Many German “Mittelstand” companies are unprepared to deal with their pension liabilities and will need to turn to contractual trust arrangements (CTAs) or Pensionsfonds to meet their obligations, according to an academic study.
The Fachhochscule des Mittelstands, a polytechnic institute specialising in the medium-sized company sector, carried out the study in conjunction with Commerzbank.
It found that half of the surveyed firms had pension liabilities and that these amounted to more than €5m at almost 10% of the companies, with the others having lower obligations.
Of those companies with pension promises, half of their liabilities were not funded or insufficiently funded.
Only 45% of the companies have a coverage ratio of more than 75%, with 21% in the 50-75% range, 16% less than half-funded and 18% having a coverage ratio of less than 20%.
It noted that the discount rate was due to fall from around 4% per annum to 2% over the next five years, and that – all else being equal – this would have the effect of lowering the coverage ratio to an average of 35%.
The majority of the surveyed companies would like to increase coverage of their pension liabilities, according to the study, with a bit more than half targeting a ratio of 75-100%.
At the same time, however, weak cashflows and low interest rates are necessitating coverage cuts, according to the study.
The situation means many companies are faced with challenges, the academics said.
Only higher contributions in appropriate financing instruments will help address the deficits, according to the study, which added that employers would need to analyse the current funding situation and then decide how to plug the funding gap.
“This calls for intelligent investment management and choosing the suitable solution,” the academics said, pointing in the direction of CTAs or transferring the pensions debt to a Pensionsfonds.
These are alternatives to what is still the most predominant way of offering occupational pensions in Germany – the Direktzusage, or direct promise, approach, whereby an employer funds benefit promises either from pension reserves or from cash flow.
In the 2000s, there was a wave of German companies, large and small, removing their pension liabilities from their balance sheets by turning to CTAs as a way of funding the obligations.