The Legal 500

Recently, certain pensions consultants have begun actively promoting the set up of pan-European pension schemes, also known as cross-border pension schemes. They are being promoted on the basis that pan-European pension schemes offer the opportunity to save costs, increase administrative efficiency and to retain talented employees. This article summarises our view of the pros and cons of setting up such an arrangement.

What is a pan-European pension scheme?

A pan-European pension scheme is one that is established in one European Union member state and is authorised to receive contributions from members based in other EU states. Pan-European pension schemes were introduced as a result of the 2003 European Pensions Directive, which was implemented in the UK at the end of last year. The aim of the Directive is to create a single market for occupational pension provision.

What are the advantages?

It is clearly an attractive proposition if a company is able to rationalise its European pension arrangements so that, rather than having one pension arrangement in each country, it operates one large pension scheme applicable to all. The rationalisation into one pension scheme should enable a company to:

• save money through reduced transaction costs and lower investment management fees;
• control risk more effectively and improve corporate governance as it is easier to monitor the one pension scheme;
• save time managing one large scheme as opposed to several smaller ones;
• pool assets and liabilities in the pan-European scheme from schemes in different countries; and:

• allow employees to work in various EU countries without their benefits being reduced;
  
• continue to build up money in one pension rather than having several smaller ones;
• avoid the problem of different vesting ages between EU states; and
• maintain salary linkage to an employee's pension.

Current difficulties

Stricter funding requirements for defined-benefit schemes

Set against these perceived advantages are a number of potential problems. One of the major drawbacks to the cross-border legislation is that defined-benefit (DB) schemes must be fully funded at all times. Schemes that fell within the cross-border legislation before 23 September 2005 had to complete their first statutory funding valuation by 22 September 2006, and have to meet their statutory funding objective by 22 September 2008. New schemes are allowed two years from the date of application for authorisation to become fully funded.

Another cost is that actuarial valuations must be undertaken every year, rather than on a three-yearly basis as with most DB schemes operated in the UK.

Tax discrimination

According to some consultants, the biggest barrier to pan-European pension arrangements has been the discriminatory tax treatment directed towards pension schemes established in other EU states. Until recently, many EU countries did not extend tax privileges to ‘foreign' pension schemes, but most EU member states have now agreed to discontinue this practice.

The EU countries that do not discriminate on tax are Austria, Finland, France, Germany, Hungary, Ireland, Luxembourg, the Netherlands, Poland, Portugal, Spain and the UK. The UK is seeking to market itself as the obvious choice for multinationals to set up their pan-European schemes.

In addition, the European Court of Justice has made it clear in recent cases that member states which continue to place higher tax burdens on schemes established in different EU states are unlikely to be allowed to continue to do so.

Compliance with social and labour laws

A further potential cost will be that a pan-European scheme will need to be divided into sections for each EU member state where members are employed, and each section must comply with the social and labour laws of the relevant country. This could involve companies in a significant amount of compliance work, given the rich diversity of social and labour laws across the EU.

Combating potential problems - harmonising legislation

Further legislation, in the form of the EU Pensions Portability Directive, is unfortunately still some way off. It will help to combat discrepancies in EU member states' approaches to pensions, but the Directive will not come into force until 2008. It will address three key areas:

• the maximum age limit for eligibility to a scheme, which will be restricted to 21;
• the vesting period before entitlement to benefit arises, which will be restricted to two years; and
• if an employee leaves work but their benefits are not fully vested, they will get back any employee contributions should they so choose.

There is also the Budapest protocol for co-operation between pension supervisors, which should further facilitate pan-European schemes. It sets out the guidelines for supervision of the schemes and should ensure greater co-operation between the different authorities in each EU country, as well as increased harmonisation of practices.

Conclusion

If your company is a large multinational that sends many of its employees to work within Europe, and has various individual pension schemes established across Europe, then there are clearly advantages to considering setting up a pan-European scheme. However, there are, at present, still significant potential difficulties in setting up and running such an arrangement and further harmonising legislation is not due until 2008. Employers will therefore need to carry out a careful due-diligence exercise and cost-benefit analysis before operating a pan-European arrangement at this stage.

Philip Goodchild is a partner and Holly Thomson an associate in the pensions team at Stephenson Harwood.

E-mail: philip.goodchild@shlegal.com.