Due to the deteriorating demographic situation and the high unemployment rate, the recent pension reform tries to ensure stability of medium- and long-term-costs by cutbacks in social security benefits. The net replacement ratio, which is net state pension to net active earnings prior to retirement, will be reduced from the current level of about 70% to less than 67% over the next 30 years. The goal is to keep total employers’ and employees’ contributions to the system below 22%. In addition, the government has decided to help to increase funded occupational and private pension provision by creating incentives. Besides tax-incentives, important changes of the occupational pensions act were ratified.
Central aspects of the reform of the Occupational Pensions Act
The vesting period for benefits from employer contributions is reduced from 10 to five years. In addition, the minimum age requirement is decreasing from 35 to 30. This corresponds with changes in tax law. Book reserve allocations and support fund contributions can be made as from age 28–29 instead of from age 30–31.
If the employee contributes to the system the benefits arising become legally vested immediately. Book reserves can therefore be built immediately.
Until the end of 2001 an employer is free to offer occupational pensions. January 1 will bring a major change. Next year employees will be able to demand deferred compensation up to more than DM4,000 (e2,045)a year. But in most cases it will be necessary that corresponding collective agreements allow this. Therefore employers’ associations and unions are negotiating deferred compensation plans. Employees and employers will have to agree on a vehicle to use for this deferred compensation. If they do not agree and the employer is not offering a Pensionskasse, Pensionsfonds, or direct insurance has to be installed.
If the employee decides on deferred compensation and pays the contributions to the occupational pension plan out of net income he or she will receive special tax benefits. The amount of tax benefits depends on personal status and number of children the employee has.
Growing diversity of vehicles for occupational pension arrangements
The four traditional financing vehicles are:
q Book reserve system (Direktzusage). By far the most important financing method is via book reserve (assets 1999: DM365.7bn(€187bn). In this case the employer makes the pension commitment to the employees and accrues a liability on the balance sheet. Cost accruals up to limits defined by tax law are tax- deductible for the employer. Benefits are taxed when received by the former employee. It is not necessary to specially identify or segregate assets linked to the pension liability. An employer is perfectly free to invest the assets in the company or accumulate them outside without any effect for the “length” of the balance sheet. A countrywide compulsary insovency insurance sheme (the PSVaG, Pensions-Sicherungs-Verein aG in Cologne) covers vested benefits and pensions in payment in the case of an insolvency.
q Support fund (Unterstützungskasse). As a separate legal entity for the sole purpose of financing occupational pensions the support fund has similarities to Anglo-Saxon pension-funds (assets 1999: DM42.2bn). Company contributions to the fund are deductible, only the benefits will be taxed later, assets and liabilities are not shown on the balance-sheet of the employer and the fund has total freedom of investment. Full funding, however, is not able by support funds unless using reinsurance of the benefits.
q Direct insurance (Direktversicherung). The employer pays premiums to an insurance company (assets 1999: DM80.9bn). These payments are offset against the taxable profits but are regarded as taxable benefit for the employee. For premiums up to DM3,408 per person and year, the employee tax liability can be settled by paying a flat-rate tax of 20%. As a result the pension obligations are transferred from the employer to the insurance company.
q Pensionskasse. Pensionskassen are essentially small mutual insurance companies set up by an employer or a group of employers to insure benefits for their own employees (assets 1999: DM131.6bn). They provide benefits in a similar way to direct insurance and are subject to regulation by the insurance supervisory authorities. Because of the costs of setting up such funds, their use was restricted to industry-wide schemes and a few very large employers.
The new Pensionsfonds
The recent reform of the occupational-pensions-act introduced Pensionsfonds as a new way to finance occupational pensions. Contributions – up to fairly restricted limits – to this new financing vehicle will be deductible expenses for the company and not regarded as employee benefits. The benefits have to be pensions, but these need not to be indexed at all. If an employee pays into the system the employer has to given a money-back guarantee. Employer contributions can be made flexibly.
Significant details are still unclear. The Ministry of Finance and the Insurance Supervisory Authority have to draft three more directives to regulate the governing of the Pensionsfonds. These legal frameworks will not be ratified before November 2001.