Carrot or stick choice

The reforms of Germany’s pension
system (the fundamental
pension reform in 2001
(‘Riester pension reform’) and the
Pension Sustainability Act and the
Retirement Income Act which
became operative in 2005), with a
reduction of the state benefit level
and an increased focus on occupational
and private pensions, were a operations on 1 January 1975. The
basis of its activity is the Act for the
Improvement of Occupational
Pension BetrAVG.
Benefits under the insurance
become due as a result of the insolvency
of the employer, provided
the employees already receive occupational
pension or have a statutory
vested claim to such pension. In the
case of employer financed pensions
a statutory vested claim only exists
for employees of a member company
above 30 years of age who
were promised supplementary coverage
at least five years previously.
Insolvency insurance coverage
applies only to the pension financing
vehicles in which the payment
of earned entitlements to pension
benefits is endangered by an
employer’s insolvency. These
include book reserve promises,
support funds, Pensionsfonds
(reduced contribution rate) and
direct insurances under certain
conditions. The resources for the
execution of insolvency insurance
come from contribution from the
employer subject to the insurance
contributions based on obligations
under public law.
On 3 May 2006, the federal cabinet
approved a draft law permitting
the Pension Guarantee Association
PSVaG to switch to a capital-based
system within a period of 15 years.
So far, employer premiums must
cover the cash value of entitlements
to insolvency insurance benefits
accruing within a given calendar
year, in addition to other insurance
costs. Entitlements to benefits in
cases of insolvency are not prefinanced.
The financing scheme in
use is a pension-value apportionment
system. A characteristic feature
of an apportionment system is
that differences in claims/losses
accrued from one year to the next
are reflected directly in contribution
rates. The PSVaG has almost
60,000 member firms. The PSVaG
transfers old age pension benefit
payment obligations assumed as a
result of the insolvency of an
employer to a consortium of nearly
60 assurance companies.
The European Commission presented
its proposals for a directive
on improving the portability
of supplementary pension rights
on 20 October 2005. The declared
aim is to reduce obstacles to occupational
and geographic employee
mobility. We believe it to be counterproductive
that, in addition to
regulating transferability itself, minimum
conditions are to be introduced
(maximum vesting period of
two years, minimum age of 21 years,
maximum qualifying period of one
year) and vaguely worded regulations
for indexation of vested rights
are to be introduced, too. There is
no justification for linking these different
elements. The proposals
make it unnecessarily expensive to
run occupational pension schemes,
even if the additional cost were taxdeductible.
Above all, don’t the
member states have ‘supreme
authority’ over the structure of
social systems? Can provisions that
affect the labour-law structure of
occupational pension systems be
prescribed by Brussels?
Looking at this draft EU directive
and the proposed transferability
rules we think that a lot could be
learnt from the German experience.
In Germany, portability of pensions
among externally financed
pension plans was greatly enhanced
starting in 2005 (Retirement
Income Act). Employees are
allowed to request that their vested
pension entitlements are to be
transferred from their former
employer to their new employer.
The new employer is required to
accommodate the employee’s
request. The request has to be submitted
within the first 12 months
following the termination of the
previous employment contract, and
the employer is not required to
transfer an amount exceeding the
social security contribution ceiling.
If the pension amount exceeds the
ceiling, it is be up to both employers
to agree to the transfer. A pension
entitlement financed through book
reserves or support funds may also
be transferred from one employer to
another. However, neither the former
nor the new employer is obligated
to agree to the transfer. If the
two employers do not come to an
agreement, the vested entitlement
remains with the former employer.
In order to protect occupational
pensions, the restrictions on the settlement
of vested pension entitlements
at termination of employment
are strict. Only marginal lumpsum
pay-outs of pension entitlements
are possible.
Many years of experience have
shown that the transfer of rights or
the assumption of third party pension
promises hardly works in practice.
Therefore the transferability
rules focus on the transfer of the
respective values.
During the transfer, the transfer
value must be com-puted in accordance
with the rules and assumptions
of the transferring employer
and the transfer value must be integrated
into the pension plan of the
new employer in accordance with
the latter’s rules and assumptions.
It’s very important that the transfer
of a pension entitlement in all
cases does not constitute a taxable
event. A labour law claim to transfer
will alone not satisfy the portability
objective. If the transferability
is not accompanied by changes
in tax and social security insurance
law, the claim would lose much of
its value.
Portability rules have to be not only
in the interest of mobile workers, but
they have to include the interests of
remaining workers, employers and
the national budgets, too.
Klaus Stiefermann is managing
director of aba and Cornelia
Schmid is an economist with aba
– Arbeitsgemeinschaft für
betriebliche Altersversorgung
based in Heidelberg
1The Retirement Income Act (‘Alterseinkünftegesetz’),
which became operative on 1 January 2005,
revised the tax treatment of all pension contributions
and benefits (statutory pension insurance,
civil service pensions, occupational and private
pensions). The act extended the general principle
of tax-free contributions and taxable benefits to all
types of pension plans (gradual transition to EET
taxation). Accordingly, employer and employee
contributions to pension plans became gradually
tax free, up to a ceiling, while pension benefits
became, in general, fully taxable. The uniform tax
treatment of pension plans financed through
Direktversicherung, Pensionskassen, and Pensionsfonds
(three of the five existing pension financing
vehicles in Germany) was introduced. Employer
and/or employee contributions to these externally
financed vehicles are tax exempt up to 4 % of the
social security contribution ceiling (€63,000 in
2006) or annual contributions up to €2,520 in
2006. In addition, employers are able to make a
fixed tax-free annual contribution of €1,800 per
employee. This amount is not indexed for future
2According to Article 8 of the Directive 80/987/EEC
of 20 October 1980 ‘Member States shall ensure
that the necessary measures are taken to protect
the interests of employees and of persons having
already left the employer’s undertaking or business
at the date of the onset of the employer’s insolvency
in respect of rights conferring on them
immediate or prospective entitlement to old-age
benefits, including survivors’ benefits, under supplementary
company or inter-company pension
schemes outside the national statutory social security
3More information about the insolvency insurance
in Germany and the Pensionssicherungsverein a.G.
could be found: => ‘Wir
über uns’ => ‘Geschäftsberichte’ => ‘Summary of
annual reports’
4‘Standard’ direct insurances und Pensionskassen
of life assurance companies: The legislator
introduced a guarantee fund for life insurances
with the ‘Law amending VAG and other
laws’ in 2004. The life assurance portfolios are to
be transferred this statutory guarantee fund in
the event of insolvency. All German life assurance
companies participate in this fund. Therefore,
the retirement provisions of life assurance
customers are protected in the event the insurance
company becomes insolvent.
5‘Entwurf eines Zweiten Gesetzes zur Änderung
des Betriebsrentengesetzes zur Stärkung der
Insolvenzsicherung von Betriebsrenten durch
Umstellung auf volle Kapitaldeckung’
6You can find the aba ‘Assessment of the proposal
for a directive on improving the portability
of supplementary pension rights’ (in English): => News => Aus Europa
7The publication in the Bundesgesetzblatt: BGBl.
I no 53, page 2546; http://www.bundesgesetzblatt.
de/. The recent version of the Insurance
Supervision Act VAG can be found (in German):

Infobox 1: pension financing vehicles in Germany
In Germany the ‘Act for the
Improvement of Occupational
Pension ‘ (Gesetz zur Verbesserung
der betrieblichen Altersversorgung
– BetrAVG) provides for
five ways of pension provision
using different financing vehicle.
Employers can organise occupational
retirement provision by
means of: direct promises/book
reserves (Direktzusagen), support
funds (Unter-stützungskassen),
direct insurances (Direktversicherungen),
traditional pension
funds/ ‘Pensionskassen’ and pension
investment funds (Pensionfonds).
Pensionskassen, Pensionsfonds
and Direktversicherungen –
three of the five implementation
types - are under the supervision
of the Financial Services Regulator
BaFin (Federal Financial Services
Supervisory Institute: In Germany, pension
promises financed via bookreserves
constitute by far the most
important vehicle for financing
occupational pension.

Inforbox 2: IORP implemented in time
The law in order to change the
Insurance Supervision Act (Seventh
Law Amending the Insurance
Supervision Act; ‘Siebtes Gesetz zur
Änderung des Versicherungsaufsichtsgesetzes’)
became operative
in August 30, 2005. The law applies
to German traditional pension
funds (Pensionskassen) and pension
investment funds (Pensionsfonds) –
but not to direct insurances (Direktversicherungen.
There is no application
of Article 4 of the IORP Directive)
to this area, as this business of
life insurers is supervised exclusively
according to the regulations
in the consolidated life insurance
The key points of the law
amending the insurance supervision
act were:
❑The procedure for cross-border
activities of German Pensionskassen
(§ 118c VAG) and German
Pensionsfonds (§ 117 VAG);
❑The procedure for cross-border
activities of IORPs located in the
territory of another member state
(§ 118e VAG; these IORPs have to
comply with the rules mentioned in
Article 18, paragraph 7 (b) and (c));
❑The information to be given to
the members and beneficiaries
(annex D, chapter III VAG);
❑The adjustment of the actuarial
interest for Pensionsfonds
(Änderung der PensionsfondsDeckungsrückstellungsverordnung
Article 3 of the law amending the
insurance supervision act). Now,
thanks to this liberalisation an
actuarial interest rate can be chosen
with caution (so far, the actuarial
interest rate was 2.75 %). As a
result, less liquidity is required
when companies remove their
balance sheet obligations and
transfer them to a Pensionsfonds;
❑The changes for Pensionskassen
(in particular definition in § 118a
VAG; § 118b VAG: regulated and
deregulated Pensionskassen).
Following the implementation of
the IORP directive, Pensionsfonds
and Pensionskassen are therefore
able to operate throughout the EU.
Created by the Riester pension
reforms of 2001, Pensionsfonds are
equity-oriented vehicles that follow
the prudent person rule to
investing. The liberal investment
provisions applicable to Pensionsfonds
do not require them to
adhere to quantitative upper limits
regarding the mix of their
restricted assets. Pensionskassen
granting a guarantee have stricter
investment provisions. The BaFin,
the financial supervisor in Germany,
revised some circulars with
detailed provisions last summer
and autumn.
The new ‘Investment Circular’, circular
15/2005 now defines the
investment options available to
insurance companies/Pensionskassen
based on the new ‘Investment
Ordinance’, replacing circular
29/2002 effective 1 September
The circulars on reporting and
notification duties (R 11/2005) were
also revised. The new circulars continue
to provide for extensive
reporting duties vis-à-vis BaFin.
Finally, the circulars on the management
of reserve assets (R 12/2005)
and the responsibilities of the
trustee (R 13/2005) were adapted to
the new legal situation.
fundamental social policy challenge.
The framework conditions in tax,
social security and labour law for
occupational pensions have been
fundamentally improved in Germany
since 2001. The first successes
have also mean-while
become visible. This was confirmed
inter alia by the study presented at
the end of October 2005 entitled,
‘Situation and development of
occupational pension in private
industry and public service from
2001 to 2004’ issued by TNS
Infratest Sozialforschung.1
The results show that since the
pension reform in 2001 much has
been achieved, though Germany
still has a long way to go to reach the
social policy goal of nationwide
occupational pension: The share of
workers subject to social security
insurance with occupational pension
promises in private industry
was 46% (30 June 2004 as compared
to 38% as of 31 December
2001). The equivalent share of
workers in private industry and
public service was 60% (30 June
As a result of pension reforms
since 2001, the state pension benefit
level is to fall to 43% of average
gross income from 2030 compared
with around 54% now. Germany’s
parliament Bundestag – where the
centre-right CDU/CSU and centre-
left SPD have a super-majority –
had/has to cope with short-term
financial problems of the state pension
❑ Last autumn, the liquidity crisis
of the pay-as-you-go system made
an emergency €500m loan from the
government necessary;
❑ A law required German employers
to forward their share of the
scheme’s payroll tax two weeks earlier
than usual. Thanks to that onetime
measure the state pension
scheme receives much more money
in 2006 than in 2005;
❑ As of 1 July 2006, the state pension
benefits, currently drawn by
20m people, will not rise. This is a
consequence of the movement in
wages in 2005 and the new pension
adjustment formula. State pension
benefits are already frozen since
2004 and will be frozen until 2008
at least;
❑ The statutory contribution rate
to the state pension scheme shall
rise to 19.9 % from 2007 against
19.5 % of pay now. The contribution
assessment limit for 2006 is
€5,250 a month in western Germany
and €4,400 in eastern Germany.
That contribution is split
equally between employers and
The next pension reform is
already in place: The federal cabinet
decided already that the government
would raise the legal retirement
age to 67 step-by-step from
65 currently.
The renaissance of occupational
pensions in recent years is due
in part to favoured worker
financed occupational pensions.
Since 2002 (‘Riester pension
reform’), employees are per-mitted
to contribute up to 4% of the state
pension contribution ceiling
(€63,000 in 2006) or annual contributions
up to €2,520 in 2006 to
an occupational pension scheme
(deferred compensation). The contribution
is free of taxes and social
security contributions.2
This framework is attractive for
many workers, because the burden
of social security contributions is
high in Germany: social security
contributions paid by employees
and employers in 2006 amount to
41% of gross wages (statutory pension
insurance: 19.5 %, statutory
health insurance: 13.3 %, statutory
long-term care insurance: 1.7 %,
unemployment insurance: 6.5 %).
These saving incentives during the
accumulation phase are important
for low- and middle-income workers.
Since 2004, all recipients of
occupational pensions with statutory
health insurance have to pay
full statutory health insurance and
statutory long-term care insurance
contributions on those pensions.
This exemption of salary converted
into pension contributions
from social security contributions
(deferred compensation) is due to
expire at the end of 2008, so that
both occupational pension benefits
and it is in the cost of making provisions
for retirement will be fully
liable for social security contributions.
As a result, this form of occupational
pension will lose its attraction
for many employees with
statutory health and long term care
insurance. Employers and employees
could switch to more attractive
forms of saving like working-hour
accounts, staff shareholdings or
real property which are a bad alternative
to occupational pensions.
Therefore, retaining this exemption
is crucial to the further expansion
of the second pillar in Germany.
The government will decide
about the future of the exemption
from social security contributions
in the spring of 2007, when a comprehensive
report on the development
of occupational and private
pensions is published.
Progress has been dramatic since
the historic Riester pension reform
of 2001. Therefore, it’s not comprehensible
that some groups
already urge the government to
make it compulsory for employers
to offer occupational pensions to
their employees or to introduce an
‘opting-out model’. The crux of
the opting-out model is that
employees are automatically
enrolled in the occupational pension
scheme upon concluding their
employment agreement, thus automatically
waiving a portion of their
salary. Employees who do not wish
to participate can opt out of the
Up to now, it has not been proven
that employees have to be protected
from poverty in their retirement
by mandatory savings. Every
form of obligation would create
more bureaucracy, would increase
the costs of supervising mandatory
provisions and would add to the
costs on employers. Therefore, the
German government which has no
plans to make occupational or private
pensions mandatory has to be
Blueprint for Europe?
In Germany, occupational pensions3
are secure – even in the
case of the insolvency of the
employer. The Pension Guarantee
Association PSVaG,4 guaranteeing
payment of occupational old age
pension benefits in the event of

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