There has been significant progress made during the past 12 months, in legislative, both enacted and planned, in practical and in conceptual terms regarding pension funding.
On the legislative front, the European pension fund directive was implemented into local German law in July of this year. The main changes made were amendments to the regulations governing Pensionsfonds and Pensionskassen.
Concerning Pensionsfonds, there was thankfully consensus among both political parties in the upper and lower parliamentary houses, namely that there should be a more European approach to funding for pensions and that the regulations should be more liberal in future. The new rules now allow a more actuarially reasonable but nevertheless still potentially restrictive framework for determining the technical reserves and such things as the contribution rate.
Specifically, the principles for selecting the discount rate have become prospective rather than retrospective in nature, currently allowing a choice of discount rate that is higher than that applicable under the previous regime.
Regarding Pensionskassen, those not soliciting pension business in the open market are now formally permitted to use less conservative demographic assumptions for determining technical reserves than Pensionskassen that are open to the pensions market in general. The rules for determining the discount rate that Pensionskassen must use have remained unchanged.
Current thinking surrounding contractual trust arrangements (CTAs) has also developed further. Uncertainties surrounding the personal income situation in the event of an actual insolvency or default of the plan sponsor are currently on the verge of being resolved. Fears that such a situation may be significantly adverse to the beneficiary have been informally allayed by the tax authorities and could be documented in a legislative amendment.
On the conceptual front, there has also been progress. General legal opinion on the contractual framework required to make a CTA insolvency-proof was recently challenged by one of the large auditing firms. Having raised a significant stir amongst advisers and their clients, the auditor finally backed down from his position allowing the continued classification of financial securities held by a CTA as plan assets under US-GAAP and IFRS.
The controversy did have a positive effect though: a fairly clear consensus has emerged as to the simplest and most effective construction of a CTA.
Prevalence of CTAs: Since CTAs are not regulated as Pensionsfonds and Pensionskassen, there are, no official statistics exist of their prevalence as yet. However, from my personal experience, I would estimate that approximately half of all book reserves obligations ie, about 25% of Germany’s total corporate pension obligations are backed by CTAs.
Role of IAS: Since the amendments made to IAS 19 in December 2004 broadened rather than restricted the range of options open to preparers of financial statements, the effect that the international financial reporting standards (IFRS) have had on funding policy in Germany in the past twelve months has been negligible.
Now that the transfer conditions from a book reserve, which is an internally financed arrange-ment, to a Pensionsfonds have become more favourable (the discount rate issue mentioned above), and because significantly lower premium payments to the pension insolvency guarantee fund, the PSV, are due under a Pensionsfonds than under a book reserve environment, will there be a trend away from book reserves towards Pensionsfonds?
No one can really know the answer to this question at present. To be on the safe side, however, the legislator is currently considering retroactive amendments to the regime governing the PSV. In general, industry is supporting this approach.
There is broad consensus that companies transferring their retirement obligations to financing vehicles requiring lower premium payments to the PSV in future should pay a single premium to cover their share of the future cost of insurance relating to events already occurred in the past. The exact form these measures will take has not been agreed upon yet, but legislation is expected to take effect before the end of this year.
Although the conditions for using Pensionsfonds as funding vehicles for pensions have been markedly improved by the implementation of the European pension fund directive, Pensionsfonds still do not have a number of characteristics that continue to make CTAs so attractive to a plan sponsor.
These include the lack of state supervision, cost effective structures and, generally, greater flexibility for the plan sponsor. Also, the attraction of paying only 20% of the regular premium to the PSV by shifting from a book reserves to a Pensionsfonds arrangement is in the process of being made less attractive to the company contemplating such change.
Considering all the relevant factors together, Pensionsfonds should gain some ground in the competition with book reserve arrangements. Firstly, there will be smaller arrangements looking to be orderly transferred to a fund without having to worry about administration. Secondly, there will be large companies that will be considering the establishment of a local fund that complies with the European Pension Fund Directive in order to fully pool and administer assets and liabilities in one location.
The former can be expected to occur a lot quicker than the latter, although a frantic run will not develop away from CTAs to Pensionsfonds.
Alf Gohdes is managing partner at Heissmann Consultants in Wiesbaden