Ageing populations; shrinking work forces, are putting intense pressure on state pensions. This is driving change throughout the whole pensions system: The relationship between the state and its citizens; the nature of the pensions promises made by employers to their employees; the design of private retirement saving products.

The pressure on the state pension system is forcing a wider rethink of our policy for long term savings and pensions markets. EU age-related expenditure is projected to increase by 4% of GDP up to 2050. In a third of EU member states this figure could be nearer to 7%. An ageing population represents a budgetary challenge over the long term for all member states, despite recent reforms at national level.

We have to use every tool at our disposal to ensure that parts of our workforce do not find themselves destitute on retirement. This will mean developing alternative sources of retirement income to the state pension, and alternative methods of provisioning other than through tax contributions. Work-related retirement schemes, known as second pillar, and private pension third pillar products accessed through direct relationships between investors and financial institutions will have to fill the gap.

This outlines my views on both occupational pension schemes and private pension products. I would like to reflect on ways in which we can harness the full potential of our integrating European financial markets in support of better retirement provisioning.

Occupational pensions markets: I believe that these offer clear advantages in terms of accumulating savings on very competitive terms throughout working life. There appears to me a clear logic in this form of asset accumulation. At EU level, we have introduced rules - the Directive on Institutions for Occupational Retirement Provision (IORP) - to allow the best pension fund managers to administer pension schemes across the single market and pension providers to compete fairly on a pan-European basis.

Given this harmonising framework, I cannot see the continued need for prescriptive rules and restrictions on assets in which pension funds invest. I am particularly disappointed to hear of instances where IORPs encounter resistance as a result of national investment limits applied to pensions funds’ asset allocations. This represents a puzzling derogation from the ‘prudent man’ principle. Fund managers are seasoned professionals and should be perfectly capable of judging how much risky investment their portfolio can absorb.

It is imperative that this directive is applied consistently and effectively across the EU. I am happy to report that CEIOPS has finalised a Cooperation Protocol for pension supervisors. This will help a lot to prevent distortions of competition and to facilitate cross-border activity of pension funds.

Proper implementation and enforcement of this directive are essential. Because well functioning, integrated and competitive second pillar pensions markets will reduce costs for pension scheme providers; they will provide workers/consumers with better retirement solutions and access to the products and providers which can best meet their individual needs. And encourage pan-European labour mobility.

 

This directive forms an important contribution towards effective and efficient EU pensions markets. But the current market context implies other challenges too. Firms are innovating in terms of investment strategies and asset allocations - to better manage risks, to seek out higher potential returns. One example of this is the trend toward liability driven investment, in part driven by regulatory and accounting rules. This is forcing changes in the way schemes are managed and operated. It introduces new challenges with regard to product design and asset mix.

There are also big changes in the nature of pension promises by employers to employees. From defined benefit commitments to collective and individual defined contribution pensions. Shifting the balance of risk further onto individuals. Amplifying the risk transfer effects from declining state benefits. Today, consumers are bearing more retirement-related risk than they have at any time since the creation of the modern welfare state. So raising the level of financial education of citizens and increasing emphasis on financial advice will be important counterweights to ensure that households can self-manage these risks. Not nearly enough emphasis is being placed on this. We are therefore having a conference next year to spark a pan-European debate on this matter.

Currently there is much experimentation at national level. Here in France, the collective retirement investment plan (PERCO), a pay-as-you-earn system, has been successfully introduced. I understand that it is popular with many employees/investors. That it provides effective incentives to save, provides investors with choice over which types of investments best meet their current objectives and needs. Of course this is just one example. In Europe, we have much to learn from each other: in generalising best practices and successful models. I watch these markets, and other innovations/developments in other countries with great interest.

 

But I want a real flexible European market to develop over the next few years. To tap in and benefit from the widening, deepening EU capital market. Private long term savings are also an integral component of a well functioning pensions system. Citizens must be well served by additional voluntary retirement savings products on competitive terms.

Investors need a financial services industry that is not burdened by unnecessary and anti competitive administrative costs or obstacles, which are ultimately passed onto consumers in the form of fees and charges. I will do my bit to ensure that the European legislative framework does not stand in the way of a more competitive fund industry.

Two weeks ago, the Commission adopted a ‘White Paper on enhancing the Single Market Framework for Investment Funds’. This sets out a phased strategy for improving the EU UCITS framework. It aims to allow EU markets to function effectively, competitively. To meet the competitive challenge from new savings products and from other parts of the world.

I would now like to touch on two broader issues. First, we need to push markets to deliver new types of retirement products. Which deliver the types of functionality which citizens and investors will need in retirement. The biggest challenge is in transforming accumulated private savings into a steady and predictable income stream that will last throughout retirement. This is arguably the most important aspect of retirement planning for savers and pensioners. A traditional option is of course the purchase of an annuity. But these markets are still fragmented and underdeveloped. The reasons for the slow evolution of European annuities and longevity risk markets need to be carefully analysed and tackled.

One of the biggest stumbling blocks to the development of annuity and other retirement products is the limited supply of instruments to hedge against longevity risk. There are now some tentative signs that this is starting to change. Given their importance in structuring retirement products, public authorities may wish to ensure that the conditions are in place to help these longevity risk markets to develop successfully. This is one of the many issues that are now being looked at by finance ministries.

Second, the need for effective intermediation and advice: The choice of retirement product - whether via a work-related scheme or on a private basis - will increasingly be the most important financial decision that an individual makes. As state pensions decline in importance, the individual pension investments will largely determine the standard of living in retirement. The choice of investment vehicle and provider will become one of the most important financial decisions that most citizens take during their entire lives. There will be a huge burden on the sales and advisory services to get it right and on their responsibility to act fairly and responsibly.

We are already putting in place some important regulatory foundations. These will ensure the quality and independence of investment advice and intermediation services. MiFID rules on inducements, conduct of business and disclosure of costs will ensure that advisers and sellers of financial instruments put the interests of the client first. It remains to be seen how these rules will work in practice.

We will need to look at whether these disciplines should be generalised to all main types of savings product. MiFID rules do not apply to insurance products for example.

We may also need to examine whether similar safeguards need to be put in place for pension products sold through the workplace. We cannot afford a situation where decisions on the choice of retirement product are a radar hit-and-miss affair. In many European member states, investment sales and advisory services are still in a period of gestation. The answer to Europe’s retirement challenge lies not only in the design of a new generation of retirement products - but also in the way that they are sold. The financial services industry holds the key to ensuring a predictable and comfortable retirement for European citizens. We have a real job ahead of us in educating consumers about the need to provision properly for their retirement and the need to seek advice. Many member states have been slow to explain this new environment to citizens. Governments do their citizens no favours if they shirk honest and effective communication about the need to prepare for old age. They merely delay the inevitable and prevent individual’s decisions to increase their personal retirement savings. And, they risk crowding out their own capital markets with unsustainable levels of government debt.

We must all evaluate how we can harness the full potential of financial markets in meeting the challenge that an ageing society presents. I am conscious of the fact that I have asked more questions than I have provided answers. This is because these are new and complex challenges.

The above is extracted from a speech Commissioner McCreevy gave to the IPE Awards seminar in Paris

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