The overall DAX pension funding level has risen slightly, according to Thomas Jasper and Alf Gohdes
The year 2010 saw stable growth in the financial basis of pension plans in German DAX companies. Pension assets rose to €165bn, a greater than expected increase of 14%. Two reasons explain this large increase: the positive returns of 8.6% and the considerable funding contributions made by the companies themselves. Pension obligations increased by around 13% to a current €250bn, caused to a certain extent by a fall in the discount rate (from a 5.3% median in 2009 to 4.9% in 2010). Despite the rise in pension obligations, the level of external funding rose from 65% to 66% in comparison with the previous year. These are conclusions reached by the Towers Watson survey ‘2010 DAX Pension Assets and Pension Obligations'. Towers Watson has carried out this annual survey since 1999 and draws on information from the DAX companies' annual reports and notes to the accounts as well as other publicly available information.
Despite the volatility in the financial markets during the year, plan funding among the DAX companies continued as planned. The level of funding has practically reached the same levels as prior to the economic and financial crisis. It is clear that occupational pensions are high on companies' list of priorities. Some companies have made additional contributions to their pension plans. It is also clear to see the effect that risk management is having on pensions. In the course of economic recovery and demographic changes, these trends will become more pronounced and will generate greater capital funding. Under these circumstances, it should not be difficult for companies to limit the impact of economic turmoil such as those at the beginning of the third quarter of 2011.
Returns above expectations
In a favourable capital market, companies were able to achieve returns of around 9% on their pension assets. This positive development is consistent with the previous year's high of around 10%. The rise in pension obligations among the DAX companies was compensated by the positive development of pension assets. Losses in the bonds market towards the end of 2010 were over compensated by developments in return-seeking plan assets. Overall, there was a slight rise in the level of external funding of DAX pension obligations. In 2010, 66% of pension obligations were funded externally whilst in 2009, the figure was 65%. In a global comparison of pension funding, the DAX companies lie pretty much in the middle (average global funding level around 70%).
In total, the DAX companies contributed €7.3bn to their pension plans in 2010, an amount similar to the previous year. The trend towards capital funding of pension obligations continues among large German corporations. The establishment of yet another company Pensionsfonds underlines this trend.
Sound investment and risk strategy
Viewed globally, the level of German pension assets invested in equities is considerably less than in other countries (25% in Germany compared with 47% on a global average). German companies have anticipated the expected trend associated with changes in international accounting standards. Equally, they have placed great importance on setting up clear governance structures and careful risk management. Expanding risk management and including pensions in the key financial ratios also confirms this trend. This is the key prerequisite for using pensions as a strategic HR instrument. Viewing pension obligations and investment structure in combination has become best practice.
DC, risk and funding
Looking back over the last 10 years, DAX companies have focussed and adjusted their plan designs, their funding and risk management practices. Defined benefit plans have been closed and replaced by defined contribution type plans (German companies are obliged by law to provide minimum guarantees, so that a pension plan can never be pure DC). The interest yield on contributions is mostly linked to the capital market. Alternatively, companies can promise their employees a low interest yield and allow them to participate in all investment surpluses. This type of arrangement was driven particularly by finance managers in an effort to reduce risk.
The last few years have seen a change in attitudes. A Towers Watson study shows that 90% of respondents in HR departments view occupational pensions as a key instrument in winning and retaining talent. This view is underlined by the fact that occupational pensions were spared drastic cost-cutting measures in the last economic crisis. Pension plans today focus on using funds for the benefit of the members. Plan design and funding strategy are carefully aligned with each other to minimise risk or volatility.
Furthermore, contributions to pension plans have risen. The collective assets of all DAX pension plans in 2000 amounted to €78.8bn. In 2010, the figure was €165bn. Pension obligations rose from €146.6bn to €250bn. Over the same period, the funding ratio rose from 54% to 66%. (As German companies are obliged to vouch for the payment of the pension benefits and certain safety mechanisms guarantee payment in the case of insolvency, there is no requirement for full funding of pension obligations. Nevertheless, the amount of funding needed to cover the actual level of pension obligations will certainly exceed the plan assets disclosed in the accounts. This is because - in accordance with German accounting standards - pension obligations are often financed through company-internal accruals and are not necessarily considered plan assets under IAS/IFRS even if they are used to fund pension obligations).
That fact that the funding ratio has risen each year since the Towers Watson DAX surveys began in 1999, (the only exception being the short term decrease during the economic crisis) emphasises the priority companies have attached to the long term funding of their pension plans. This attitude is also strengthened by the continued development in the structure of pension asset and risk management. The success of these measures was proven during the economic crisis when the impact of capital market fluctuations on pension assets was kept to a minimum.
Thomas Jasper is head of retirement solutions and Alf Gohdes is manager, actuarial consulting at Towers Watson, Germany