Peter Doetsch & Claus Adam look at the controversy over pension scheme models
Germany has been shaken by a controversial discussion about the necessity of further funding instruments or an improvement of the existing financing tool since early 1996. There is hope that this debate will lead in due course to an outcome that all interested parties will accept.
Before looking at the proposal for the implementation of Anglo-Saxon style pension funds in Germany, it should be noted that the reality is not as negative as suggested by the discussion. First of all, one has to keep in mind that the book reserve system is not the only method defined for pension finance in the German pension law. But a company can as well choose external vehicles including the 'Pensionskasse' a form of pension fund, direct insurance and the 'Unterstütz-ungskasse' or support fund to finance its pension promise.
But these investment funding vehicles are, however, to some extent de-fective. The 'Pensionskasse' and di-rect insurance are 'fiscally defective' because of the taxation of company contributions as current income to participants and providing for a flat tax-rate only up to a contribution of DM3,408 ($2,004) pa. Both funding vehicles are also faced with rather severe investment restrictions. The 'Unterstützungskasse' suffers from very low limits on deductible contributions if not re-insured or a lack of flexibility in funding if reinsured.
Despite the surprising findings of our survey (see panel), that contrast somewhat with the criticism by the German banking industry there is, without doubt, a necessity for an im-provement of the conditions for providing company pensions. This can be shown by looking at the national figures that reveal for many years a slow decline in the number of those entitled to pensions in company sponsored pension plans.
Various proposals have been made during the last three years how to improve the German Corporate Pension Act and to create an Anglo-Sax-on-type of pension fund in Germany.
Only two recent proposals are re-garded as having a chance to lead to a new bill. One is the proposal made by the Federation for Company-Sponsored Retirement Provision (aba) that covers industry, pension providers, insurance companies and actuaries as well as pension consultants. The other is a paper issued by the so-called 'Gerke-Kommission', a commission initiated by the German Ministry of Finance that consisted inter alia of members of the banking industry, insurance industry, aba, stock ex-change and company representatives.
Following the German path of 'per-fectionism' and the need for consensus, three different types of funds have been suggested by the 'Gerke Kommission' (named after its chairman, Prof Wolfgang Gerke). The following three types of fund have been recommended:
o a company-internal pension fund ('betriebsunmittelbarer Pensionsfonds')
o a company-detached pension fund ('betriebsmittelbarer Pensionsfonds')
o an investment-oriented pension fund ('anlageorientierter Pensionsfonds')
The 'Gerke-Kommission' proposes deferred taxation of benefits instead of tax favoured contributions for all three new types of pension funds.
The company-internal pension fund would be a means of externally funding the so-called direct pension pro-mise which is disclosed in the book reserves of the balance sheet. The 'voluntary ' accumulation of assets in such a fund would lead to a contraction of assets and liabilities from the balance sheet (off balance-sheet status of book re-serves), a solution invented by Siemens.
The assets of the company-internal pension fund should be tax-exempt. This funding vehicle is intended to finance defined benefit (DB) commitments without employee contributions. It would not be a legally in-dependent entity but be the property of the company. So the company would still be liable for meeting the pension obligations. The fund would provide old-age, disability and death benefits and be supervised by the company and an actuary. The assets would be pledg-ed to the beneficiaries and protected against insolvency by the German Insolvency Insurance Institution.
The company-detached pension fund is a new type of support fund. It would be a separate legal entity. Thebeneficiaries would, however, not have a legal claim against the fund but only against the sponsoring company. The fund is intended to serve as a funding tool for DB plans of small and mid-sized entities.
This new type of pension fund has certainly been promoted by the representative of the aba, since it corresponds with the proposal made by the aba on its own. Allocations to the fund should be flexible, eg to allow for full tax free funding of the liabilities and investment in stocks and equities should be promoted. Like the company-internal pension fund the company-detached pension fund should be under the supervision of the company and an actuary and its assets should be safeguarded against insolvency by the German insolvency arrangements.
The investment-oriented pension fund, an idea based on a former proposal by the banking industry, would complement the existing instruments for the provision of occupational pensions on a DC basis. It is structured as a separate legal entity similar to a support fund but giving the beneficiaries a direct claim to its benefits. The sponsoring company would not have an obligation to provide for a specific benefit at the time of pension payment. The company would have the duty to pay the promised contributions. It would be liable only for the safeguarding of biometric risks and the payment of a minimum benefit by the fund equal to the sum of the nominal contributions (deducting risk premiums paid) paid up to date. The sponsoring company would have to appoint a professional asset manager to administer the fund.
Employer and employee representatives would decide together which part of the contributions is used for the safeguarding of biometric risks and which one is used for investment. The risks could be borne by the company itself (self-insurance) or can be taken over by a third party (insurance company). Employer and employee representatives together would su-pervise the fund and decide on the in-vestment strategies.
The second proposal or improved package has been issued by the Fed-eration for Company-sponsored Re-tirement Provision (aba) to the German Ministry of Labour. The aba-proposal strongly emphasises the need for DC plans to be among the four existing financing vehicles. Pension funds should be implemented in form of an 'improved' support fund with the possibility of a flexible and full funding of the liabilities. The already existing possibility of free and unrestricted investment of assets should at the same time be preserved. The aba-proposal aims at a uniform deferred taxation of benefits (also for 'Pensionskassen' and direct insurance contracts) and a tax free accumulation of contributions.
Obviously, both proposals aim at the same goal of strengthening and supporting company-sponsored re-tirement provisions in Germany by demanding:
o a defined contribution option
o a more flexible external funding and reduction of investment restrictions
o a uniform deferred taxation of benefits instead of contributions
The major differences are that the proposal from the Gerke-Kommission wants to add three further funding vehicles to the existing four and to limit DC approaches to the new in-vestment-oriented fund, whereas the aba-proposal opts for a further development of the existing support fund and the possibility of a DC approach for all existing funding vehicles.
At the moment it is difficult to say which one of the proposals will be adopted and what possible amendments will be applied to the proposals in the future. From looking at both papers one could say that the aba proposal is more mature in the sense of labour and tax law implications al-ready been carefully considered. The outcome will also highly depend on the impact on taxes. Right now it is assumed that an immediate switch to a taxation of benefits instead of contributions for existing 'Pensionskass-en' and direct insurance contracts will lead to an initial shortfall in tax revenue of dm3bn.
The recent proposals are certainly not a revolution of the German pension system but if adopted in one way or the other, it will increase the number of new pension plans and at the same time the investment of pension assets in the capital markets.
Is Germany adapting the Anglo-Saxon approach on pension funding? We would like to answer with 'Yes and No'. It seems that compared to the Anglo-Saxon pension fund on a one-to-one basis the German approaches look more like sisters and brothers than clones or copies.
Peter Doetsch and Claus Adam are with Buck Heissmann in Wiesbaden