Company pension promises have had a total value of approximately E340bn at the end of 2001 in Germany. Over E200bn (or nearly 60%) are book reserve liabilities. Calculated according to IAS 19 the liability can easily be more than 20 % higher as valuations according to the German tax accounting standard, depending on the actuarial assumptions such as interest rate, salary increase and pension in payment indexation rate. For many companies the unfunded book reserves creates problems, but for different reasons:
o Company sell-off
o Liquidation
o IAS 19
o Rules governing raising capital (Basel II)
o Shortening the balance sheet
o Improved equity ratio
o Improved debt-equity ratio
o Especially after Standard & Poor’s has downrated the German multinational Thyssen Krupp on the grounds that their unfunded book reserve financed pension promise are debt-equity, more and more companies were sensitised to these issues.
There are a number of ways to get the book reserves off the balance sheet. One of the easiest way is to pay a compensation. This is without any restriction for the active employees and the pensioner. In the case of small pensions (maximum E23.80 monthly) it is possible without the agreement of the employee in the event of them leaving the company.
Making a move to direct insurance, Pensionskasse and support fund is not always appropriate because of income tax implications, with the exception of shifting pensions in payment to a support fund. Much more appropriate are contractual trust arrangements (CTAs) or a Pensionsfonds solution.
CTAs are a kind of trust. Their special feature is that the CTA does not come under the state supervision like Pensionskasse, Pensionsfonds and direct insurance. Therefore the company has a free choice about how to invest the assets. There are no limitations. On the other hand, the company bears the whole investment risk. Asset are recognised as ‘plan assets’ under IAS 19 and FAS 87 and can be deducted against the benefit obligation. A number of German multinationals have gone this way and now medium-sized companies are thinking about this opportunity.
Pensionsfonds can take over the pension obligation, too. Due to different actuarial assumptions calculating book reserves, the Pensionsfonds needs a higher single premium to take over the obligation than the level of the book reserves. The amount of book reserves are immediately tax deductible for the company. The difference between the single premium to the Pensionsfonds and the book reserves has to be split as business expense over the next 10 years.
Other special ways are the so called ‘assumption of debt’ (Schulduebernahme, according to § 414 Civil Law) and the ‘retirement company’. In the case of ‘assumption of debt’, another company takes over the pension liability. To do so, this company gets a lump sum which covers all future pension cost including administration costs and insolvency protection contributions. The pensioner will get the benefits then from this special company.
The ‘retirement company’ approach requires the splitting (Abspaltung) of a company into two parts: in the new company the active business and employees will be transferred. In the old company all pensioners and terminated vested employees remain. This old company can then be sold to a service provider company which will do all administration work in the future.
Marcus Mueller is a consultant with Gerling Pensionsmanagement, the German partner of the IBN Network