Germany: A market dominated by providers
Pensionsfonds are established in the German occupational pension market yet bureaucratic hurdles hamper further development, write Alfons Schwarz and Ralph Rost
Occupational pension plans in Germany can be provided through five vehicles - direct promise, support funds, direct insurance, Pensionskasse or Pensionsfonds. The Pensionsfonds is the newest vehicle - it was introduced in 2002.
Companies that want to manage their occupational pension schemes through a Pensionsfonds can either set up their own company Pensionfonds (generally more common amongst multi-national corporate groups) or make use of a third-party Pensionsfonds from a life insurance company or financial service provider. Third party Pensionsfonds are open to more than one member company (predominantly medium-sized companies).
With increasing market volume, the majority of contributions paid into Pensionsfonds flow into six company funds and four to five group Pensionsfonds. In 2008, five company funds held over 80% of a total €14.5bn invested in all German Pensionsfonds at the time.
However, the 2010 Towers Watson Pensionsfonds Study only looks at the current 23 provider-managed Pensionsfonds in the German market, which provide a variety of insolvency-protected options for externally funded pension obligations. Out of the providers currently active, 15 took part in the study, including the most significant providers. Company Pensionsfonds do not offer their services publicly and were not part of the study.
During 2009, 6,559 companies paid a total of €940m into provider Pensionfonds. These contributions were for 161,615 beneficiaries, of whom around 16% are pensioners.
Contributions paid into German Pensionsfonds have almost quadrupled since 2005. The number of providers and the volume of pension obligations transferred to them are also increasing steadily. The increasing range of flexible models for non-insurance-based Pensionfonds is helping to firmly establish the Pensionsfonds as a fifth pension vehicle. After the law changed in 2006, Pensionsfonds no longer have to provide insurance-based guarantees - even in the retirement phase, thus enabling the introduction of so-called ‘non-insurance-based' pension plans. Non-insurance-based Pensionsfonds are able to apply the same discount rate prevailing in the market which is also used for international accounting valuations.
There is also the option of using actuarial tables other than those from the German Association of Actuaries (DAV 2004) which are calculated with enormous reserves. These factors make it possible to finance pension promises through the Pensionsfonds with funds that approximately equal the level of the pension obligations on the balance sheet (valued under international accounting principles); in other words the ‘true' volume of promises. This, however, is only true if the employer remains obliged to make additional contributions in line with the pension plan in the payout phase if the plan is not fully funded.
Bureaucratic hurdles in the way
The seventh and ninth amendments to the Insurance Supervision Act (German VAG) improved the regulatory framework for Pensionsfonds considerably. Stumbling blocks which slow down the future development of the Pensionsfonds market still exist though.
At the moment, a maximum of only €4,440 per person can be paid into a Pensionsfonds tax-free. Where the employee contribution is not sufficient after the contribution from the employer, the Pensionsfonds becomes unattractive to certain categories of employees, such as skilled staff and management personnel. In order to compensate for this deficit, employers have had to choose additional vehicles through which the scheme is financed. This automatically leads to plan rules that are fragmented, complicated and require a lot of explanation.
On the other hand, lower tax-exemptions could mean tax drawbacks for active employees, if their employers switch to the Pensionsfonds. The Pensionsfonds could achieve much higher growth if legislation removed these obstacles - a revenue-neutral way.
Financial crisis, short-term losses
The financial crisis created serious collapses in provider-managed Pensionsfonds at first. Contributions paid into the 15 Pensionsfonds included in the study fell by 48% in 2008 compared with the year before. This was followed by rapid recovery. In 2009, contributions rose by 240% (from €270m in the previous year to around €940m). What is remarkable is that this enormous increase in contributions can essentially be attributed to five pension funds.
The biggest increase in the volume of contributions in 2009 was registered with non-insurance-based pension plans. Many Pensionsfonds focused particularly on making a transfer to non-insurance-based pension plans more attractive, as a comparison with the data from 2006 shows. This strategy has clearly paid off.
What is astonishing when looking at the provider-managed Pensionsfonds, is that the volume of contributions to insurance-based pension plans developed just as positively despite the long-running financial crisis. Due to the way insurance-based pension plans are calculated (mortality tables and discount rate) they usually require much higher contributions than non-insurance-based plans. The growth in deferred compensation (defined contribution with minimum benefit), which is predominantly financed by regular contribution payments, was unsurprisingly restrained.
Vehicle for external funding
Pensionsfonds are often used in Germany to fund pension obligations (direct promises) externally. With a share of over 50% of the entire funds covering pensions (2008: €453.8bn), the direct promise is still the most predominant vehicle. Its dominance is based on the fact that it is the only option that offers companies a tax deferral on book reserves in the tax balance sheet. For some years, however, the tax deferral benefit associated with building up reserves that act as a liability has been increasingly countered by drawbacks in its external impact.
By externally funding their pension obligations, German companies aim to avoid recognising their pension obligations in the financial statements under German commercial and/or international accounting regulations. This is often done in an attempt to achieve a better credit rating and key performance indicators. Besides the effect on the balance sheet, if a company chooses to finance its pension obligations externally, it can also pass on any risks (biometrics, cost and capital investment resulting from pension commitments) to a third party. Against the backdrop of demographic change, there is also a growing desire to uncouple the occupational pension scheme from the company's future business prospects. After all, funding via a Pensionsfonds often brings a more professional approach to capital investment and the administration of pension obligations and, hence, corresponding improvements in efficiency.
Insolvency protection can also play a role when it comes to considering external funding. Direct promises and support funds as well as Pensionsfonds are covered by the German pension insolvency fund known as PSVaG. This body is legally responsible for insuring company pension schemes against insolvency and its sole purpose is to guarantee occupational pension provision in case the employer becomes insolvent. The insolvency protection fund is financed by mandatory employer contributions. The annually determined contribution rate is based upon the claims made over the year. Reduced contributions apply to promises in Pensionsfonds. In the wake of the financial crisis, the PSVaG contribution rate payable for 2009 rose considerably due to numerous claims and major insolvencies (14.2 per thousand for 2009 compared to 1.8 per thousand for 2008 and 1.9 per thousand for 2010). In this period, the comparatively cheaper insolvency protection for Pensionsfonds - as opposed to direct promises and support funds - came under the spotlight as a further argument in favour of funding pension obligations externally. However, this high rise in contributions was a special case. In addition, the contribution is usually only one of many factors relevant to the decision-making process.
During the financial and economic crisis, some companies held back plans to fund their company pension schemes externally to postpone the associated cash outflow. Yet this short-term collapse was more than compensated by a rapid recovery in 2009.
Alfons Schwarz and Ralph Post are consultants at TowersWatson in Germany.
The 2010 German Pensionsfonds Survey is available from Anna-Maria Angermann, firstname.lastname@example.org