GERMANY - Small-to-midsize companies in Germany that finance pension liabilities via book reserves could face insolvency if they do not find an alternative, like creating an external fund, a senior Frankfurt tax official has warned.

"Each day, I see first-hand that German SMEs woefully underestimated their pension liabilities and don't have the necessary cash-flow to meet them," said Georg Harle. "If they don't act soon, like creating a pension fund, they could face insolvency."

"Another big problem for them is that because their liabilities seem unfunded, they can't be easily acquired," Harle told IPE.

International accounting standards tend to treat book reserve-funded pension schemes - known as Direktzusage in German - as unfunded. But only German SMEs that raise money on capital markets must adopt IAS; others report under German accounting rules which don't consider Direktzusage schemes as unfunded.

Over the past years, other German firms that use the Direktzusage but report under IAS have created contractual trust arrangements (CTAs), or external pension funds, for their liabilities. IAS views CTAs as an ideal way of financing pension liabilities.

Companies using CTAs have tended to be bigger companies, including near 20 traded on Germany's Dax-30 blue-chip stock index and several on the MDax mid-cap index. The question of whether German SMEs adequately meet their pension liabilities is a crucial one, as they account for 90% of the nation's industry.

Indeed, Germany's economic woes in the new century have, to a large extent, been caused by a record number of SME failures. Harle also released a study by German insurers saying that while German pension assets would grow from €381bn in 2004 to €659bn by 2010, companies needed twice that figure to meet their pension obligations.

But the study is misleading, since, according to a rough IPE estimate, 40% of the €381bn in assets are held by pension schemes that would qualify as unfunded under IAS. Harle himself said he did not agree with the study's findings, adding that he released it only to underscore the point that many German SMEs using the Direktzusage have unfunded pension liabilities.