Supplementary pensions in the Single Market - A Green Paper
Date: 1997-06-10
Institutions: European Commission
Subjects: European social policy, freedom of movement, social security, supplementary pension

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 

CHAPTER  I 

THE DEMOGRAPHIC  AND ECONOMIC CONTEXT 

A.  Current demographic trends 
B.  Budgetary  implications of demographic changes on state pension arrangements 
C.  Current structure of pension  provision 
D.  Conclusion 

CHAPTER  II 

RETIREMENT PROVISION AND EU CAPITAL MARKETS 

A.  Size of EU pension funds 
B.  How EU pension and  life  insurance funds  are invested 
C.  Returns on pension  funds  assets 
D. 
E.  Can higher returns be achieved without undue risk ? 
F.  How could  EU capital  markets absorb future  increases in EU pension  funds  and life  insurance 

Impact of differences  in rate of return 

investments ? 

CHAPTER  III 

APPROPRIATE PRUDENTIAL  RULES FOR A SINGLE  MARKET 

A.  Role of supervision  of pension  and  life  insurance  funds  and fund  managers 
B.  The effect  of excessive rules on pillar 2 pension  fund  investments 
C.  Rules on pillar 3 life assurance  investments 
D.  Should there be similar EU rules for pillar 2 and 3 schemes 
E.  Fund managers 
F.  The way forward 

CHAPTER  IV 

FACILITATING  THE FREE MOVEMENT OF WORKERS 

A.  General considerations 
B.  Obstacles to free movement of persons relating to supplementary pensions 
C.  Possible approaches 

CHAPTER  V 

THE  IMPORTANCE OF TAXATION  FOR  SUPPLEMENTARY 
PENSIONS 

A.  General considerations 
B.  Avoiding double taxation 
C.\  The case  for a common  approach 

Table  I 

Coverage Levels - Pillar 2 

TABLES 

Table  II 

Pension fund assets - total and as a percentage of GDP (1993) 

I 

1 

I 
I 
2 
8 

9 

9 
9 
10 
11 
11 

13 

15 

15 
15 
17 
18 
19 
19 

22 

22 
22 
26 

28 

28 
29 
30 

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 
Footnotes 

Pension  funds  v life  assurance 

/  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 
in  the  Union.  This 
commitment  is borne  out  by the  Commission's  Confidence  Pact  and  the  employment 
strategy agreed at the Dublin European  Council. 

is  committed  to  improving  employment 

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. 

legislation  on  mobility 

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 
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 

to  addressing 

the  question  of  maintaining 

The  Commission  believes  the  ideas  discussed  in  this  Green  Paper  can  make  a 
significant  contribution 
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. 

income 

invites  comments  from 

The  Commission 
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  Member  States, 

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. 

3. 

• 

Budgetary implications of demographic changes on state pension 
arrangements 

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-

• 

4. 

C. 

5. 

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%) . 

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. 

Current structure of pension provision 

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 
scheme,  whilst  pillar  2 
compulsory  earnings  related  top  up  pillar  1 
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) 

Pillar 2 

Pillar 3 

earnings related, defined  benefit  (pay-as-you-go /  funded) 

occupational pension schemes (pay-as-you-go /  funded) 

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 
P A Y G ," 

Pillar  2 
Funded,  book  reserve,  insured  plans 

Pillar  3 
Personal  pensions 

Other 
Means  tested,  guaranteed  income  scheme,  poor 
relief  p r o g r a m m es 

Source: 

EUROSTAT 

7. 

Pillar 1 

I 

8 8 . 8% 

7% 

0 . 9% 

.'>..>°<> 

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: 
member. 

investment  risk  is  taken  by  the  scheme 

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  . 
Recent Member State  reforms 

11. 

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 
Communication on improving social protection in Europe  . 

is  discussed 

issue 

in 

the  Commission's 

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. 

17. 

18. 

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). 

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. 

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. 

23 

Impact  of differences  in rate  of  return 

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 
the  current  rules  of  prudential 
prudential  control.  It  discusses  whether 
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. 

24 

Can  higher  returns  be achieved  without  undue  risk  ? 

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 

26 

27 

28 

focus  on  prudential  controls  designed  to  reduce  risks  to  which  funds  are 
susceptible. 

risk  management 

techniques  suggest 

Advocates  of  modern 
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 
In  this  way  they  can  maximise  returns  at  minimum 
profiles  are  different. 
increased  risk. 

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. 

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 
Investment  in  a  selection  of  imperfectly  correlated  markets  will 
returns 
investments,  and  reduce 
provide  managers  with  a  spread  of  diversified 
in  one 
potentially  the  risk  of  over  concentration  in  assets  denominated 
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  conduct 
investment  policies  that  are detrimental  to their members  in the  long  run  ". 

to  assume  more  risks,  while  sacrificing 

return,  and 

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 

30 

F, 

31 

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. 

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. 

How could EU capital markets absorb future  increases in EU pension funds 
and life insurance investments ? 

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. 

33. 

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. 

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 
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. 

investing  in  securities 

investors 

issued 

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 
contributions, in particular requiring that they be invested  prudently. 

investment  of  members' 

rules  on 

the 

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 

any  'privileged  access'  by  central,  regional  or 
Further,  the  Treaty  prohibits 
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: 
quantitative 
The  Commission  would  like  to  know  how  far 
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^ 

that  was 
the  Treaty  rules  tor  pension  funds:  first,  in  a  draft  Directive 
withdrawn  because  the  amendments  proposed  by  Member  States  would  have 
legitimised 
them; 
secondly, 
in  a  Communication  "\  which  was  annulled  recently  by  the 
European  Court  of  Justice  on  the  basis  that  the  Commission  intended  to 

restrictions  on  pension 

liberalised 

rather 

funds 

than 

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 

27 
. 

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 

Third  Life  Insurance  Directive 

to offer  services  all over the  EU; 

28 

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 
restrictions 
imposed  on  prudential  grounds  must  be  proportional  to  the  objectives 
they  may  legitimately  pursue 

justified  prudential  grounds.  Any 

than  on 

. 

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 
liberal 
is  that-  fund 
in  this  context 
investment  regimes.  A  further  observation 
managers  very  often  do  not  currently 
investment 
take  advantage  of  the 
freedom  they  do  have, so a rush  towards  equities  appears  unlikely. 

those  Member  States  with 

the  most 

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 
is  authorised  and 
Market  provisions'  .  Once  a  life  insurance  company 
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. 

the  prudential  rules  concerning 

This  Green  Paper  has  examined 
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 
The  Commission  would  be 
interested  to hear any  concrete  suggestions; 

life  assurance. 

Option  IV:  accept  the  differences  that  currently  exist  because  de  facto 
they  do not  lead to  significant  distortions  of  competition. 

Question: 
interested  parties. 

Before  making  up  its  mind  the  Commission  seeks  the  view  of 

E. 

Fund  managers 

45. 

46. 

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. 

implies  an  appropriately 
Efficient  management  of  a  pension  portfolio 
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 
increased 
call  on  such  services.  The  Commission  also  considers 
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. 

that 

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 
investors  to  buy 
classes  of  assets  (e.g.  equities)  so  de  facto  obliging 
(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. 

Adoption  of  a  Directive.  An  alternative  approach  would  be 
Option 3. 
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 

OF 
IMPORTANCE 
THE 
SUPPLEMENTARY  PENSIONS 

TAXATION 

FOR 

A. 

General  considerations 

64. 

65. 

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. 

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. 

73. 

74. 

75. 

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 
. Finally,  there  is  no  general  knowledge  of  these  agreements, 
enlargement 
and  no  equality  of treatment  of  equivalent  situations  under  different  bilateral 
agreements. 

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 
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. 

in 

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. 

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 
.  The 
these  are  the  themes  of  promoting  enterprise  and  employment 
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 

Characteristics 

Coverage 
Estimation  in % 
of  total  private 
sector 
employment 

Supplementary 
pensions  as % 
of  total 
pensions 
(1993) 

31 

80 

46 

5 

15 

90 

40 

5 

30 

85 

15 

48 

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 

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) 

^ 

Belgium 

Denmark 
Germany48 

Spain 

France 

Ireland 

Italy 

The Netherlands 

UK 
EU49 

US 

Japan 
Source: EFRP - op. cit. 

Assets bn ECU 

Assets in % of GDP 

7 

26 

106 

10 

41 

18 

12 

261 

717 

1198 

3546 

1800 

3,4 

20,1 

5,8 

2,2 

3,4 

40,1 

1,2 

88,5 

79,4 

20,3 

59,1 

44,7 

J 

W 

Table III  Assets of life assurance companies - total and as 

a percentage of GDP (1995) 

Country 

Belgium 

Denmark 

Germany 

Greece 

Spain 

France 

Ireland 

Italy 

Luxembourg 

Netherlands 

Austria 

Portugal 

Finland 

Sweden 
_ 

EUR 15 

Life assurance enterprises 
assets bn  ECU) 

Assets as % of GDP 

6 

65 

379 

n.a. 

18 

3Ï7 

n.a. 

31 

5 

138 

5 

3 

6 

65 

__ 

Ï6Ô4 

2^9 

49 

20^5 

4^2 

30^0 

377 

37,6 

45^6 

1,7 

3^ 

6,3 

36^9 
_ 

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 

10 

n.a. 

Belgium 

Denmark 

Germany 

Spain 

France 

Ireland 

Italy 

Netherlands 

Portugal 

Sweden 

UK 

US 

Japan 

36 

22 

11 

14 

55 

14 

30 

47 

65 

75 

82 

39 

35 

72 

58 

(18) 

(57) 

32 

80 

(52) 

(29) 

47 

11 

(36) 

(63) 

11 

10 

13 

40 

19 

13 

n.a. 

25 

n.a. 

12 

30 

10 

n.a. 

Source:  Royal Institute of International Affairs,  UBS and EFRP 
estimates). 

(Figures between brackets are 

X 

Table V 

Distribution of life assurance assets (pillar 3) as % of 

total assets, (1994) 

COUNTRY 

EQUITIES 

FIXED INCOME 

REAL 
ESTATE 

OTHER 

Domestic 

Foreign 

Domestic 

Foreign 

Denmark 

Germany 

Spain 

France 

Italy 

Netherlands 

Sweden 

UK 

20 

5 

2 

19 

7 

12 

23 

49 

5 

n.a. 

n.a. 

5 

2 

n.a. 

12 

66 
762 

55 

69 

70 

71' 

61 

24 

n.a. 

n.a. 

5 

4 

n.a. 

3 

3 

5 

10 

8 

12 

6 

7 

9 

6 

14 

33 

4 

2 

6 

9 

3 

* 
1 
2 
Sources: Comité Européen des Assurances, OECD Insurance Statistics Yearbook  1987-1994 

denotes countries where split between domestic and foreign  assets was unavailable 
includes loans (50%) 
includes loans (61%) 

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 

Germany 

France 

Italy 

Netherlands 

Sweden 

UK 

US 

Japan 

Source: E.P. Davis:  1995 

7,0 

9,5 

9,4 

4,0 

7,9 

8,4 

8,1 

4,7 

10,9 

3,4 

2,7 

1,0 

-0,2 

1,0 

-0,9 

-0,5 

-0,5 

0,2 

2? 

Table VI b 
(%pa) (1981-1995) in domestic currency 

Excess returns of equities over bonds markets 

Belgium 

Germany 

France 

Italy 

Netherlands 

Sweden 

UK 

Japan 

US 

Source: 

JP Morgan 
FT/S+P Actions World Indices 
Pragma Consulting 

11,5 

7,1 

4,5 

1,5 

6,9 

15,5 

2,9 

2,9 

1,5 

$1 

Table VI c 

Real returns (%  p.a.) from  US markets  (1926-1984) 

Small company stocks 

Large company stocks 

Long term govt, bonds 

Source: Ibbotson Associates Inc. 

9,1 

7,1 

1,7 

Real returns (%  p.a.) from  UK market  (1919-1993) 

Equities 

Gilts (long) 

Source: BZW 1994 

7,9 

2,0 

Real return  (%  p.a.) from  Belgian  market  (1959-1994) 

Equities 

Fixed income 

Source: Banque Degroof 

4,6 

2,3 

nb 

Table VII  Pension funds  1984-1993. Average Rates of Return, 

Volatility and Relationship of Return to Risk. 

Average nominal 
Pension  Fund Return 
(real returns in 
brackets) 

Average Standard 
Deviation of nominal 
returns 

Return/risk ratio  on 
nominal returns (Col 1 
-  Col 2) 

Belgium 

Denmark 

Germany 

Spain 

Ireland 

Netherlands 

Sweden 

UK 

US 

Switzerland 

Japan 

Source: EFRP 

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) 

8,9 

9,4 

7,2 

19,9 

13,7 

7,2 

8,5 

11,4 

9,4 

6,7 

8,3 

1,3 

1,1 

1,3 

0,7 

1,1 

1,3 

1,7 

1,4 

1,4 

1,1 

1,0 

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 

Belgium 

Denmark 

Germany 

Greece 

Spain 

France 

Ireland 

Italy 

Luxembourg 

Netherlands 

Austria 

Portugal 

Finland 

Sweden 

UK 

EU 

US 

Japan 

market  capitalization  in %  of GDP 

45.9 

41.8 

29.6 

19.7 

42.3 

38.9 

49.7 

21.7 

193.4 

97.8 

14.3 

23.7 

50.7 

97.2 

149.9 

32 

68 

65 

Source:  Federation of European  Stock Exchanges and European Commission. 

11 

Table IX  Summary of National Regulations on Pension Fund 

Country 

Denmark 

Germany 

Spain 

France 

Italy 

Portfolios (pillar 2) 

Restrictions 

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. 

Maximum  30% EU equity, 25% EU property,  6% non-EU  shares, 6% non-
EU bonds, 20% overall foreign  assets,  10% se If-investment  limit  ' 

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. 

At  least  50%  to  be  invested  in  EU  government  bonds,  less  than  33% in 
loans to sponsors 

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 

USA 

Japan 

5% self-investment  limit; prudent man rule 

Prudent man rule. 

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) 
Restrictions 

Country 

Denmark 

Germany 

Spain 

France 

Italy 

Netherlands 

Sweden 

40% combined  limit on domestic  equity and  foreign  equity,  10% limit 
on unlisted securities,  10% combined limit on mortgages and loans 

Maximum  30% domestic equity, 25% property, 6% foreign  equity, 5% 
foreign  bonds,  10%  unlisted  securities,  50%  combined  limit  for 
mortgages and loans 

No specific  limits. 

65% combined  limit on domestic equity, unlisted  securities and  foreign 
equity.  40% limit  on  property,  10% combined  limit  on  mortgages  and 
loans 

Maximum: 20% domestic equity, 20% unlisted  securities, 20% foreign 
equity, 50% foreign  bonds, 50% property, 50% mortgages, 0% loans 

10% combined  limit on unlisted  securities and mortgages, 8% limit on 
loans 

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 

Germany 

Spain 

France 

Netherlands 

Finland 

Sweden 

UK 

EU55 
Source: CEA 

% 

73 

12 

52 

6 

25 

56 

81 

5 

<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. 
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. 
Also includes the French second  pillar, which  is a pay as you go system  with many of the 
characteristics of a slate scheme. 
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. 
COM(97)  102 
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. 

I 

II 

1 

! 
15 
i6 

"' 

* 
!(' 

14? 

In  addition  insurance  companies  are  obliged 

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 
to  keep  a 
ensure  the  liabilities  can  be  covered. 
"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 

40 

41 

42 

43 

44 

4.S 

4(i 

47 

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 

L-2985 Luxembourg 

sb