Until recently it was all quiet on the German pensions front, with the promise of the imminent, big advance keeping all eyes focused on that debate. But other fronts have been under development in the employee benefit and rewards field and probably in no area has been as the activity been as great as that of deferred compensation schemes.
“Salary deferral schemes have been popular for higher paid employees,” says Brigitte Miska, a consultant with the Munich-based Pension Consult. “The concept is gaining ground that employers have to be more flexible in their approach.”
Under such schemes, employees can defer receiving part of their salary, and receive it later as a pension after age 60, provided the total pension does not exceed 75% of salary prior to retirement. This pension is taxed and subject to social security contributions but only in respect of health benefits. “Even when pension plans start to develop again in Germany, there will be continued interest in these schemes, as employers are virtually under an obligation to provide them as part of the package,” says her colleague Hartmut Ritter.
There are signs that the culture is permeating down the corporate ladder, as the trade unions are becoming increasingly interested these approaches, particularly in the Zeit-Wertpapier (ZWP) concept, first developed by giant motor group Volkswagen.
Pension Consult, the pension advisory arm of HypoVereinsbank, Germany’s second biggest bank, is now working with VW under an exclusive co-operation agreement to market the concept more widely to industry across Germany.
In the discussions on deferring pay what was omitted was consideration of deferral over the whole of the working life, says Miska. “So people began to look seriously at the idea of setting up time accounts so that in their younger years when they invest a lot of time in working they could take this in the form of early retirement, but without affecting pension entitlements.” From this grew the notion of taking these hours and investing them. As ZWPs are early retirement arrangements with the worker still in employment, the payments are subject to tax and full social security contribution. Employees can only use their balance for this purpose after age 55.
Ritter says: “So what has been put in place in VW is that part of employees’ working hours are invested over periods of 10, 20, or 30 years. As this grows, it should be at greater rate than salaries develop over time, so that employees should get more time than originally invested. If they do not want to use it for early retirement it can be used for an additional package on top of their pension.” It is like the first step into a 401k plan, he adds. “In legal terms, of course, it is not the same, but in terms of economic reality it has the same effect.”
The concept first came up in 1996, but Miska says the legal framework allowing it to develop did not happen until 1998 with the arrival of the ‘Flex Law’. “What VW was able to do was to break through a number of the restrictions on using working time in this way at all. It was not possible until 1998 to take time you have worked during a period and not obtain the benefit until some time later. This was totally new.” No doubt, VW’s considerable clout with the government may have helped. “They were able to push the concept forward using some novel interpretations of existing legal terms, which hopefully will be redefined into new regulations. This was very important, as ZWP will only be really successful if we achieve the changes in the legal system.”
VW launched its scheme in April 1998, with a series of internal advertisements and offered it on a voluntary basis. Around 20% of employees joined up in the first year. But the group was not satisfied with this level of take-up. “So VW used part of the bonus that was given to all employees as an investment in ZWP shares, with everyone obtaining DM400 in shares to get them to make use of the new instruments. This helped immensely in getting the new scheme accepted. And the same happened again this year.”
Initially, VW used a series of seven Spezialfonds created for the scheme, each having a different manager, with Allfonds, the institutional asset management arm of HypoVereins, running one. “The treasury department at VW decides about the investments, along with employee representatives. However, initially, they had one asset allocation for each fund, around 30% equities and 70% bonds and the funds were given a yield target of 8 to 12% per annum,” says Ritter. “Already, they are heavy with money.” Recently, VW has recently increased the range to include five additional funds with a more specialist approach. State Street Bank in Munich acts as the custodian for the scheme. The scheme has now has 150,000 participants.
Now VW is examining whether it is legally possible to introduce the ZWP model into its operations in Spain, Belgium and China, while working with Pension Consult to spread the concept in Germany. The asset management arms of the bank have introduced it for their staff. Miska says that there has been interest from smaller employers, who could not set up their own Spezialfonds. “So we have designed a mutual funds structure using the fund of funds approach. This makes it possible for employers from different backgrounds to invest for a period which could be up to 40 years. We have set up seven funds for seven age groups, each covering a five-year span, starting with a total equity allocation at the youngest ages and increasing the bond content with each age-band.” An IT –based administration system to handle ZWP accounts for clients’ personnel departments has been developed
While VW gives a capital guarantee that the fund will at least equal the amount contributed to the scheme, Miska says other employers, particularly smaller companies, will be unlikely to do so. “The employee does take that risk then.”
One legal change expected is one to make the system portable. “At present it is restricted to the company where the employee started investing, but believe they will soon be able to take it with them when moving from one employer to the next,” she says. “Ultimately, people could deal in them and there may even be an exchange system like a time-share exchange.”
But that’s further out. The immediate task is to respond to the increasing market interest in the concept, with the unions taking more notice, particularly for lower paid workers. “By investing maybe eight hours a month in a fund they perhaps could be rewarded with one or two years’ of early retirement. It certainly can be an encouragement for people to work overtime hours that they might not do otherwise,” says Ritter. There has been some adverse public reaction, particularly employers were concerned it might be used as a ploy to claim extra overtime hours, but he claims that has now passed.
“We are trying to establish a ‘brand’ for the idea as happened with AS funds and there is a good chance of this occuring as other investment groups and banks are working in the same direction. But we think we are one step ahead of the game,” says Mishka.
She does not see any difficulties in offering independent advice in the area, while being part of a major banking group. “We give our advice on a fee-paying basis and take great care that we remain independent of the bank.” It is up to the client to decide if they wish to use the bank’s asset management services.