The reform to introduce pure defined contribution plans is a huge opportunity. But if it does not succeed it may mark the beginning of mandatory corporate pensions, says Tobias Pross
The current draft of the law strengthening corporate pensions (Betriebsrentenstärkungsgesetz) was preceded by two separate legal opinions and more than two years of political discussions. While some details still need clarification, the new rules are expected to come into effect in January 2018.
Although the reform has to be seen as a complement to the current corporate pension landscape, it breaks with a principle of the German second-pillar system.
Currently, all forms of German corporate pension scheme (Durchführungswege) oblige a firm to guarantee its employees’ future pension payments. In contrast to other countries, defined contribution (DC) plans contained a guaranteed minimum benefit and only existed in Germany within a narrow context of accounting standards and specific insurance-type corporate pension plans. Small and medium-sized companies often identify this liability of last resort as an important reason for not offering a corporate pension.
This new law tries to increase the rather insufficient reach of corporate pensions in Germany. Indeed, over the last five years, corporate pension entitlements have flatlined, despite a booming German labour market.
While the number of people in work went from 29m in 2012 to 31m in 2017, the number of employees with a corporate pension has hovered at about 17.5m.
Furthermore, corporate pension schemes have been made mandatory in a number of sectors.
Removing these employees from the equation, the overall membership rate for corporate pensions in Germany drops from 57% to below 30%. As a result, employees on lower salaries in particular face significant income gaps in their retirement.
Key principles of the reform
Corporate pensions remain voluntary: all reform considerations are based on the continuation of the current approach – in other words, to explore and establish further possibilities which expand corporate pensions on a voluntary basis.
Easy and efficient corporate pension at plannable costs: the reform aims to increase the ratio of employees with corporate pensions, particularly those working in small and medium-sized enterprises and on lower salaries, by implementing easy and efficient corporate pension schemes at cost levels that can be planned in advance.
To achieve this, the reform package envisages granting a high level of autonomy and responsibility to the social partners – the trade unions and respective employer associations. The planned legislation will affect labour and tax law, as well as insurance supervision and social security law. The current draft can be understood through two perspectives.
Tax and social security law to improve attractiveness of corporate pensions: The most significant improvement from a taxation point of view is the doubling of tax-exempt pension provisions that can now be put into pensions: a maximum of 8% of the annual salary threshold, equivalent to about €6,000.
The most important change from the social security law perspective affects the retirement phase: voluntary additional old-age provision – up to a certain threshold – cannot form part of the so-called Grundsicherung, the state-financed minimum old-age income.
For the first time, the draft law also sets incentives for low-paid workers to increase their pension provisions. All this should encourage both employers and employees to do more corporate old-age provision, thus increasing the reach of second-pillar pensions.
The model of social partnering: The centrepiece of the reform package is the expansion of corporate pension law (Betriebsrentengesetz) to include true DC pensions. The employer commits to a DC system, which needs to be determined in a contract between trade unions and employer associations. The contributions are paid to a pension fund, Pensionskasse or direct insurance. Only annuities are allowed for retirement.
For an employer to be no longer forced to accept pension payment liability (Subsidiärhaftung) is nothing short of a paradigm shift in the German corporate pension system. Furthermore, the law specifies no pension protections.
The legal guidelines for the investment framework are being discussed intensively at the moment. In this context, the hottest topic is whether a formal guarantee can be given by the pension vehicle or not. Principally, the social partners will be able to influence the investment guidelines to a certain degree.
They are also encouraged to decide on a security contribution (Sicherungsbeitrag) from the employer to further stabilise the desired retirement outcome. This approach, known as collective DC, is already well-established in the Netherlands.
Social partners can also decide if the new DC scheme is offered to member employees on an opt-out basis. Evidence from the UK, US and New Zealand indicates that this can be a powerful tool to increase take-up rates. And a recent survey conducted by TNS Infratest suggests it could work in Germany too, with 70% of respondents saying they would value an automatic tax-exempt deduction from their salary if it went towards their retirement provision.
Stable retirement income is not the same as a guarantee. In this context, the new, pure DC pensions in Germany could define plan-specific requirements for the asset and risk management. The new law gives plenty of leeway to social partners as to how they choose a suitable solution. Any solution should take advantage of the long accumulation phase of pensions in order to invest sustainably in higher yielding assets, thereby truly differentiating themselves from existing corporate pension products.
“This new law tries to increase therather insufficient reach of corporate pensions in Germany. Indeed, over the last five years, corporate pension entitlements have flatlined, despite a booming German labour market”
So what could these products look like?
The current draft legislation leaves considerable discretion about deciding the right investment concepts. From individual unit-linked savings plans backed and organised by insurance companies, to collective solutions for whole industries, pension consultants, actuaries and asset managers have started a scientific debate about the perfect solution.
The pure DC approach reflects the wish of employers to ‘pay and forget’, without worrying about pension liabilities. Investments in the new DC world will be conducted in an employee’s name, based on their risk appetite and without a formal guarantee. This has generated an intense debate, as guarantees have been an integral part of German corporate pension provision for decades, and are hardwired into the consciousness. However, it is difficult to have both a guarantee and no pension liability.
Another question under discussion touches on the exclusivity of social partner agreements. Should employers not subject to bargaining processes between social partners be allowed to implement DC pensions?
At this stage, policymakers do not want to go down that route, as they fear it might lead to sub-standard arrangements.
Policymakers are trying hard to explain the reform measures with the utmost transparency. And they need to succeed. While it will take a few years to measure whether the uptake of corporate pensions has risen among low earners, future reform could bring mandatory pensions to corporate Germany.
Hopefully the social partners will make the best possible use of their options. In this way, employees will be able both to maintain their autonomy in old age provision and to achieve a better retirement income.
Tobias C Pross is head of EMEA and member of the global executive committee, Allianz Global Investors. He is also president of the BVI, the German Investment Fund Association
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