New proposals to create a harmonised funding regime for pension schemes throughout the European Union could force UK employers to pay off deficits more quickly, according to Towers Watson.

The European Commission has told the European Insurance and Occupational Pensions Authority (EIOPA) that it wants a revised pensions directive to require consistent recovery periods across all Member States. It has formally asked EIOPA to provide advice by December 2011 to inform a review of the directive which governs pension scheme funding. Its call for advice discusses how DB pension liabilities should be measured and how deficits should be repaid.

Towers Watson suggested that a consistent European recovery period might shorten permitted recovery plan lengths in the UK to bring them into line with those seen in other countries where companies have smaller DB pension liabilities. If so, the firm says the Commission would need to consider what should happen in situations where diverting more cash to the pension fund would threaten the future of the employer’s business.

The EC said the main purpose of the Pensions Directive is to enable an employer in one Member State to sponsor a pension scheme based elsewhere. Towers Watson said the Commission appears to regard the fact that there are currently fewer than 80 pension schemes operating across borders as a failure of the Single Market.

John Ball, head of UK Pensions at Towers Watson, said: “When the directive was introduced in 2003, it was left to national governments to translate its requirements into law. The Commission’s main objection to the way they did this seems to be that different countries adopted different rules, rather than that employees’ benefits are not adequately protected.

“The Commission thinks national differences are depriving employers of the right to operate pension schemes that cross borders. However, most employers will be more concerned about how harmonised rules might affect their responsibilities in respect of pensions they have already promised to employees in a particular country. In 2006, it was estimated that 61% of the DB pension liabilities covered by the directive are in the UK and 24% are in the Netherlands, so a common set of rules will primarily affect employers with DB liabilities in these two countries.”

The Commission believes that “pension schemes and pension products containing similar risks should be subject to similar regulatory requirements”. It said that, where assets do not cover the resulting measure of liabilities, pension schemes “should set up concrete and realisable recovery plans. The recovery periods should be consistent across Member States and prudentially sound”. In the annex to its call for advice, the Commission asked EIOPA to pay “particular attention” to “the length of the recovery period allowed” when recommending rules for pension schemes.

A fully harmonised regime for deficit recovery periods would involve changes to some approaches currently used in Europe, said Towers Watson. The Pensions Directive already requires schemes that carry out cross-border activity to be fully funded at all times. The Commission has asked EIOPA to look at whether “a specific wording for cross border activity” is still needed or whether they should be subject to the same rules as domestic pension plans.

Moreover, several countries currently impose maximum recovery periods, in some cases of three years or less, while others, like the UK, do not impose a maximum recovery period. The Pensions Regulator expects deficits to be paid off as quickly as reasonably affordable, and it said the average recovery period for UK schemes with valuation dates between September 2008 and September 2009 was 9.4 years.

Ball concluded: “If there is a big deficit and not much money available, something has to give. If the recovery plan cannot take the strain, what will? In some countries, the solution can include cutting the benefits the scheme must pay out but solvent UK employers are not allowed to do this and forcing a company into insolvency will seldom be in anyone’s interests.”

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