On 6 January 2020, the Belgian Financial Services and Markets Authority (FSMA) published a study on the financing of defined benefit pension schemes administered by insurance companies. The study, in itself, does not introduce any new legal rule. Nevertheless it gives a good overview of the rules and practices in the financing of pension schemes by insurance companies.
Differences in schemes administered by insurance companies and pension funds
A first difference to note is that the Belgian legislation treats pension plans completely differently depending on whether the pension plans are administered by an insurance company or by a pension fund (an institution for company pensions - “IBP” in Dutch). The latter are supervised by the FSMA, in particular the requirement for an annual reporting. Moreover there is the possibility of the FSMA imposing restructuring measures, as set out in the Act of 27 October 2006 concerning the supervision on pension funds. With the insurance companies, the basic principle of the legislation holds that it is up to the insurance company administering the plan to monitor the financing levels, and to inform the employer if there is a likelihood of underfinancing. It is then up to the employer to address the underfunding - in principle within six months - in the absence of which, the insurance company can reduce the pension entitlements pro rata with the available financial means.
Although we will not go into detail on all aspects of the study, we would nevertheless like to draw your attention to a number of conclusions drawn in the study.
Notification to the employer
Article 50 of the Royal Decree of 14 November 2003 requires an insurance company that becomes aware of an underfunding, to immediately inform the employer of this. In practice, the study shows that in 50% of the cases, it took the insurance company administering the plan up to more than three months to notify the employer. In 25% of the cases, it took the insurance company more than six months. A prudent employer should thus be aware that there may be a delay between the moment an underfunding actually occurs and the moment the employer is informed of this by the insurance company.
Frequency of reviewing the financing levels
A related point, is that this Royal Decree stipulates the insurance company should on a permanent basis monitor the financing levels of the pension plans they administer. While it is clear this requires at least an annual calculation, with regard to the obligation to issue a yearly pension statement, the law remains silent on precisely how often the financing levels should be calculated. On this point, the FSMA does not impose a specific frequency of the review, and merely states that this should be assessed on the basis of the factual elements, notably the evolution of the underlying assets.
Given this delay, the study found that 18 % of the pension schemes had an underfunding in terms of the legal requirements. Generally, it concerned small amounts that were relatively easy to rectify, but this shows nevertheless that foreseeing an adequate safety margin is good practice.
Calculating financing levels
The Belgian law leaves insurance companies on some crucial points the freedom to determine how the financing levels of the plans they administer are calculated. This notably concerns the impact of future increases of remuneration in defined benefit pension schemes. These schemes do typically use the remuneration applicable at the moment the affiliation to the pension scheme ends, for the calculation of the pension entitlements. This will have a consequence in an increase in remuneration and effectively have a huge impact on the pension entitlements if the employee was already affiliated to the pension scheme for a long period.
On this point, the FSMA clearly recommends that the insurance companies follow a prudent approach, even in the absence of clear mandatory rules on a method to use for calculating the financing levels. This notably applies to taking into consideration future remuneration increases, as the study showed a substantial part of the insurance companies do not take this into account, resulting in substantial underfunding if the employees remain in service and do receive increases in their remuneration.
The same holds for the assumption in the future return on investments. It is indeed clear that using an unrealistically high future return will artificially reduce the contributions necessary for obtaining a certain pension capital, whereby the actual contributions to be paid will only become visible once realistic assumptions are being used or as time goes by, the lower actual returns gradually replace the estimated returns.
In function of the actuarial assumptions that are being used, the study concludes indeed that up to around two thirds of the schemes involved in the study could potentially in the long term show an underfunding in the actuarial sense of the word.