Barbara Ottawa examines the reasons behind the growth of group CTA products
While Pensionsfonds were the German government’s answer for a vehicle to fund the on-balance sheet pension obligations of corporates, many firms have turned to contractual trust arrangements (CTAs) to fund these obligations.
Most of the Dax 30 companies already have a CTA and two-thirds of those companies’ obligations are now funded. But now small- and medium-sized companies are likely to want access to this type of vehicle.
At least that is what the providers are arguing. Among the various ways of offering occupational pension provision in Germany, the most predominant is the so-called Direktzusage, where an employer makes a benefit promise and funds it either from pension reserves built over the years or, as was traditionally the case, from cash flow.
“Every one of these unfunded pension reserves is a small PAYG pension scheme within the company and as such suffers from the same problems as retirement systems worldwide including demographic changes,” says Martin Katheder, co-CEO of the newly created Allianz Treuhand.
“This is one of the reasons foreign investors and banks view unfunded pension obligations critically when they want to invest or grant a loan, which means more and more companies are interested in getting these liabilities off their balance sheet,” adds fellow co-CEO of Allianz Treuhand, Marc Braun.
Therefore, in a possible environment of a global mergers and acquisitions, unfunded pension liabilities could be a disadvantage for German companies and a CTA might be a solution.
“You can make a company or a subsidiary more attractive by setting up a CTA for pension reserves, which means retirement liabilities are, at least partly, funded,” says Wolfram Schaab, (pictured left) senior client adviser at Metzler Asset Management, which in 2002 was the first to create a group CTA structure. “Back then setting up an individual CTA, like the large DAX companies did, was very costly and complex. But in the meantime there are also standardised group CTAs for small and medium-sized enterprises.”
However, so far the vehicle has remained relatively unappealing for small and medium-sized companies because the vast majority of them are still using the HGB German accounting standards.
“Under HGB it is not allowed to balance accounts by creating plan assets and offsetting reserves against liabilities as under IFRS,” says Nikolaus Schmidt-Narischkin, head of pension solutions at DB Advisors, the new institutional brand of Deutsche Asset Management. “At the moment only around 10-15% of mid-sized companies with unfunded defined benefit schemes are using CTAs. But that will change should the amendments to the accounting standards come into effect from next year as planned.”
The German parliament is currently discussing draft legislation, the so-called Bilanzmodernisierungsgesetz (BilMoG), which governs local accountancy standards. The bill foresees that companies using HGB accounting standards would also be allowed to create plan assets and thereby simplify their accounts, says Rolf Misterek, (pictured right) team leader in the outsourcing business of Mercer Germany, which is the first consultant to offer a group CTA. He confirmed that Mercer is already seeing “increasing demand with clients in consulting projects about group CTAs asking us for standardised solutions - similar to group Pensionskassen”.
Apart from optimising a company’s balance sheet, a group CTA offers companies the possibility to outsource some of the pension administration. “Companies that have done the pension administration themselves over the last years often came to realise they were not very good at it - this is not a question of money but of quality,” says Misterek.
Not all providers offer this extra service yet but Schaab points out providing this service “will be the future as most companies are not that keen on doing it themselves”. Metzler takes on some of its clients’ pension administrative services, he adds.
Another service that providers can sell in connection with group CTAs is investment advice as most group CTAs allow companies to choose their own asset allocation. “By law the trust is not responsible for asset allocation in the CTA or its success,” says Schaab. “But we offer individual consulting for German Spezialfonds as well as various standard portfolios to choose from.”
The regulator puts very few restrictions on the type of assets used in a group CTA. “Typically investment funds are used whereas, for example, direct real estate holdings would not be possible,” says Misterek.
Similar investment freedom is granted by the regulator in Pensionsfonds but many companies prefer a CTA or indeed have opted for both, as is the case with MAN, Siemens and Bosch.
Schmidt-Narischkin notes that as CTAs are “less complex to set up and less regulated, since the German supervisor BaFIN has decided single CTAs are outside the regulatory realm”, companies prefer this vehicle to a German-style Pensionsfonds.
Braun points out that “a company-owned CTA or multi-employer CTA offers an easy way to get pension obligations funded”. Katheder adds: “If companies want to set up or join a Pensionsfonds they usually need to get the approval of their employees. With a CTA the obligation stays with the company. Only the assets are separated in a trust, therefore approval is not required.”
Misterek explains that with a CTA “the employer does not have to commit to a specific level of funding”.
“The funding of a CTA can be, but does not necessarily have to be, calculated using actuarial assumptions,” Katheder says.
One of the major disadvantages of a Pensionsfonds frequently pointed out by providers is that only a limited level of contributions are tax reduced. However, Schaab is convinced Pensionsfonds “are getting more and more attractive for clients” as the law is amended continuously. “In future it might be possible to have direct transfers from a CTA into a Pensionsfonds,” he adds.
With CTAs playing an increasing role in funding pension liabilities, companies using this vehicle will put more pressure on the government to grant them equal rights to those companies offering Pensionsfonds.
“Currently companies with a German-style Pensionsfonds only pay 20% of the contribution to the state pension protection fund (PSV), that companies with an unfunded direct pension promise or a CTA have to pay,” explains Schmidt-Narischkin. “Companies with a CTA have long demanded a reduction as they are also funding their pension liabilities. However, if all those companies were granted a reduction, the assets in the PSV would go down and the risk for those in the fund would increase.”
But not all companies are using a CTA structure to fund their pension liabilities. Providers of group CTAs also manage occupational savings schemes, so-called Zeitwertkonten, into which employees can put overtime, unused holidays, bonus payments and early retirement provision - so-called Altersteilzeit.
Some companies have tried to combine the management of all three of these liabilities under their own CTA and this has rendered the structure quite complex. “Some company-owned CTAs are using real estate, which is difficult to administrate and value, to fund their obligations,” says Braun. He sees demand for multi-employer CTAs in future also from larger companies.
Another structural problem that company CTAs might face in the future is that often the board members of the trust are also the managers responsible for the financial decisions of the company, says Schmidt-Narischkin. “The unanswered question is whether some shareholders might think this is against the traditional Anglo-Saxon view of a trust and might decide it is worth going to court over.” He adds no such attempt has yet been made and “it might never happen”, but it is a possibility.
Schaab sees another group of potential clients for group CTAs coming from the increasing internationalisation of industries worldwide, including in Germany. “Although the credit crunch has led to a halt of mergers and acquisitions, the trend of companies focusing on core businesses and selling subsidiaries will continue once markets have recovered,” he notes. “And what does a foreign company do with the CTA which is attached to the company it has bought? It can put it into a group CTA where we are mirroring the existing CTA.”