this 
is possible) from a funded scheme in the home state to a scheme in the host state. 
The transfer from the home state scheme may be subject to a tax charge; this can 
lead to tax disadvantages where the host state does not give tax relief for the 
incoming transfer, but the benefits are ultimately received subject to income tax. 
This illustrates the unfavourable position that workers exercising their right of free 
movement can find themselves in by comparison with those who transfer accrued 
benefits within a Member State. 
58. The specific disadvantage of changing schemes arising in the case of a worker 
who goes to work for a short term period in a Member State other than that in 
which he has been building up pension rights. 
Two situations can be distinguished: 
• Workers seconded by their employers to another country in the context of the 
same company or associated companies: this situation will be dealt with by 
the proposal for a Directive, which is mentioned above. 
• All other workers moving for a limited period to another Member State: 
These workers, as much as seconded workers, are disadvantaged by changing 
25 
pension schemes. This constitutes a discouragement of free movement of 
labour across Member States' boundaries. 
C. Possible approaches 
59. One question which has been raised is whether it would be feasible to deal only 
with the obstacles encountered in the context of compulsory schemes, as opposed 
to voluntary schemes. It is argued that a regulatory initiative applying to voluntary 
schemes would act as a disincentive to employers who would otherwise choose to 
establish such schemes. It seems difficult, however, to treat differently regimes 
which, so far as the worker is concerned, have the same purpose of completing his 
or her pension provision. To exclude voluntary systems would have very different 
effects according to the Member State concerned. 
60. From the consultations carried out, it appears that a particular problem arises in 
relation to any proposal of limitation, imposed by Community legislation, of the 
length of vesting periods. However, lengthy vesting periods whatever their 
advantages in other areas may be, constitute obstacles to free movement; so it is 
necessary to consider how this problem might be overcome. This could be done 
by legislation at Community level, which would impose a maximum number of 
years by way of vesting periods. It could also be specified that no Member State 
could increase the length of existing vesting periods. Another option could be that 
the Community should not propose anything by way of legislation in this area, 
and should rather limit itself to promoting the debate at European level by the 
social partners. 
61. On the question of transferability, the approach discussed with Member States and 
social partners so far is to require that transferability should be allowed where the 
nature of the scheme permits (typically, funded systems). In other cases, 
preservation would be the only option. It could also be required that the amount 
transferred be given a fair actuarial valuation, both by the transferring scheme and 
the scheme receiving the worker. 
In order to resolve technical problems relating to the transferability of pension 
rights such as the transfer of rights only to approved supplementary pension 
schemes or the establishment of actuarial standards of transfer values, the creation 
of a Community Pension Forum, as suggested by the High Level panel, made up 
of representatives of Member Slates, the Social Partners and Pension funds, could 
be useful. 
62. In order to remove tax disadvantages. Member States could be encouraged to 
include specific provisions on the tax treatment to be given to contributions, 
transfer values and benefits in their bilateral double taxation treaties. Although 
this would allow individual agreements to be adapted to the specificities of the tax 
systems concerned, agreeing specific provisions in all the bilateral treaties would 
be a lengthy and cumbersome process. It would also be less transparent than 
having common rules at Community level, although such rules might be difficult 
to negotiate. 
26 
63. The proposal for a Directive as referred to above will in principle contain 
measures allowing workers temporarily seconded by their employer in another 
Member State to remain affiliated to the supplementary pension scheme in the 
State in which they were previously working. 
This possibility of trans-border affiliation could be extended to all workers 
moving for a limited period to another Member Slate. This would require an 
agreement between the employer in the State of origin, the employer in the Host 
Member State, the worker, and, where applicable, the supplementary pension 
scheme in question. 
Questions: 
1. Is action at Community level required in order to overcome the identified 
obstacles to free movement (i.e. other than those which will be dealt with in the 
forthcoming proposal for a directive) in the field of supplementary pensions? 
2. If so, which action would be the most appropriate for each of the identified 
remaining obstacles (legislation, agreement between social partners)? 
3. If not, how could the remaining identified obstacles to free movement he 
removed? 
4. Which further initiatives should the Commission take in order to remove the 
remaining obstacles to free movement? 
27 
Chapter V THE IMPORTANCE OF TAXATION FOR 
SUPPLEMENTARY PENSIONS 
A. General considerations 
64. The taxation of retirement provision is of particular importance in the design 
of any funded supplementary scheme, and most, if not all. Member States give 
some form o\' tax privilege. The design of pension schemes and the choice 
between different models of taxation are, however, essentially a matter for 
Member States. Each national government must decide which tax environment 
will be most effective for its circumstances, bearing in mind the exchequer 
costs of giving reliefs. The tax rules which have been developed over many 
years are extremely complex and specific to each Member State. They contain 
detailed regulations whose purpose is to ensure that government income that is 
foregone to encourage saving for retirement is used only for that purpose. 
65. This diversity leads to a situation where taxation can be a barrier to free 
movement of people and the free provision of services. Tax privilege usually 
depends upon a scheme meeting a number of detailed rules, and, as a 
consequence, a scheme that is approved in one Member State is very unlikely 
to meet the tax requirements for schemes in another. This has the practical 
effect of discouraging contributions to pension funds established in other 
Member States. 
66. Within this framework, the Commission is concerned that any specific tax 
rules should be consistent with the fundamental Community principles of 
freedom of movement of persons and of provision of services. This applies 
both to pillar 2 and pillar 3 pension arrangements. For pillar 3 arrangements 
the Third Life Directive now provides for the free provision of services in the 
EU, on the basis of home state supervision. The removal of supervisory 
barriers to cross-border business by insurance companies has, however, 
highlighted some tax disadvantages which can occur, particularly in relation 
to the tax deductibility of life assurance premiums. 
67. Tax rules that discriminate against a policyholder who buys a policy from an 
insurer established in another Member State run contrary to the freedom to 
provide services. In its decision in the Bachmann case ~ however, the 
European Court of Justice held that such discriminatory provisions might be 
retained to the extent that they are necessary to preserve the particular 
coherence of the tax system of a Member State. In this case the EC.I upheld a 
provision of Belgian tax law whereby premium relief for life assurance 
contracts was only permitted in respect of policies issued by companies 
established in Belgium. The reason was that relief on premiums was linked to 
taxation of the policy proceeds; if relief were given on premium payments 
made to foreign insurers, the Belgian tax authorities would not be certain that 
tax would ultimately be paid on the proceeds. 
28 
68. In a later case the Court has made it clear that fiscal coherence could not be 
invoked as a justification in circumstances where a Member State had 
voluntarily given up that coherence, for example in the provisions of a double 
taxation treaty with another Member State. The judgment in the Wielockx 
case " shows that a Member State should take into account the effect that 
double taxation agreements might have on the fiscal coherence that the 
particular measure creates at a national level. If under the terms of a double 
taxation treaty a Member State allows benefits paid to non-residents to be 
taxed only in the country of their residence, the inability to tax these payments 
should not be a reason for denying tax deductibility only when the 
contributions are paid to a scheme that is established elsewhere in the 
Community. 
B. Avoiding double taxation 
69. Each Member State has entered into a large number of double taxation 
agreements with other states, both within the Union and outside. These 
treaties, which are nearly all bilateral in nature, are designed to promote 
economic activity by removing the possibility of double taxation, while at the 
same time ensuring co-operation to combat tax evasion and fraud. Within the 
Union, 98 of the 105 possible bilateral relations are currently covered by such 
a double taxation agreement. Where no bilateral treaty exists, some Member 
States allow relief from double taxation on a unilateral basis. 
70. When it comes to the taxation of occupational pensions, existing agreements 
tend almost exclusively to concentrate on eliminating the double taxation of 
pensions when they are paid. Most bilateral treaties follow Article 18 of the 
OECD Model Treaty in giving the country in which the taxpayer resides the 
exclusive right to tax pension income from a private employment. (On the 
other hand, pensions for public service are covered by Article 19 of the OECD 
Model, and are generally taxed in the country in which they originate.) Even 
though some recent bilateral tax agreements give taxing rights over pensions 
from private employment to the source country, the essential principle of 
preventing double taxation holds good. In this way, the same income will not 
be taxed twice. 
71. A few bilateral agreements between Member Stales, such as the ones between 
France and the UK and between Denmark and the UK, specifically cater for 
pension contributions which a migrant worker may continue to pay to a 
scheme in one country after moving to the other. These provisions, which go 
beyond the scope of the OECD Model, essentially provide for a form oi^ 
mutual recognition of tax-approved pension schemes in the other country. This 
has the result of allowing the migrating worker to continue to get tax relief in 
his or her new country of residence on pension contributions paid to the former 
one. These steps can result in the lifting of barriers to mobility of workers. 
29 
C. The case for a common approach 
72. Bilateral double taxation agreements have the considerable advantage that they 
can be tailored to the specificities of the taxation and the pensions systems of 
the two countries concerned. Against this, however, must be set the relatively 
cumbersome nature of the system in that, for relations within the Union, it is 
clearly time consuming to have to negotiate and renegotiate 105 agreements. 
This number can be expected to rise sharply with the prospect of future 
enlargement . Finally, there is no general knowledge of these agreements, 
and no equality of treatment of equivalent situations under different bilateral 
agreements. 
73. Closer co-ordination of the cross-border tax treatment of pensions could, 
however, substantially streamline the process of updating, and possibly 
extending, the scope of bilateral tax agreements. Such co-ordination seems 
particularly suited to the needs of a developing Single Market, and could be 
effected in a number of ways. As a first step, it would be necessary to consider 
whether any specific initiatives or measures are called for by the particular 
Union context. If Member State governments agreed any rules, there would 
then be a choice of how to implement them: they might, as now, be 
incorporated in individual agreements between Member States; or, 
alternatively, they could be implemented on a multilateral basis. It may on the 
other hand be appropriate for an agreement on certain aspects of pension 
taxation to be enacted as Community legislation. 
74. In particular, given the need to ensure that the tax benefits that are accorded to 
pension schemes are not misused, there will also be a continuing need for rules 
against tax avoidance. With this in mind, there appears to be particular merit in 
exploring the concept of mutual recognition of tax-approved schemes in other 
Member States, as already exists in a few bilateral double taxation treaties. 
Such an approach, for example in the area of cross-border contributions, could 
prevent retirement tax reliefs from being misued for other purposes. 
75. The Commission's report of 22 October 1996 on the development of tax 
systems stresses the need to view taxation policy in the context of the major 
political challenges that are currently facing the European Union. Chief among 
these are the themes of promoting enterprise and employment . The 
Commission's report, which reflects and draws conclusions from the work of 
the High Level Croup on Taxation , underlines its belief that, in order to 
harvest the full benefits of the Single Market and to stimulate enterprise, tax 
obstacles and disadvantages to doing business within the Union must be 
tackled head on. 
76. The Commission's report notes the taxation of pensions as a possible area for a 
future initiative at Community level, and also that, in the High Level Group, 
many personal representatives called for action to improve the functioning of 
bilateral double taxation treaties. While fully bearing in mind the principles of 
subsidiarity and proportionality, the Commission considers that it may prove 
30 
most useful to explore ways of improving the co-ordination and scope at 
Community level of tax rules relating to pension provision. Such rules would, 
of course, be subject to unanimous decision in the Council. 
77. The previous chapter discussed the particular concerns associated with 
workers temporarily employed in a Member State other than their home state, 
and the legislation which the Commission intends to put forward. This 
proposal provides an opportunity to take a small but significant step towards 
co-ordinating certain taxation provisions, at least in the specific area of 
supplementary pensions. 
Questions: To what extent do current tax rules or regulations (for example, 
related to membership of approved schemes) constitute an actual barrier to the 
freedom of movement of workers? 
Is it feasible to rely on bilateral or multilateral tax treaties to take forward 
closer co-operation between Member States as regards cross border pension 
arrangements? If so, what should these cover, and how can this co-operation 
be achieved practically? 
Is Community legislation an appropriate and feasible alternative ? 
31 
TABLES 
General comment: 
Qiven the growing economic importance of funded pension schemes it is essential for those involved 
with retirement provision, whether economic operators, public authorities or other interested parties, to 
have at their disposal reliable and harmonised Community statistics on institutions for retirement 
provision. Such statistics are to be integrated in the competent Community framework regulation, 
Council Regulation 58/97, concerning structural business statistics. 
31 
Table I Coverage Levels - Pillar 2 
Country 
Belgium 
Denmark) 
Germany 
Greece 
Spain 
France 
Ireland, 
Italy 
Luxembourg 
The Netherlands 
Portugal 
UK Coverage 
Estimation in % 
of total private 
sector 
employment 
31 
80 
46 
5 
15 
90 
40 
5 
30 
85 
15 
48 Characteristics 
Voluntary/funded/pension 
funds and group insurance 
Company funds/professional 
funds through collective 
bargaining/all funded 
Voluntary/partially book-
reserved (approx. 56%) 
funded (44%) through 
Pensionkassen, Support 
Funds and Collective 
Insurance 
Voluntary/mainly top 
hat/some (limited) funding 
Voluntary/mainly top hat in 
view of high levels of social 
security pensions/partially 
funded/mainly book reserves: 
will now be phased out 
Quasi mandatory/collective 
bargaining/PA YG/plus 
voluntary top hat funded 
schemes 
Voluntary/funded/pension 
funds and group insurance 
Voluntary/mainly top hat in 
view of high levels of social 
security pensions/partially 
funded 
Voluntary/mainly book 
reserve type plans/a limited 
amount of funding exists 
Company funds/industry­
wide funds through collective 
bargaining/all funded 
Voluntary/pension plans (not 
funds) executed by 
recognised management 
companies and insurance 
companies/funded/mainly top 
hat in view of high levels of 
social security pensions 
Voluntary/funded Supplementary 
pensions as % 
of total 
pensions 
(1993) 
8% 
18% 
11% 
n.a. 
3% 
21% 
18% 
2% 
not available 
32% 
not available 
28% 
Source: European Federation for Retirement Provision (EFRP) - European Pension Funds 1996 -
based on World Bank Report - Tamburi Report 
33 
Table II Pension fund assets - total and as a percentage of GDP 
(1993) 
^ Assets bn ECU Assets in % of GDP 
Belgium 7 3,4 
Denmark 26 20,1 
Germany48 106 5,8 
Spain 10 2,2 
France 41 3,4 
Ireland 18 40,1 
Italy 12 1,2 
The Netherlands 261 88,5 
UK 717 79,4 
EU49 1198 20,3 
US 3546 59,1 
Japan 1800 44,7 J 
Source: EFRP - op. cit. 
W 
Table III Assets of life assurance companies - total and as 
a percentage of GDP (1995) 
Country Life assurance enterprises Assets as % of GDP 
assets bn ECU) 
Belgium 6 2^9 
Denmark 65 49 
Germany 379 20^5 
Greece n.a. 
Spain 18 4^2 
France 3Ï7 30^0 
Ireland n.a. 
Italy 31 377 
Luxembourg 5 37,6 
Netherlands 138 45^6 
Austria 5 1,7 
Portugal 3 3^ 
Finland 6 6,3 
Sweden 65 36^9 
_ __ _ 
EUR 15 Ï6Ô4 24^ 
N.B. Figures not completely comparable, owing to different national valuation rules (investments can 
be valued at purchase price, as in Germany, or at current price, as in the UK). 
EU total included only Member States listed. 
Source: Eurostat 1997 
Si 
Table IV Distribution of pension funds (pillar 2) assets, as % of 
total assets (1994) 
Equity Fixed income Real estate Short term % of Foreign 
placements assets 
Belgium 36 47 10 n.a. 
Denmark 22 65 
Germany 11 75 11 
Spain 82 13 
France 14 39 40 
Ireland 55 35 n.a. 
Italy 14 72 10 
Netherlands 30 58 25 
Portugal (18) (57) 19 n.a. 
Sweden 32 47 13 12 
UK 80 11 30 
US (52) (36) 10 
Japan (29) (63) n.a. 
Source: Royal Institute of International Affairs, UBS and EFRP (Figures between brackets are 
estimates). 
X 
Table V Distribution of life assurance assets (pillar 3) as % of 
total assets, (1994) 
COUNTRY 
Denmark 
Germany 
Spain 
France 
Italy 
Netherlands 
Sweden 
UK EQUITIES 
Domestic Foreign 
20 
5 
2 
19 
7 
12 
23 
49 5 
n.a. 
n.a. 
5 
2 
n.a. 
12 FIXED INCOME 
Domestic Foreign 
66 
762 
55 
69 
70 
71' 
61 
24 n.a. 
n.a. 
5 
4 
n.a. 
3 REAL OTHER 
ESTATE 
3 
5 
10 
8 
12 
6 
7 
9 6 
14 
33 
4 
2 
6 
9 
3 
* denotes countries where split between domestic and foreign assets was unavailable 
1 includes loans (50%) 
2 includes loans (61%) 
Sources: Comité Européen des Assurances, OECD Insurance Statistics Yearbook 1987-1994 
7> 
Table VI Differences in rates of return of equities compared to 
bonds 
The period over which the differences in rates of return of equities compared to bonds 
is calculated is important. The premium normally associated with the returns on 
equities over bonds depends very much on the level of the stock market and the 
beginning and end of the period over which comparisons are made. Several different 
sources are given below. Whilst the difference varies, all sources show consistently 
the higher return on equities. 
Table VI a Real rates of return (% pa) (1967-1990) in 
domestic currency 
Country Equities Bonds 
Denmark 7,0 3,4 
Germany 9,5 2,7 
France 9,4 1,0 
Italy 4,0 -0,2 
Netherlands 7,9 1,0 
Sweden 8,4 -0,9 
UK 8,1 -0,5 
US 4,7 -0,5 
Japan 10,9 0,2 
Source: E.P. Davis: 1995 
2? 
Table VI b Excess returns of equities over bonds markets 
(%pa) (1981-1995) in domestic currency 
Belgium 11,5 
Germany 7,1 
France 4,5 
Italy 1,5 
Netherlands 6,9 
Sweden 15,5 
UK 2,9 
Japan 2,9 
US 1,5 
Source: JP Morgan 
FT/S+P Actions World Indices 
Pragma Consulting 
$1 
Table VI c 
Real returns (% p.a.) from US markets (1926-1984) 
Small company stocks 9,1 
Large company stocks 7,1 
Long term govt, bonds 1,7 
Source: Ibbotson Associates Inc. 
Real returns (% p.a.) from UK market (1919-1993) 
Equities 7,9 
Gilts (long) 2,0 
Source: BZW 1994 
Real return (% p.a.) from Belgian market (1959-1994) 
Equities 4,6 
Fixed income 2,3 
Source: Banque Degroof 
nb 
Table VII Pension funds 1984-1993. Average Rates of Return, 
Volatility and Relationship of Return to Risk. 
Belgium 
Denmark 
Germany 
Spain 
Ireland 
Netherlands 
Sweden 
UK 
US 
Switzerland 
Japan Average nominal 
Pension Fund Return 
(real returns in 
brackets) 
11,8-(8,8) 
10,0-(6,3) 
9,4-(7,1) 
13,8-(7,0) 
14,0-(10,3) 
9,5 - (7,7) 
14,5-(8,1) 
15,5-(10,2) 
13,5-(9,7) 
7,6 - (4,4) 
8,2 - (6,5) Average Standard 
Deviation of nominal 
returns 
8,9 
9,4 
7,2 
19,9 
13,7 
7,2 
8,5 
11,4 
9,4 
6,7 
8,3 Return/risk ratio on 
nominal returns (Col 1 
- Col 2) 
1,3 
1,1 
1,3 
0,7 
1,1 
1,3 
1,7 
1,4 
1,4 
1,1 
1,0 
Source: EFRP 
Note: Similar figures on the returns on life insurance investments will shortly be available through 
EUROSTAT within the framework of Insurance Service Statistics. 
HI 
Table VIII Stock markets' size (domestic equity) (1996) 
Country market capitalization in % of GDP 
Belgium 45.9 
Denmark 41.8 
Germany 29.6 
Greece 19.7 
Spain 42.3 
France 38.9 
Ireland 49.7 
Italy 21.7 
Luxembourg 193.4 
Netherlands 97.8 
Austria 14.3 
Portugal 23.7 
Finland 50.7 
Sweden 97.2 
UK 149.9 
EU 32 
US 68 
Japan 65 
Source: Federation of European Stock Exchanges and European Commission. 
11 
Table IX Summary of National Regulations on Pension Fund 
Portfolios (pillar 2) 
Country Restrictions 
Denmark A maximum of 40% may be invested in "high risk assets" - these include 
domestic equities, foreign equities and unlisted securities. Also 80% 
currency matching requirement. In case of EU currency, up to 50% of 
liabilities can be covered by assets denominated in ECU. No self-
investment. 
Germany Maximum 30% EU equity, 25% EU property, 6% non-EU shares, 6% non-
EU bonds, 20% overall foreign assets, 10% se If-investment limit ' 
Spain 5% limit in securities issued by any one enterprises. 90% of assets must be 
invested in quoted securities, bank deposits, property or mortgages. 1% 
must be in current accounts or money market. 
France At least 50% to be invested in EU government bonds, less than 33% in 
loans to sponsors 
Italy No pension law for self-administered schemes but investment policy 
determined by the board of directors and usually restricted to government 
bonds, bank deposits, insurance policies and property. 
Netherlands 5% self-investment limit; prudent man rule 
Sweden Majority to be held in bonds, debentures and loans 
UK 5% self-investment limit; prudent man rule 
USA Prudent man rule. 
Japan Minimum 50% in bonds, maximum 30% equity, 20% property, 30% 
foreign, 10% in one. 
Source: European Commission "Supplementary Pensions in the European Union" (1994) 
W 
<<£ 
Table X EU rules on investment by life insurance companies 
(pilla r3) 
The EU rules on investments by life insurance companies may be summarised as 
follows (Articles 20 ff and Annex I of 3rd Life Directive): 
- investment must take account of the type of business carried on by an 
undertaking in such a way as to secure the safety, yield and marketability of its 
investments, which the undertaking shall ensure are diversified and adequately 
spread ("prudent man"); 
- the types of assets that can be used to cover technical provisions (basically 
future claims/pension payouts) are specified (equities, bonds, etc.); 
- the method of valuing these assets is specified; 
- Member States may not require insurance companies to invest in particular 
categories of assets; 
- in addition Member States shall require every assurance undertaking 
to invest, with respect to its technical provisions, no more than: 
- 10% in any one piece of land or building; 
- 5% in shares or bonds of the same undertaking except those to a State, 
regional or local authority: 
- 5% in unsecured loans including 1 % for any single unsecured loan 
-3% cash in hand 
- 10% in shares not dealt in on a regulated market, and 
- finally Member States cannot oblige an insurance undertaking to keep 
more than 80% of its assets in a currency matching its liabilities 52 
H7 
Table XI Summary of national regulation of life assurance 
companies (pillar 3) 
Country Restrictions 
Denmark 40% combined limit on domestic equity and foreign equity, 10% limit 
on unlisted securities, 10% combined limit on mortgages and loans 
Germany Maximum 30% domestic equity, 25% property, 6% foreign equity, 5% 
foreign bonds, 10% unlisted securities, 50% combined limit for 
mortgages and loans 
Spain No specific limits. 
France 65% combined limit on domestic equity, unlisted securities and foreign 
equity. 40% limit on property, 10% combined limit on mortgages and 
loans 
Italy Maximum: 20% domestic equity, 20% unlisted securities, 20% foreign 
equity, 50% foreign bonds, 50% property, 50% mortgages, 0% loans 
Netherlands 10% combined limit on unlisted securities and mortgages, 8% limit on 
loans 
Sweden 25% combined limit on domestic equity, unlisted securities and foreign 
equity. 25% combined limit on property and mortgages, 10% limit on 
loans 
UK 10% combined limit on unlisted securities, mortgages and loans 
Source: Policy Issues in Insurance, OECD, 1996 
Table XII Assets of group life schemes as a percentage of pillar 2 
pensions assets (1994) 
Country % 
Belgium 73 
Germany 12 
Spain 52 
France 6 
Netherlands 25 
Finland 56 
Sweden 81 
UK 5 
EU55 
Source: CEA 
<4f 
Table XIII Pension funds v Life Insurance 
Similarities exist between pension funds and certain life insurance products: both aim 
at provision of a sum at a future date and are often granted tax inducements to 
encourage such provision. In some states this outward similarity is reflected by the 
application to pension funds of the regulations similar to those that apply to life 
insurance under the Third Life Directive. The principal similarities and differences arc 
listed below. 
Similarities: 
• Both are long term investments 
• Both involve professional management of assets through authorised persons 
• The interests of consumers are crucial in both 'products' 
• Both therefore entail standards to avoid unnecessary risk to the funds entrusted by 
the consumer to the manager/company. 
Differences: 
• Pension scheme liabilities are longer term than life insurance liabilities. The 
average for life assurance contracts is around 8-12 years. For pensions, liabilities 
are very often in the region of 20 - 25 years; more, if the pension benefits are paid 
from the same source. This suggests that pension funds need to match their longer 
term liabilities with longer term assets. This tends to lead towards a higher 
proportion of equity or property investment than is the case for life assurance. 
Life policies are subject to the risk of early surrender. This requires appropriate 
provisioning in the form of readily liquidable assets, or cash, in order to meet 
expected, and unexpected, levels of early encashment. By contrast, regulations 
generally prevent early surrender of pension funds benefits, except in very limited 
circumstances. In addition, transfers to other schemes may be permitted only in 
certain circumstances, for example on a change of job, and this will generally result 
in a penalty. The level of short term liquidity requirement is therefore much lower 
for pensions. 
Similar points can be made in connection with loans. Life insurance companies 
generally offer loans on the security of life policies. They need to ensure short 
term liquid assets exist to provide these loans. Pension schemes cannot usually 
offer such a facility; therefore short term liquidity for this purpose is not necessary. 
Life insurance liabilities are generally expressed in nominal terms: there is a given 
sum assured, fixed at the outset of the policy. In contrast, pension liabilities are 
linked to salaries - in which ease what is important is real growth. Purchasing 
shorter term assets in respect of long term pension liabilities could be dangerous, as 
there is a strong risk that those assets will not achieve a level of growth sufficient 
to maintain the pension expectations of scheme members. 
H(a 
In defined benefit schemes an important factor is the 'guarantee1 provided by the 
employer that the pension promise will be honoured whatever the investment 
return on the fund. No such guarantee exists in the context of life insurance. This 
guarantee can obviously affect the attitude to investment of the fund manager. 
i;} 
Com (97) 102. 
There are some exceptions for certain occupational schemes, for example in France where 
occupational schemes are pay as you go, and in Germany where pension provisions are backed 
by book reserves. 
See I). Franco and T. Mun/i, "Public Pension Expenditure Prospects in the European Union. A 
Survey of National Projections", European Economy. 1996, No. 3. 
National projections are not homogeneous in the coverage of pension expenditure. Comparable 
estimates of the impact of the pension expenditure on general government accounts have been 
produced on the basis of national expenditure trends and 1995 ratios of total public pension 
expenditure to GDP. 
Weighted by 1995 GDP in units of Purchasing Power Standard 
The figures for Luxembourg and Portugal are based on projections to the period 2015-2020 
only. 
Eurostat, 1995 estimate. 
I Assets in 1996 120 % of the wage bill, 39,5 % of GDP. 
Subject to the possibility of opting out in favour of a private arrangement. 
This category is often seen as comprising any form of saving that might be used to provide 
retirement income, such as individual precautionary savings, residential property ownership, 
share ownership, family support, etc. 
II Also includes the French second pillar, which is a pay as you go system with many of the 
characteristics of a slate scheme. 
1 For example Finland, see paragraph 5 above. 
For example in France, the compulsory ARRCO and AG IRC schemes; in Germany, the 
approach of many companies of backing pension promises with balance sheet reserves ('book 
réserves1 ). 
! The issue of group arrangements is discussed in Chapter IV. 
15 COM(97) 102 
i6 For our purpose we can identify two types of risk: 
- credit risk: the risk that the creditor will not pay because the company goes bankrupt or the 
government defaults. Over the long term these are reflected in the average rate of return of the 
different assets. Although of course in any one year they can be important and be reflected in 
the volatility of the asset. 
- market risk: the risk that the price of an asset will fall such that the investor may not be able to 
meet his liabilities in that year without liquidating a higher proportion of his assets than 
expected. This market risk is reflected in the volatility of an asset. 
See also Table VII where some of the real returns on government bonds were negative over 
quite long periods. 
Prof. B. Solnik, "Fundamental considerations in cross-border investment: the European view". 
The research foundation of the Institute of Chartered Financial Analysts, April 1994. 
In the United Stales pension fund managers are not subject to quantitative investment 
restrictions. I localise (hoy have continent-wide opportunities to buy dollar assets, only 10 "<> 
ol'their investments are in lac ! outside the \ ISA. 
Investment Services Directive ') t/22/i,'.l,'.('. 
"' Art. 73b of the Treaty. 
Art 73d 1(b). 
Art 104a. 
Of course individual pension funds may be constrained by the maximum rules even if on 
average for all funds the limits are not reached. Some funds may be very "conservative" in 
their investment strategy and wish to keep a high proportion of government bonds. Other funds 
with a profile of young members may wish to take a higher proportion of equities. 
* OJ 93/C 171/11 
!(' OJ 94/C 360/08 
Case no. C-57/95 France v Commission. 
14? 
40 
41 
42 
43 
44 
4.S 
4(i 
47 Investment Services Directive 93/22/EEC; Second Banking Directive 89/646/EEC; Third Life 
Insurance Directive 92/96/EEC. 
The Commission suggested in its draft Directive and Communication as a fust step that 
currency matching requirements should not exceed 60%. In any case the introduction of the 
EURO will reduce the constraining effect of any currency matching requirements. 
Third Life Directive, 92/96/EEC. 
These provisions concern the EU prudential rules for investments made by life assurance 
companies, i.e. the assets side of the balance sheet. On the liabilities side of the balance sheet 
there are also harmonised EU rules. These are based on the calculation of "technical 
provisions" which are the expected liabilities, and the assets that must back these provisions to 
ensure the liabilities can be covered. In addition insurance companies are obliged to keep a 
"solvency margin" of 4% own capital to cover unexpected circumstances and give added 
assurance that liabilities can be met. 
See footnote 30. 
See Third Life Directive 92/96/EEC, and also Ch. II para 28 above. 
Second Banking Directive 89/646/EEC; Third Life Insurance Directive 92/96/EEC; Investment 
Services Directive 93/22/EEC. 
Article 59 
Since the extension in 1982 of its personal scope to self-employed persons. Regulation 
1408/71 is based on Articles 51 and 235. 
Lastly amended and updated by Regulation (EC/118/97; O.J. of L28 of 30 January 1997) 
Communication of the Commission to the Council, "Supplementary social security schemes: the 
place of supplementary pension schemes in the social protection of workers and their effect on 
the free movement" SEC(9I )I332. 
This would also be the case if the new employment relationship did not provide for membership in 
an occupational pension scheme. 
See Finanzamt Koln-Altstadt v. Schumacker, Case C-279/93, judgment of 14 February 1995. 
See Kraus, Case C-19/92, ECR [1993] 1-1663, judgment of 31 March 1993. 
Bachmann v. Belgium, Commission v. Belgium (C204/90 and C300/90, judgment of 
28 January 1992), 
Case C-80/94, judgment of 11 August 1995.. 
It would, for example, require 190 agreements to cover all bilateral relations within a Union of 
20 Member States. 
Com (96) 546.Final. 
Florence European Council 21-22 June 1996. Presidency Conclusions (SN300/96) pages 2-3. 
This High Level Group, under the chairmanship of Commissioner Monti, brought together 
personal representatives of EU finance ministers.on four occasions between June and October 
1996, following the informal ECOFIN meeting on 13 April 1996 
Book reserves in Germany: 124 bn ECU (1992) source CEA 
EU total includes only Member States listed 
The higher the better 
This does not apply to book reserve schemes 
Assets denominated in ECU are deemed to be matched 
Bulk (56" o) of assets of pension funds are book reserves 
Group life premia as a percentage of total pension premia. Assets could not be calculated in 
view of fact that main pension schemes (AGIRC/ARRCO) are on a PAYG basis 
Includes only listed Member States and excludes France 
kci 
ISSN 0254-1475 
COM(97) 283 final 
DOCUMENTS 
EN 04 05 06 10 
Catalogue number : CB-C0-97-296-EN-C 
ISBN 92-78-21509-0 
Office for Official Publications of the European Communities 
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