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Risk, return and pension funds

When it comes to economic policy, there is much to criticise about the centre-left government of German Chancellor Gerhard Schröder. Despite an unemployment rate not seen since the 1930s – namely around 5m – Schröder’s government is still not doing enough to make Germany’s labour market more flexible.
Schröder’s government also has not gone far enough in reforming Germany’s inefficient tax and social welfare systems, though there has been progress, like the Hartz labour reforms and a possible cut in corporate taxes soon.
However, when it comes to boosting German occupational pensions, Schröder’s government has achieved a great deal since taking office in 1998. The historic Riester reforms of 2002 gave employees the right to a defined contribution (DC) pension and provided tax breaks to encourage second and third pillar saving.
Riester also created the Pensionsfonds, Germany’s answer to the Anglo-Saxon pension fund which faces no restrictions on equity investments. Riester was further strengthened last year, when the government simplified the tax break criteria and improved the portability of second pillar pensions.
Now in September, Germany’s occupational pensions industry is due to take another step forward when Schröder’s government transposes into law the EU pension funds directive. And as the important date approaches, everyone in the industry – pension funds, insurers, consultants and asset managers – is wondering: “How big of a step will it actually be?”
If the step is big enough, history will reward Schröder’s government for laying the groundwork for a vibrant German occupational pensions industry. If not, the conservative opposition, which looks likely to win next year’s federal election, will get its chance to make history.
When details of the finance ministry’s draft law transposing the EU directive first emerged last autumn, it looked as though the government had got it right again on pensions. Pensionsfonds and Pensionskassen, the traditional corporate vehicle that accounts for one-fifth of the e354bn in pension assets, were given the right to do business in any EU member-state.
As part of the de-regulation, the finance ministry hinted that rules governing Pensionskassen – particularly their inability to invest more than 35% of their holdings in equities, might be relaxed. Barbara Hendricks, deputy finance minister, said at the time: “The opening of this market gives us the opportunity to review the traditional way the Pensionskassen are
regulated.”
Yet since then, the finance ministry has decided to change little where Pensionskassen are concerned. This was no doubt largely due to input from German financial services regulator BaFin, which, like any regulator, thinks it knows best for its industry. As a result, Pensionskassen will continue to be treated as insurance vehicles, meaning that the equity restriction and others like a 5% cap on hedge fund investment will be maintained. BaFin will also continue to regulate Pensionskassen and Pensionsfonds when they enter other EU member states.
The investment restrictions were built into the Pensionskassen to ensure that they provide a guaranteed minimum return, which is currently 2.75%. Yet if Pensionskassen decide to compete in the EU, the restrictions could prove to be a handicap for two reasons. Firstly, other European pension funds, including Germany’s Pensionsfonds, are in a position to deliver higher returns as they face no investment restrictions. Secondly, employees in EU countries outside of Germany will ask themselves what added value Pensionskassen offer when the guaranteed return they promise can be had with local insurance products.
Even so, German pension experts point out that even if the draft law had better equipped Pensionskassen to compete in the EU, this would not have prompted many of these vehicles to venture outside of Germany anyway. This, they say, has to do with the absence of a single market for European pension funds.
“The EU pension funds directive does not provide freedom of movement for pension_funds that the European Commission wants. This is because there is no tax harmonisation in the EU and because the various social and labour laws have to be respected in each EU country,” observes Hans Melchiors, board executive at the life insurer Volksfürsorge (VFS) in charge of its occupational pensions business.
Citing an example, Melchiors says: “It wouldn’t make sense for a German pension fund to open its doors in Lithuania just for the sake of a few employees. If it did, the fund would have to go to the cost and trouble of translating its business in Lithuanian and adhere to the local laws beyond what BaFin is requiring.”
A further barrier pertaining to central and eastern Europe is the absence of mature financial markets among the new EU entrants in that region, says Ernst Schmandt, a partner at German pensions consultant Dr Heissmann. Germany’s Pensionskassen are not too thrilled about the EU pension fund directive. For example, BVV, the e17bn Pensionskassen for Germany’s entire financial service sector, has no plans to compete elsewhere in the EU, even though it has the resources and expertise. According to Rainer Jakubowski, BVV’s chief financial officer, the Pensionskasse sees its future growth potential foremost in Germany (See article page 48)
However, Schmandt does expect some movement between European pension funds, noting that it will take place in those EU member states which have similar social and labour laws. “Like German Pensionskassen, Belgian pension funds must guarantee a minimum return on employee savings, so Belgium would not be unfamiliar territory for Pensionskassen,” he says.
That Pensionskassen do not currently harbour great ambitions for the EU may actually be a blessing for the German occupational pensions industry. Consider that, as the EU directive permits German companies to operate their pension funds elsewhere in the EU, they may actually begin to snub Germany in favour of places like Ireland and Luxembourg. These countries are more attractive in that they offer low taxes and a mature but not over-regulated financial industry. Luxembourg is even more attractive as it is the place where all major European languages are spoken.
Peter König, managing director at the German Society of Investment Professionals (DVFA), and a well-known pensions expert, believes it is likely that German multinationals in particular will take advantage of the EU directive. “To be honest, this may not be a good thing for the German pensions industry, as it would lose assets,” he says.
König did not cite examples, but it is easy to imagine that some companies, for example, Siemens Pensions Trust, the e10bn pension fund for the German technology giant, are cheering the arrival of the directive in Germany. The trust looks after a multitude of pension funds for Siemens units from Munich. In Luxembourg, it could theoretically do so at lower cost.
Bernhard Wiesner, head of the Pensionsfonds for German auto component and appliance maker Robert Bosch, also expects a good number of German small and medium-size enterprises (SMEs) active around Europe to make use of the directive. “Particularly for cost-sensitive SMEs, it makes sense for them to consolidate their pension plans into a central fund instead of continuing to run them separately around Europe,” he says.
However, losing corporate pension assets as a result of the EU directive is something that the industry cannot afford to happen. It is already in a fragile shape after the introduction of the Riester reforms, which created new DC business, have not had a big impact on asset growth since they took effect in 2002.
German pension experts stress, therefore, that in the interest of ensuring the industry’s competitiveness, the government must strengthen the vehicle which is Germany’s equivalent to the Anglo-Saxon pension fund: the Pensionsfonds.

Launched three years ago with great fanfare, the Pensionsfonds, whether industrywide vehicles like Chemie Pensionsfonds or company ones like that for Bosch, have flopped. Estimates are that Pensionsfonds have taken in a few hundred million euros in assets, far below the tens of billions many in the industry had expected at this stage.
For one thing, Pensionsfonds sales have been cannibalised by the pre-dominant Pensionskassen. The equity-oriented vehicle also had the bad luck of emerging at the height of the equity market slump and midway through Germany’s economic stagnation of 2001-2003.
More importantly, though, Pensionsfonds have not fulfilled their original mission. This was to provide German companies using the Direktzusage – that is funding pension liabilities with balance sheet assets – an attractive alternative. Companies using the Direktzusage, especially quoted ones, have come under pressure amid new international accounting rules to finance their pension liabilities via an external fund.
Since the Direktzusage accounts for no less than 60% of the e354bn in German pension assets, Pensionsfonds stand to benefit enormously. So far, companies using Direktzusage have shunned Pensionsfonds in favour of contractural trust agreements (CTAs) to fund their pension liabilities.
The reason is the so-called Rechnungszins – a figure used in calculating how pension obligations are met by a company. The higher it is, the lower the capital reserves needed to meet the obligations and vice versa. As the Rechnungszins for Pensionsfonds is 2.75%, while that for Direktzusagen is 4-6%, there has been no incentive for companies to switch to the former vehicle.
According to pension experts like Melchiors, König and Wiesner, the solution is simple: the government should adjust the Rechnungzins so that it is similar to that for the Direktzusage. “If this is not done, German companies will not have a suitable external vehicle at their disposal with which to meet their pension obligations,” says Wiesner, noting that CTAs are not suitable due both to the high costs and complexity involved.
Keeping the status quo would prolong the Pensionsfonds’ suffering, and, adds Wiesner, “hold down the further development of Germany’s occupational pensions industry in a European context”.
It is difficult to imagine that Schröder’s government would not follow the experts’ advice. Having created the Pensionsfonds as an innovation on the traditional Pensionskasse, the vehicle’s competitiveness must be one of its key priorities. Indeed, once foreign pension funds begin competing in Germany, a crucial question will be whether German vehicles can fight off the challenge. Pensionskassen have investment restrictions that these foreign vehicles lack, so Germany needs to have a viable alternative, namely the Pensionsfonds.
Moreover, some German pension experts estimate that if the Rechnungszins for Pensionsfonds is upwardly adjusted, it could lure up to 50% of the more than e200bn in assets held in the Direktzusage in the medium term. This scenario shows that by exerting a little bit of effort, Schröder’s government could help Germany’s occupational pensions industry take a big step.
The signs from Berlin are encouraging. The German social affairs ministry, which Walter Riester led between 1998 and 2002, has already said it will recommend an adjustment of the Rechnungszins when the EU directive is implemented in September. However, the finance ministry, which has final say over the matter, remains unconvinced, says VFS board executive Melchiors, who is lobbying the government on the issue.
For the sake of Germany’s occupational pensions industry, the hope is that ultimately, Schröder’s government will again demonstrate forward-thinking on pensions this September.

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