AS fonds - a model for Europe?
In April last year Germany introduced a new type of investment fund under the German Investment Company Act (KAGG): the so-called ‘Altersvorsorge-Sondervermögen’, or ‘AS’. AS funds are mutual funds which are legally required to invest with the target of pension provision. The AS system is the only ‘true’ defined contribution system which is currently available in Germany, ie which fully releases companies from any liability for biometric risks.
Looking at the performance record of Anglo-American pension funds it is evident that for the purposes of optimum retirement provision it is sufficient to invest 75% of the fund’s assets in equities. At the same time this investment limit ensures that the unit prices of AS funds are less volatile than those of equity funds, thus accommodating the safety concerns of large groups of the population who still regard the volatility of the equity market more as a risk than an opportunity.
Investment companies launching AS funds are required by law to offer retirement savings plans (with a term of 18 years or up to the age of 60). Regular contributions into such a savings plan overcome the timing problem of the equity market for the contributors and at the same time provide the benefit of the ‘cost average effect’, ie when equity prices are high the inv-estor/employee acquires fewer units, when prices are low they acquire more which means that they obtain a favourable average purchase price.
Contrary to what is sometimes claimed - AS funds are not just another investment product but a novel, legally recognised retirement system with the special-purpose AS fund as its key element. Its purpose is to provide an adequate level of retirement income at minimum cost and with maximum safety. Since the law-makers were not bound by any traditional legal structures, it has been possible to design each element of the system in the best possible way.
That AS fonds are organised under the German mutual fund law KAGG - which in many respects is more demanding than the UCITS directive - provides a framework of institutional safety which should help to foster pensioners confidence in the industry. Overall pension provision through the AS fund system offers a similar level of safety as the state pension system. After all, the safety of any pension system depends on the sustainability of the economic factors on which it is built.
The viability of the state pension system is dependent on the continuing existence of a sufficient number of gainfully employed persons who are able to pay for the benefits of the retired population. By contrast, the safety of the AS system depends in particular on the continued existence of profitable companies around the world.
This premise is certainly no less likely than the continuance of the pay-as-you-go system which is the basis for the state pension.
The first AS-Funds were launched in October 1998; 34 AS-Funds are currently offered by 17 investment companies. From October 1998 until the end of 1998, these funds had net sales of DM751.1m (E384m) which on an annualised basis is more than total sales of unit-linked life insurance1. Total assets of AS stood at DM808.4m and total contract values at about DM64bn at the end of 1998.
AS funds offer a variety of different investment styles in order to suit different investor profiles and preferences. Most AS funds tend to be fully invested in stocks up to the 75% limit. On the other hand, there are AS funds catering to the more conservative investor which limit stocks to a low of 25% of assets with the remainder in bonds and units of open-end property funds.
First and foremost, AS can be reasonably expected to have a long-term performance in excess of 8% 2 which is approximately 2.25 times higher returns than what the traditional instruments of occupational retirement systems offer. Because of their bond-oriented investment policy traditional instruments have a long-term average performance of about 6% which means that the use of AS for occupational retirement schemes will produce the same level of retirement income at lower cost for the company.
AS funds furthermore will provide in particular small and medium-sized companies with the most modern state-of-the-art pension system thus creating a level playing field between SMEs and large companies.
This is important given the fact that the vast majority of German workers are employed in small and medium sized businesses, the ‘Mittelstand’. They allow for the establishment of an occupational pension scheme to which contributions can be paid - depending on the economic situation of the enterprise - either wholly or partly, continuously or temporarily, by the company only or jointly with its employees. Contributions by the employer and possibly also tax incentives could be made subject to the condition that the employee covers his biometric risks, for instance, by buying an occupational disability insurance and/or a term insurance. This would release companies fully from any liability for occupational disability and survivor risks. The sale of companies would no longer be encumbered by past liabilities such as pension liabilities and liabilities for biometric risks. On the other hand, companies continue to have a choice between conventional instruments of occupational retirement provision and an AS pension fund system based on securities.
At the same system the AS system ensures equal opportunities for all employees. It can be operated without waiting periods. It therefore provides an occupational pension system which is available to all employees (including part-time and short-time employees). The future pension level of an employee is not affected by changing jobs. This is of particular and fundamental importance in view of the current structural changes leading to greater labour force mobility.
Under the conventional system it could happen that employees who had contributed for more than 25 years to a supplementary pension scheme lost all their entitlements because they changed to another job.
The employee has legal title to the assets underlying the AS fund units and not, as in the past, just an unspecified claim vis-à-vis the sponsor of the pension scheme. Employees have a maximum freedom of choice during the capital accumulation process because they can switch from one AS system to another. At retirement age employees can freely decide how they want to cover their longevity risk.
A major milestone in the acceptance of AS in the second pillar has been the announcement of the powerful trade union of construction workers, IG Bauen Agrar Umwelt “to form as a subsidiary or sister company of the existing pension fund ZVK a Kapitalanlagegesellschaft which acts as a platform for workers investment in AS funds” for the purpose of additional retirement provision3.
The introduction of the AS system is a first step towards a fundamental review of the retirement provision system in Germany. In view of their high performance, great flexibility and universality - which makes them eligible both for personal and occupational schemes, AS funds are able to overcome the structural deficits of traditional retirement schemes not only in Germany but also in other countries. This can be achieved without requiring major changes in legislation.
The discussions within the European Federation of Investment Funds and Companies (FEFSI) have made it clear that European AS type funds could be set up in all EU member states on the basis of a European Directive. There would be no need to co-ordinate or harmonise existing laws and regulations as AS funds do not yet exist in the other countries.
This approach would be the fastest way to meet the demands of internationally operating companies for a Europe-wide pension fund system.
It would, however, require a policy decision - which surely will not be easy to achieve - at EU level on the introduction of a Europe-wide taxation treatment (flat-rate front-end or deferred taxation). The detailed of taxation, ie tax rate or whether tax relief is provided only if biometric risks need to be covered too, could be left to the discretion of the member states. This would make it possible to introduce relatively quickly an Europe-wide pension fund system for retirement provision which would fully meet the needs of companies and employees without having to change the existing traditional systems of retirement provision.
International experts such as Professor Blake, director of the Pensions Institute at London University, have described the AS system as “the system for the 21st century” and as “a model for Europe”. Modernising the conventional occupational pension instruments and at the same time integrating AS type pension investment funds as second pillar into the occupational pension systems would provide both Germany and Europe with a pension fund system which is leading in the world.
1.Estimated new premiums of unit-linked insurance in 1998: DM875.4m (Source: Tillinghast, Cologne).
2. An analysis of the BVI’s savings plan statistics covering all saving plans which invest primarily in German equities shows that after 35 years (and including all costs except for account-keeping fees which are only charged in few cases) 71% of all plans generated a long-term average annual performance between 11.02 and 8.01%. For the other 29% the results were between 7.2 and 8%. This long period of 35 years ensures that practically all stock exchange phases - from bullish trends to flat or bearish trends, even stock market crashes - are included. Nevertheless, even the poorest performer was not below 7.2%. The average annual performance was roughly 8.7%. But normally, the results were clearly above 8 %.
3. Industriegewerkschaft Bauen Agrar Umwelt, “IG Bau will Versorgungslücke mit Tarif schließen” (press release), November 2, 1998.
Rudolf Siebel is director policy and international affairs and Marcus Mecklenburg is internal counsel at the BVI Bundesverband Deutsche Investmentgesellschaften in Frankfurt