The German Pensionskasse(PK) has been overlooked as a model in the debate about European pension provision, says Ekkehard Brüning, who runs the PK of the Frankfurt-based chemicals group Degussa, which has recently merged with Hüls, to form Degussa-Hüls. “If we had a common basis for tax and contribution levels and with freedom to invest up to 50% in equities, the PK comes very close to the system in the UK.”
Brüning acknowledges that UK funds have the freedom to invest up to 100% in equities, but points to the inherent volatility in such strategies. “The risk levels are very high. In Germany, the limits imposed by law on the distribution between shares, fixed income and property do provide a greater degree of safety,” he says, going on to maintain that balance over the long term is essential.
And who is to disagree with Degussa about having a long-term perspective? The scheme precedes the Bismarckian social security revolution in Germany, dating back to 1881, when it started life as more informal support or benefit fund. The full PK was not set up until 1907. Brüning adds: “There was no social security for white collar workers then, only for blue collar workers.”
The plan has been mandatory for all employees and their contributions have amounted to 2% of pay up to the social security contributions ceiling, while the employer contributes 3%. The goal is that with social security entitlements and the payments from the PK employees will obtain a very adequate pension with an income replacement ratio of around 80% after a 30 year career with the company, with 60% coming from the state and 20% from the group scheme.
Currently, the plan has around 16,500 active and 10,000 retired members, but this is due to change when the Degussa and the Hüls schemes merge.
Brüning joined the group in 1968 straight from university with a legal background. “At that point, I had no interest or knowledge about the PK and certainly no intention of becoming involved with the area.” But because of his duties, he came in contact with the actuaries and end up joining the PK board in 1972 and at the age of 38 was the board member responsible for both the investment and the administration side. He believes that combining the financial and benefits side makes his role more interesting: “If you are responsible for both, it gives you a much better feel for what you are doing. You must not be too cautious, but still not take too many risks. You have to find the right way with the right balance – the middle way.”
In the early days, the PK fund had mainly fixed income and real estate investments. For the first 12 years or so of Brüning’s involvement, he says that the emphasis was still very much in this direction. “We changed our strategy to go more into equities in the mid-1980s. The move was early by German standards then, although we only we had an equities proportion of 5 to 10%. This followed the easing of the official restrictions at the time.”
The equity component has been increased over the years. The equity/fixed income split is 20%/80% in book value terms, though in market value terms the equity percentage would be significantly higher. About 45% of the total portfolio is in fixed income in Schuldscheindarlehen, the unquoted loan notes, which the fund has very long experience in managing. There is, in addition, some directly held real estate amounting to around DM100m (E51m) and some mortgage loans and housing.
The equity portfolio is largely in domestic equities, with some excursions from time to time into the US and other markets. Areas such as emerging markets are regarded as terra incognita and are likely to remain so. As Brüning notes: “We have no experience of these markets.”
The PK runs its own portfolio, but with some outside help, says Brüning. Degussa established an internal bank, which handles much of the corporate treasury activities of the group some decades ago and this looks after all the dealings for pension funds. In fact, any mortgages the group undertakes are now done through the bank, with the PK releasing funds to the bank for this purpose. “We used to do mortgages, but stopped and handed this activity over to the in-house bank. It made no sense for both of us to handle these loans, we were able to give the bank money, top loan as mortgages to employees at a bit lower than market rates,” he says.
“We have Spezialfonds as well, but the two KAAGs (Kapitalanlagegesellschaft) only do administration work since all the investments we do through our group bank. This makes it much more economical than doing it externally.”
What attracted them to using Spezialfonds as a vehicle were the tax considerations. “What appealed to us particularly was the ability to keep gains unrealised within the funds and to decide ourselves when we would use them.” Originally, the KAAGS could not act in an administration only capacity, but later on the Universal group was able to offer these facilities. Now the PK has two funds, one still with Universal and one with Dresdner.
The investment committee of the PK includes two or three board members, and a representative of the bank, as well as people from the two investment companies. While the strategy on asset allocation is set down on a yearly basis, the day-to-day transactions will be handled by the bank and Brüning’s team. “We have a small weekly meeting to discuss current events, but any changes coming out of these will be quite small. But we have ‘big meetings’ twice a year, which everyone can attend. These give us the freedom to adjust if we see the market going in a certain direction.”
The fund aims to achieve an annual rate of return of 7%, of which three percentage points are for inflation. “We are of course interested in obtaining more than this,” says Brüning. By law the PK has to obtain returns of at least 3.5% each year, or 10.5% over the three-year actuarial period. But in fact the returns have consistently outstripped this by as much as two percentage points. In his mind the stability of performance is the most important aspect of all. “There is little point to have a period of significant gains, followed by a period in which you lose all that you have gained. We have always been on the plus side.”
Of the fund’s DM2bn value at the end of last year in book value terms, about DM1bn was in the Spezialfonds and DM900m in the Schuldschein. “We probably have unrealised reserves of around 10 to 15%,” he says.
In fact, when you look at the Degussa PK in contrast with the other major PKs in Germany, he says that the fund has been within the top five performing PK funds, according to the official figures from the supervisory authority. One of the next challenges on the agenda will be the merger of the Hüls PK with that of Degussa.
At Degussa the balance between the unfunded book reserve element in pension provision and the portion funded through the PK has been good, in his view.” The book reserve system has served German companies well and allowed them make pension provision at minimum cost, while leaving resources free for the benefit of the developing the company without external finance.” But this is changing, he acknowledges. “The book reserve system in its traditional form will alter. It will be underwritten by the use of special funds or some form of asset financing.”
As to the future of the PKs, Brüning believes this is still bright, but there will be changes here too. “At present, PKs can’t invest in private equity or other alternative investments, but that will come. We will obtain all the new instruments.” IPE