Klaus Stiefermann, Sabine Mahnert and Dr Cornelia Schmid argue that a few regulatory adjustments could greatly improve occupational pensions
The pension reforms of 2001 set the course for fundamental changes in German retirement provision. Alongside cuts in state pensions, rules were introduced to promote funded pensions. The right to make salary sacrifice contributions to an occupational pension plan, the Pensionsfonds, and a DC-type pension promise with a limited guarantee were introduced. The taxation regime for externally funded pensions was improved. With the Riester pension, the promotion of individualised third pillar provision became a focal point.
This package made an impact. Occupational pension coverage levels have risen, even though the reform was incomplete and economic and financial conditions were less than ideal. For example, certainty was only reached in 2007 that salary sacrifice contributions would continue to be exempt from social security levies. Moreover, the occupational pension system proved its resilience during the economic and financial crises and currently reaches over half of employees.
With a few minor adjustments to the regulatory framework and, importantly, no adverse developments from Europe, second-pillar provision in Germany could be greatly enhanced.
An important component of the 2001 reform was the introduction of a new second pillar vehicle, the Pensionsfonds. Initially, the focus was on the third pillar, with the Riester pension designed as an individual product that would provide a tax-deferred (or subsidised for low income earners) retirement savings vehicle to citizens affected by cuts to their state pension entitlements. However, the industry had for some time been calling for a Europe-compatible second pillar pension vehicle along the lines of UK and Dutch pension funds. Important prerequisites were that it be allowed to externally fund book reserve benefits, be free from investment restrictions and be able to operate on a pan-European basis. Not coincidentally, the European Commission was at the time working on the first pension fund directive (later to be known as the IORP Directive). So it was that at the eleventh hour, the ‘Riester reform' was augmented by a package for the second pillar and the Pensionsfonds was born on 1 January 2002.
Features that would make the Pensionsfonds attractive were:
• Few investment restrictions;
• Ability to accept transfer values of accrued past service benefits from book reserves and support fund schemes on a tax preferred basis;
• Ability to offer defined contribution schemes (albeit with minimum guarantee of nominal contributions at retirement) without exposure to longevity risk during the deferred period;
• 80% discount on the PSV-levy compared to book reserve and support fund schemes;
• Tax-free build-up of capital;
• Suitable for cross-border purposes.
Unfortunately, there were teething problems. Soon after the Pensionsfonds' birth, the world experienced a financial crisis with the implosion of the dot-com bubble. Confidence in risky assets eroded and the lack of investment restrictions lost its appeal as a major selling point.
Moreover, the taxation and regulatory framework for the Pensionsfonds, which heavily leant on an insurance model, was fraught with a number of design faults, which inhibited its initial adoption and growth.
Firstly, there was a contribution cap on the funding of future service entitlements. The cap remains and is viewed by practitioners as the single biggest hurdle preventing the Pensionsfonds from becoming an industry standard. It is, effectively, a per person cap of 4% of the social security contribution ceiling (ie, €2,688 in 2012). This amount limits the ability of companies to use the Pensionsfonds as a vehicle to fund defined benefit plans whose contribution rates are determined collectively and rise with an ageing population. As it happens, most Pensionsfonds currently fund either salary sacrifice quasi-DC schemes, or pensioner benefits, or a combination of both.
Secondly, the terms on which pensions in payment could be transferred from book reserves or a support fund scheme to a Pensionsfonds were prohibitively expensive. This costly transfer value basis also applied within a Pensionsfonds when an active member changed status to a pensioner and rested on the notion that pensioner liabilities should be defeased, ie, not give rise to any more funding contributions. This was the result of the regulator taking an insurance view of the world of pensions and ignoring the ability of the sponsor to fill funding gaps. In 2005, this disadvantage was addressed after which Pensionsfonds were able to use an actuarial basis that conformed with international accounting standards (IAS 19). Unfortunately, a third problem remained which would take the government another two years to address.
Funding and coverage ratios were inflexible. Underfunding of up to 5% was only tolerated as a temporary phenomenon, thereby limiting the ability of Pensionsfonds to invest in risky assets or, otherwise exposing the sponsor to the risk of regular cash injections. This significant disincentive to establish a Pensionsfonds was removed in 2008 when the law was amended to allow underfunding of up to 10% before triggering a recovery plan. A scheduled recovery period of a maximum of 10 years was then allowed. Formally, this provision can only be adopted if the Pensionsfonds does not itself guarantee benefits and the employer sponsor commits to funding any shortfalls.
After these reforms, Pensionsfonds were finally viable, although tax issues still remained. Coupled with the potential to reduce PSV premiums by 80%, the reform lead to a wave of companies establishing Pensionsfonds (Deutsche Post, MAN, Nestlé, RWE, Siemens among others). However, the problem of future service funding remained. A work-around solution for this was to combine the CTA (Contractual Trust Arrangement) and the Pensionsfonds, where the former acts as the funding vehicle for future service obligations, albeit without tax benefits, and the Pensionsfonds the funding vehicle for past service.
Evidence that the reforms in 2005 and 2008 achieved the final breakthrough for the Pensionsfonds is the growth in assets since that time (see figure 1). Over the five-year period to the end of 2006, assets in Pensionsfonds grew to a modest €2.11bn spread over 23 funds. At that time, the universe was dominated by financial services institutions offering multi-employer vehicles. The Bosch and Telekom Pensionsfonds were the only single employer funds established in the early days. In 2007, assets jumped to just over €14bn, a more than six-fold increase. Most of this increase can be attributed to single-employer funds that have taken on previously book-reserved liabilities. In 2010, assets stood at €25.4bn (the latest figure available) spread over 30 funds. One wonders what the growth rate would have been without the effect of the global economic and finance crisis.
As Pensionsfonds reaches its second decade, new challenges loom on the horizon. The revision of the IORP Directive risks undoing the painstaking efforts that were necessary to make the Pensionsfonds viable in the first place. ‘Solvency'-regulations as applied to the insurance industry would relegate the Pensionsfonds to the sidelines and thereby thwart the evolution of a potential industry standard not only for Germany, but also for Europe.
Klaus Stiefermann is secretary general of the German Occupational Pensions Association, AbA. Sabine Mahnert and Dr Cornelia Schmid are policy specialists at AbA