Ireland: The EU Pensions Directive – Considerations For Transposition

Introduction

The first steps in EU pre-emptive regulation of Member States’ pension arrangements culminated in the publication, on 23 September 2003, of Directive 2003/41/EC ("the Pensions Directive"). The Pensions Directive represents a tentative move by Europe’s legislators to harmonize cross-border provision and regulation of financial services in the pension sector. National priorities and significant differences in domestic fiscal arrangements for pension provision rendered tax harmonization for pensions through unanimity unattainable at this point in the Union’s development. Instead, the Pensions Directive, adopted pursuant to Articles 47(2), 55 and 95 of the EU Treaty, represents a political compromise to minimize, in so far as possible, national obstacles to the establishment and free movement of institutions for occupational pension provision in the internal market.

The Pensions Directive, adopted for the benefit and security of an ageing population of European pensioners, will facilitate the free movement of institutions for occupational pension provision while respecting Member State competence with regard to social protection and the taxation of pension schemes. It identifies as a primary objective the protection of pension scheme members and beneficiaries and requires (i) legal separation between sponsoring undertakings (employers) and institutions responsible for pension provision; (ii) monitoring of activities of these institutions by a competent national authority; and (iii) the provision of adequate information for the protection of present and future pensioners. While many of the legal obligations imposed on Ireland by the Pensions Directive are already housed in domestic legislation, others will pose challenges and opportunities for the Irish Government, Ireland’s regulators and the pensions industry.

The Scope of the Pensions Directive

The scope of the Pensions Directive is limited. It applies neither to first pillar pension arrangements (e.g. typically state funded pay-as-you go pensions such as the exchequer funded contributory and non-contributory old age pensions) nor to third pillar pension provision (e.g. private pension arrangements including retirement annuity contracts and ARFs). Rather, its parameters encompass a limited class of second pillar arrangements, namely occupational pension provision.

The Pensions Directive addresses the activities of an institution for occupational pension provision ("iorp"). An iorp is described in Article 6(a) as:

"an institution irrespective of its legal form, operating on a funded basis, established separately from any sponsoring undertaking or trade for the purpose of providing retirement benefits in the context of an occupational activity on the basis of an agreement or a contract agreed individually or collectively between the employer(s) and the employee(s) or their respective representatives, or with self-employed persons, in compliance with the legislation of the home and host states and which carries out activities directly arising therefrom".

Where an iorp lacks legal personality under Irish law, per Article 2(1) the directive applies to "authorized entities responsible for managing [it] or acting on [its] behalf".

Iorps already covered by the preemptive provisions of Directive 79/267/EEC, Directive 73/239/EEC, Directive 85/611/EEC, Directive 93/22/EEC and Directive 2000/12/EC fall outside the Pensions Directive. As do institutions where employees of a sponsoring undertaking have no legal rights to benefits, where the sponsoring undertaking (employer) can redeem the assets at any time and not necessarily meet its obligations for payment of retirement benefits. In cases where an employer company uses book reserve schemes to pay out retirement benefits to employees, the directive, likewise, does not apply. Nor do its provisions extend to those institutions which manage social security schemes covered by Regulation 1408/71/EEC and Regulation 574/72.

The Scope of the Pensions Directive in the Irish pensions market

The Pensions Directive will directly impact upon a limited category of iorps operating within the Irish pension framework. These Irish iorps will be required by Article 7 to restrict their operations solely to retirement benefit related operations and activities arising therefrom.

Irish occupational pension schemes (defined benefit schemes and defined contribution schemes) are trust based vehicles and, as a rule of thumb, should fall within the scope of the directive. The Oireachtas, however, has power to restrict the scope of the directive. A large proportion of occupational pension schemes, the so-called small schemes, could be excluded under Article 5. Additionally, the legislature may choose not to apply Articles 9 to 17 to larger iorps where pension provision is made under statute, pursuant to legislation, or is guaranteed by a public authority.

The Pensions Directive will apply solely to pension schemes operating on a funded basis. As trusts established under Irish law lack separate legal personality, the directive must be addressed to those persons responsible for managing them. In the case of occupational pension schemes the primary addressees of the directive are likely to be their trustees.

A Personal Retirement Savings Account (PRSA) is colloquially referred to as a "pension product" but in legal terms a PRSA is simply a contract between an individual and an authorized PRSA provider in the form of an investment account that can be used to save for retirement. The statutory framework for PRSAs (and associated tax relief) is provided for in the Pensions Act 1990 to 2003. PRSAs (being contracts) lack separate legal personality and, logically, do not enjoy the capacity to sue or be sued in law. If the Pensions Directive is to apply to PRSAs, its provisions will have to be directed to their managers, the authorized PRSA providers.

The Oireachtas should address whether or not PRSA contracts are capable of consideration as iorps within the meaning of the Pensions Directive. A PRSA product may or may not be dependent on the existence of an employment activity. Where "group PRSAs" operate and are specifically provided for in employees’ contracts of employment, a decision will have to be made whether or not they ought properly to fall within the scope of the Pensions Directive. The portability of PRSAs from the work place to third pillar categorisation upon termination of employment gives rise to particular considerations. More straightforward though is the case of a PRSA contract concluded outside the scope of an employment activity; it falls to be viewed as a third pillar pension arrangement outside the ambit of the Pension Directive.

As a general proposition, the answer to any question regarding the application of the Pensions Directive to PRSA products may be found in the PRSA regulatory framework. IFSRA supervises PRSA providers while the Pensions Board authorizes and supervises PRSA products. PRSA providers are supervised either by reference to the Investment Services Directive (ISD) or the Third Life Directive. ISD PRSA products appear to fall outside the scope of the Pensions Directive whereas PRSA life products may be brought within the scope of the Pensions Directive where the Oireachtas positively chooses to apply the provisions of Article 4 to them. The Oireachtas, before making any decision on the application of the Pensions Directive to PRSA products, should as a matter of policy consider obvious competition implications. The need to maintain a level playing field for life office and ISD PRSA products at home and the costs of compulsory ring-fencing should be weighed against the opportunities for cross border trade within the framework of the Pensions Directive.

The De Minimis Rule

An iorp falling within the scope of the Pensions Directive may avoid substantive application of its provisions where the de minimis exception of Article 5 is applied. The Oireachtas will have discretion whether or not to apply the Pensions Directive (with the exception of Article 19) to small Irish iorps which operate pension schemes of less than 100 members. In exercising its discretion, the legislature is obliged by Article 2(2) to vest in small iorps the right to apply the directive on a voluntary basis. Voluntary application affords an iorp the possibility of engaging in cross-border activities within the meaning of Article 20.

Recent Pensions Board figures underline that at least 1,233 of a total 1,693 defined benefit pension schemes would escape application of the Pensions Directive if the Article 5 exception were applied to Irish schemes. Similarly, only 170 of a total 110,972 Irish defined contribution schemes would be covered by the directive if the Oireachtas were to exclude small schemes. Politically, it might appear anomalous that the benefits of a directive, adopted by the EU for the protection of present and future pension scheme members/beneficiaries, should not extend to some 219,632 current pension scheme members by decree of our national legislators.

The Oireachtas, as mentioned above, has additional discretion not to apply Articles 9 to 17 of the directive to iorps where occupational retirement provision is made under statute, pursuant to legislation and is guaranteed by a public authority. Leaving aside any debate on group PRSAs, where doubt exists regarding the possible application of the Pensions Directive to PRSA products, the legislature could apply Article 5 to individual PRSA arrangements essentially involving one contributor (member) and his/her PRSA provider.

Substantive provisions of the Pensions Directive

The substantive provisions of the Pensions Directive are housed in Articles 9 to 17. Their importance lies not only in their facilitation of cross border trade but also in their direct jurisdictional impact on national pension law requirements. The primary considerations are as follows:

Article 16(1) imposes an "EU funding standard" for second pillar pensions in Ireland. Each Irish iorp not excluded from the directive whether or not it engages in cross border activities must, at all times, have sufficient and appropriate assets to cover the technical provisions in respect of the total range of pension schemes operated by it.

Article 16(2) provides for a limited exception to Article 16(1). Ireland may allow an Irish iorp for "a limited period of time" to fail to meet the EU funding standard. While the definition of "a limited period of time" is not provided in the directive, under EU interpretation rules, any exception to the specific requirements of Article 16(1) must be interpreted strictly.

In Irish law, defined benefit pension schemes must satisfy a general statutory requirement of 100% funding. The funding crisis which ensued from the post-2000 stock market downturn resulted in many defined benefit schemes reporting serious funding difficulties. The Parliament’s response in the Social Welfare (Miscellaneous Provisions) Act, 2003 was to enable the Pensions Board to operate a "flexibility programme" for seriously underfunded defined benefit schemes. The newly inserted Section 49(3) of the Pensions Act 1990 to 2003 is temporally open-ended. It does not specify a statutorily "limited period in time" during which the full funding standard may be avoided. Instead, Pensions Board current practice permits, on a case-by-case basis, the underfunding of schemes for at least ten years. Its July 2004 Consultation Paper on the Funding Standard for Defined Benefit Schemes explores funding standard options for Irish schemes but, having taken into account the transposition requirements of the Pensions Directive, indicates a preference for continuing its present practice subject to slight modification.

To ensure effective compliance with EU law, as the State body charged with transposing Article 16, the Oireachtas should consider:

• Upon entry into force of the Pensions Directive, will the requirements of the first and second paragraphs of Article 16 engender directly effective legal rights in pension scheme members and beneficiaries upon which they can rely before Irish courts?;

• Does the EU doctrine of "effet utile" require that the term "limited period in time", as an exception to the general legal right vested in Article 16(1), be interpreted to oblige the Oireachtas to provide for a clear temporal delimitation in its transposing statute?

• Should the State fail to implement Article 16(1) effectively, either through parliamentary transposition or Executive action, would Ireland be exposed to State liability under EU law?

• Where an underfunded defined benefit pension scheme and/or its sponsoring undertaking collapse in the future and its members/beneficiaries (in vulnerable age groups) suffer loss, would a court of the European Community, on appeal or on reference, having regard to the clear, precise and unconditional wording of Article 16(1) view a deviation from full funding of ten years or more as "a limited period of time" within the meaning of Article 16(2)?

Iorps are required by Article 15 to establish at all times in respect of the total range of their pension schemes an adequate amount of liabilities corresponding to the financial commitments which arise out of their portfolio of existing pension contracts. Article 15(3) empowers Ireland to permit the calculation of technical provisions every three years.

Ireland is obliged under Article 12 to ensure that every iorp prepares a written statement of investment policy principles at least every three years. This statement must address such matters as investment risk measurement methods, risk management processes and strategic asset allocation with respect to the nature and duration of pension liabilities. Where an iorp significantly changes its investment policy during a particular three year period, the statement must be revised without delay.

Articles 11 and 13respectively address the information which must be provided to members and beneficiaries of an iorp’s pension scheme and competent authorities. In large part, these provisions mirror existing domestic disclosure requirements.

Article 14 may be interpreted as imposing on the State increased obligations as regards intervention and supervision of pension matters. Article 14 (1) legally obliges every national competent authority "to require" iorps to have sound administrative and accounting procedures and adequate internal control mechanisms. Where a national competent authority fails to discharge directly effective EU obligations properly any beneficiary of rights under the directive who suffers loss may sue the State.

Article 18 sets out the investment rules to be followed by iorps so as to protect the best interests of pension scheme members and beneficiaries. An iorp will be statutorily obliged to invest assets in such a manner as to ensure the security, quality, liquidity and profitability of the portfolio as a whole. Pension scheme assets must be properly diversified in such a way as to avoid excessive reliance on any particular asset, issue or group of undertakings and accumulations of risk in the portfolio as a whole.

Management and Custody

Article 19 seeks to ensure full respect for the EU’s rules on free movement of services and establishment. No national restriction can be imposed on Irish iorps when appointing investment managers, custodians and depositaries in accordance with existing EU secondary legislation.

Framework for cross- border iorp activity

The free movement provisions of the Pensions Directive essentially turn on the legal rights of:

• sponsoring undertakings (employers) in one Member State to make cross-border financial contributions to pension arrangements of an iorp established in another Member State; and

• iorps established in one Member State to accept cross-border sponsorship from an undertaking (employer) of another Member State.

The Oireachtas, when transposing the Pensions Directive, must be conscious of the opportunities available for cultivating in Ireland an international funds centre for the crossborder provision of pension services. International financial centers like Luxembourg and London will no doubt seek to maximize the opportunities afforded by the Pensions Directive. An essential element for consideration by Ireland is the tax status of authorized Irish iorps in a context of reverse fiscal discrimination.

Before an Irish entity can accept cross-border sponsorship within the parameters of the Pensions Directive, it must be authorized under Irish law as an iorp by the national competent authority, presumably the Pensions Board. An Irish authorized iorp may only engage in cross-border activities (i.e. accept cross border contributions) where:

• it notifies the Irish competent authority of its intention to accept contributions from a sponsoring undertaking of another Member State; and

• it complies with all the provisions of the Pensions Directive.

Upon receipt of notification of the Irish iorp’s intention to engage in inter-state activity, the national competent authority must obtain from the iorp the name of the non-Irish sponsoring undertaking, the name of the Member State where the sponsoring undertaking operates (i.e. the host Member State) and the main characteristics of the "pension scheme" to be operated for the non-Irish sponsoring undertaking (employer).

The Irish competent authority must relay this information to the competent authority of the host Member State within three months of receiving it, unless it has doubts about the funding of the Irish iorp or the good reputation or professional qualifications/experience of those persons responsible for managing it. In turn, the competent authority of the host Member State must, within two months of receiving the information, inform the Irish competent authority of the requirements of the social and labour laws of the host Member State which it would want to be applied to the Irish iorp before it would be allowed to operate a cross-border pension scheme for the sponsoring undertaking.

The competent authority of the host Member State may require the Irish competent authority to communicate to the Irish iorp, the host Member State’s requirements to be applied. These requirements, pursuant to Article 18(7) may also include (in respect of those assets of the Irish iorp which relate to its cross-border activities on behalf of the sponsoring undertaking) obligations that the Irish iorp must:

• not invest more than 30% of these assets in shares etc not admitted to trading on a regulated market;

• invest at least 70% of these assets in share etc admitted to trading on a regulated market;

• invest no more than 5% of these assets in shares and other securities etc issued by the same undertaking and no more than 10% in shares etc issued by the same group of undertakings; and

• not invest more than 30% of these assets in assets denominated in currencies other than those in which the liabilities are expressed.

Once the Irish competent authority relays all relevant communications to it (or where the iorp receives no communication within the statutory time limits) the Irish iorp may commence pension scheme activities on behalf of its cross-border sponsor. Its scheme must be operated in accordance with Irish law, social and labour law requirements of the host Member State (as notified) and any further requirements notified pursuant to Article 18(7).

In addition to regulatory supervision by the Pensions Board pursuant to the Pensions Acts 1990 to 2003 and the Pensions Directive, the Irish iorp engaged in cross-border activities will be subject to ongoing supervision by the competent authority of the host Member State to ensure adherence to the social and labour law requirements of the host Member State. Where breaches occur, the Pensions Directive provides for co-operation between the two competent authorities to ensure compliance.

Concluding Remarks

The Pensions Directive was negotiated at EU level between 2001and 2003 as collapsing stock markets wiped euro-billions of the value off Irish pension assets, leaving many occupational pension schemes seriously under-funded and requiring greater flexibility from the national pension regulator. The Pensions Board recently sought views from interested parties on the Irish Government’s proposed implementation of the Pensions Directive, which must in large part be transposed into Irish law by 23 September 2005. The regulator’s input to the State’s transposition process will, it seems, coincide with its consultative review of the funding standard for defined benefit pension schemes.

The Pensions Directive accommodates through its reliance on the "prudent man plus principle" two pension philosophies articulated by those EU Member States which, on the one hand, traditionally regulate pension provision by reference to qualitative norms and those, on the other hand, committed to quantitative regulation. In the former group, the interests of the UK and Ireland coincide while in the latter is grouped primarily the interests of civil law States. The prudent man plus formula establishes a principle-based harmonized framework for free movement of iorps with an absolute minimum of quantitative requirements.

The transposition of the Pensions Directive would be an ideal opportunity for consolidation of all pension legislation, old and new. The Government’s preferred implementation route is stated to be by statutory enactment amending the Pensions Acts, 1990 to 2003, introduced through the Social Welfare Bill, 2005. In transposing the Pensions Directive, the Oireachtas, pursuant to the European Communities Act, 1972 and Article 249 of the EC Treaty, must be conscious of and ensure the supremacy of European law, and the protection of Articles 40.3 and 43 of Bunreacht na hEireann afforded by judicial extension to the pension property rights of members/beneficiaries of occupational pension schemes.

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