Ask asset managers doing business with German corporate pensions what they feel is driving the industry these days, and many will rattle off two acronyms: “CTAs and ZWKs”.
No need to worry if these acronyms don’t ring a bell. No one outside of corporate pensions in Germany has a clue what they mean either, and the first one, “contractual trust arrangements” isn’t even a German term.
Still, there’s no doubt that CTAs - external funds that enable companies to finance pension obligations externally instead of with on-balance sheet assets - have created a boom in German corporate pensions.
Due in large part to their popularity among big companies listed on the Dax-30 index, tens of billions of euros have already been allocated via the funds. Experts also believe that the boom will be sustained by CTA demand among listed companies outside of the Dax. Yet it’s debateable whether ‘Zeit-Wert-Konten’, which loosely translates to ‘overtime accounts’, are having a similarly big impact.
Pioneered by German car giant Volkswagen in 1998, a ZWK enables an employee to save, on a tax-deferred basis, the monetary equivalent of overtime hours, unused holiday, cash bonuses or a portion of salary to help finance early retirement or any time off work. The scheme is simple and attractive to companies, as they are neither obliged to provide a top-off nor guarantee the paid-in savings.
Adds Thomas Keil, director of pensions at Universal-Investment, a Frankfurt asset manager: “Another big advantage of ZWKs is that they allow flexibility in using employees. People can be hired for certain projects and during certain seasons. In this way, companies can keep labour costs under control while employees still have a source of income during quiet periods.”
For most employees, a greater ability to finance time off work or early retirement is inherently attractive. Another argument for ZWKs is that the fact that the government is raising the legal retirement age and plans to end ‘Altersteilzeit’ (subsidies for workers near retirement) from 2009.
Perhaps. Yet until recently, ZWKs really did not catch fire in corporate Germany as a whole. Instead, they were mostly found among multinationals. Beyond Volkswagen, examples include BMW, DaimlerChrysler, Deutsche Bank, Deutsche Telekom, Siemens, SAP and EADS.
While these are well-known names with tens of thousands of employees, they only account for a fraction of corporate Germany. Moreover, among the firms which dominate corporate Germany, namely the Mittelstand (small- to midsize enterprises), ZWKs have played a marginal role. The handful of SMEs known to have the accounts are the German units of computer firm Hewlett-Packard and tyre maker Michelin, as well as sensor maker SICK and microscope maker Leica Microsystems.
Indeed, for asset managers active in Germany, the volumes generated by ZWKs are too small to get excited about. Excluding Volkswagen, which says its ZWK has generated nearly €600m in assets since its launch, the market is estimated to be at most €250m.
Even so, many asset managers beyond Universal-Investment are convinced of the market’s long-term potential. Allianz Global Investors, for example, says its business with ZWKs is currently growing between 25 and 30% annually, though it did not disclose the total volume of this business.
“What is particularly encouraging is that interest in the accounts is growing fast among unions and employers, particularly those in the chemical, metalworking and port sectors,” says Lars Strohmenger, director of pensions markets at AGI in Munich. “These positive signals mean that ZWKs may one day become an integral part of wage agreements.”
Equally as bullish about the future of ZWKs is the German arm of US asset manager Invesco. Invesco was one of the first movers into Germany’s ZWK market earlier this century. In early 2004, it scored a coup by winning the mandate to set up and manage the accounts for 18,700 employees at Airbus Deutschland. The mandate was broadened in late 2005, when Airbus’ parent EADS announced that Invesco would establish ZWKs for its 21,400 German employees.
Now, Invesco says it aims to acquire between 15 and 20 new ZWK mandates in 2006, adding that the total volume from this business should reach €50m. Invesco has generated around €40m from the Airbus/EADS mandate alone.
The volumes from ZWKs are certainly underwhelming, but the asset managers are right to be optimistic about the future of the business. After a slow start, they are beginning to proliferate in corporate Germany and should get a further boost owing to government moves cited earlier.
Moreover, due to the popularity of ZWKs among Germany’s biggest firms, tens of thousands of employees - many of them young - already have access to the accounts. Pension Consult, a Munich consultancy owned by German bank HVB, estimates that each employee using a ZWK saves between €1,200 and €1,400 annually.
Hence, though asset managers specialising in the accounts will not forecast their growth, it’s a good guess to say that within a decade, ZWKs could be become a multi-billion euro market.
Beyond AGI and Invesco, Deutsche Asset Management and DekaBank are considered major players in the market. Universal-Investment has also recently begun a joint venture with German pensions advisor Lohoff and Partner to offer ZWKs. In addition, the German arm of Fidelity Investments will offer the accounts later this summer.
Because of the low volumes, these asset managers use mutual funds instead of Spezialfonds – traditional German institutional funds that require investments of €25m and more. The managers also typically invest according to a life cycle model involving equities bonds and cash.
To illustrate how the model works, consider AGI’s mandate for SICK, a sensor maker based in Germany’s Black Forest. If a 25-year-old SICK employee opts for the ‘growth approach’ to investing, 95% of the assets are invested in equities and the remaining 5% in bonds. Once the employee turns 50, the equity quota is reduced to 60% while the bond quota is increased to 40%. Finally, between the ages of 59 until retirement, all of the assets are invested in fixed income and cash.
Regarding the costs of ZWKs, Keil from Universal-Investment says they are nominal for companies, partly because the employees pays the management fees related to the selection of mutual funds.
ZWKs have a lot to commend them, but they are not without controversy. Professor Bert Rürup, one of Germany’s best-known pension experts, sees a problem with their being used to retire early instead of, as originally intended, to promote flexible employment.
Rürup argues that amid dramatic demographic change in Germany - namely a greying workforce combined with one of the lowest birth rates in Europe- it has never been more economically crucial for people to work longer. Indeed, demographics are already putting enormous pressure on the state-run pay-as-you-go health care and pensions schemes.
“Moreover, the ageing of the population combined with fewer babies means that the economy will not be able to afford to lose people with the proper skills and know-how,” Professor Rürup, who is also head of the government’s independent council of economic advisers, adds.
According to Keil, ZWK’s tax-deferred status might pose a problem for the government, especially if, as expected, the accounts flourish. “With a ZWK, taxes and social contributions only become due when the account-holder begins to withdraw the money. Since the sum is only taxed, a lot of potential (tax) revenue is transferred into the future,” he notes.
The Berlin government, however, looks favourably on ZWKs. In their coalition agreement of last November, the governing Conservatives and Social Democrats, signalled that they would do more to promote their use. This is probably because the government sees the accounts as a means to make the labour market more flexible and, as Keil suggests, to cushion the effect of its pension reforms.
Christian Westhoff, a spokesman for the social affairs ministry in Berlin, also says the government does not currently see a problem with the tax-deferred status of ZWKs.
Finally, Keil believes that ZWKs can also help greatly in the spread of corporate pensions in Germany, which is one of the government’s chief domestic aims. Currently, 40% of German employees do not own a corporate pension, though the historic Riester pension reforms of 2001 gave them a legal right to a defined contribution scheme. The reason for the gap has to do either with the employees not knowing about their right or the employers not bothering to inform them of it.
“ZWKs can possibly fill that gap, especially at small firms, as these firms do not face considerable costs by introducing them,” says Keil. Small wonder then that the German government is, at least for now, is welcoming the advent of the accounts.