Occupational pensions in Germany − time for action, Ruediger Blaich of AEGON Global Pensions

8/8/2019 Occupational pensions in Germany time for action, Ruediger Blaich of AEGON Global Pensions

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Occupational pensionsin Germany:

Time for action

Rdiger Blaich


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Table of contents

Introduction 11 PensionsinGermany 2

2001-2009reformsanincreasedroleforprivatepensions 2

2Anunsustainablesystem 4

3 Theneedforoccupationalpensions 7

DenedBenetplansindecline 7

Salaryconversion:newimpetusforcorporatepensionprovision 7

Executivepensionsontherise 8

4Stimulatingoccupationalpensionsamoralimperative? 9

Anewdealbetweenunionsandemployers? 9

Becominganemployerofchoice 10

5Communicationiskey 11

Educatingandencouragingemployees 12

6 Theriseofexternalnancingvehicles 13

TheriseofpensionfundsandCTAs 13

Bookreservedplansamodelindecline 15

Timetoderisk? 16

BilMoGmakingpensionliabilitiesmoretransparent 16

Deriskingpensions 17

7 Buildingsustainablepensionseightguidelines 18

8Timetoact 19

Acknowledgements 20

Referencesandnotes 21


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Introduction

Say Die Rente ist sicher(Thestatepensionissafe)andmostGermansovertheageof40willimmediatelyrecallNorbertBlm,HelmutKohlslabourminister(1982-1998).Duringahighlypublicised

campaigneventin1986,BlmhungaposterinthemarketsquareinBonnthatread,Andonething

isforsurethestatepension.

Morethan20yearslater,BlmsstatementisstillfrequentlyquotedintheGermanmediaindebates

about pensionsand pension reform.Unfortunately, it appears tohave convincedmany ordinary

Germansthatalliswellwiththeirpensionandthatnofurtheractionneedstobetaken.Thatwould

beamistake.Despitesomeimportantreformsoverthelast10years,thelevelofpensionpeoplewill

receivefromthestatewillcontinuetodecline.

Giventhisincreasingdecline instatepensions, employerswillplayakeyandgrowing role instrengtheningtheoverallsystem.Thisisnotacaseofpurealtruismonthepartofcompanies.By

offeringemployeesasupplementarypension,theycanbetterattractandretainemployees.

Forthosecompaniesalreadyofferingpensions,theintroductionofnewGermanaccountingrules

thisyearhasledmanycompaniestolookatsolutionstohelpthemtostrengthenboththeirpension

provisionandtheiroverallnancialposition.Thesesolutionsincludepensionderiskingandliability

driveninvestmentsolutions.

Inthispaper,wediscusswhyoccupationalpensionsinGermanyarenotyetasfullydevelopedasthey

couldandshouldbe.WellalsoaddresswhymultinationalcompanieswithoperationsinGermany

shouldtakeanotherlookattheirpensions.

Germany is not unique in facing serious challenges with its pensions, but the German pension

system itself is unique and requires different solutions compared to other countries.


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1 Pensions in Germany

In 1889,Germany introduced theworldsrststatepension system.Germanyssystem,designedoriginallybytheChancellorBismarck,hassurvivedtwoworldwars,currencyreformsandperiods

ofhyperination.Originally,Germanysstatesystemwasafundedsystem,but,in1957,inorderto

removeinationrisk,itwasconvertedintoapay-as-you-go(wealthtransfer)system.

Untiltoday,thankstoBismarck,Germanpensionershavebeenabletoenjoyrelativeprosperity.From

the beginning, the state pensionsystemwasdesignedtoenablepensioners tocontinue toenjoy

thesamestandardoflivingtowhichtheywereaccustomedduringtheirworkinglife.Fordecades,

the contribution rate for pensions has been adjusted in order toprovide a replacement rate of

approximately70%ofnalaverageearnings.Pensionshavealsobeenindexedtogross(andlater

net)wagesinordertoallowpensionerstoparticipateinthecountrysgrowingprosperity.

Butthatprosperityhascomeataprice.PensionsarenowthesinglelargestitemintheGermanbudget.

Germanyspends11.4%ofitsGDPonpensionscomparedwith7.2%intheOECDasawhole.Thepriceis

alsohighforindividualsandemployers.Today,everyemployeesubjecttothestatutorysocialsecurity

systempays19.9%ofgrosssalaryintothepensioninsurancesystem(DeutscheRentenversicherung),

whichcoversretirement,survivorspensionsanddisabilitycover.Contributionsarepaiduptoasocial

securityceiling(currently66,000intheWestand55,000intheEast).Thetotalsocialsecurity

systemtakesmorethan41%ofanemployeesincomeandissplitapproximately50/50byemployer

andemployee.Understandably,companiesarekeentopreventfurtherrisesinthecontributionrate

inordertokeepnon-labourcostsincheckandpreventtheerosionofcompetitiveness.

AlthoughoccupationalpensionspresentlyplayaminorroleinGermany,theyenjoyalongtradition.

Germancompanieshavelongdemonstratedtheirsocialresponsibilitytowardtheiremployeesand

takentheinitiativetoprovidethemwithanextrapension.Alreadyin1850,largeindustrialcompanies

suchasBosch,KRUPPandSiemenswereofferingemployeebenets.

Germanyhasoneofthemostrapidlyagingpopulationsinthedevelopedworld.Accordingtothe

FederalStatisticalOfce,theproportionofthepopulationaged65andoverincomparisontothe

workingagepopulationwillmorethandoublefrom24%in2009to50%in2050.Thisposessome

serious nancial problemsfor all stakeholders.Asa result, the Germangovernment has started

implementingreformstoaddressthisincreasinglyurgentissue.

2001-2009 reforms an increased role for private pensionsWiththereformsof2001and2005,theGermangovernmentattemptedtoputthepensionssystem

onamorestablefooting.Themainobjectiveofthe2001reform(ActonAssetsforOldAge)wasto

preventanexcessiveburdenoncurrentandfuturegenerationsbystabilizingthecontributionrate

intothestatesystemto20%ofgrosswagesuntil2020and22%until2030.Thiswasachievedby

reducingthereplacementratefrom70%to67%.Tomakeupforthegap,thegovernmentcreated

incentives tosaveadditionally throughstatesubsidizedprivatepensionproducts (calledRiester-

Renteproducts).Theintroductionofstate-subsidizedprivateretirementsavingsproductswasarst

forGermany.


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TheRetirementIncomeActof2005introduceddeferredtaxationonpensionincome,withtaxreliefon

somecontributionsandtaxationonbenets.ThisalignedGermanytotheEuropeanandinternational

norm.

Themostrecentreform,in2009,hasbeentheincreaseintheretirementagefrom65to67,tobe

implementedgradually,startingin2012andtakingfulleffectin2029.

Key elements of 2001 reform:

A basic minimum pension was introduced.

The pension fund was introduced as a new nancing vehicle.

Employees earned the legal right to set aside part of their gross earnings toward an employer-

sponsored retirement plan.

The portability of occupational pensions improved.

Key elements of 2005 reform

Tax relief for capital life insurance was abolished for new contracts.

The so-called sustainability factor was introduced. This adjusts the pension level depending.

on a number of factors, including longevity and the number of contributors in the system.

Contributions toward third-pillar retirement savings became exempt from tax, beginning with

12,000 per year in 2005 and growing to a maximum of 20,000 of tax relief per year by

2025.

The proportion of pension income subject to tax will depend on the year of retirement. In

2005, 50% of pension income was subject to income tax. The tax rate will increase 2% each

year, so that, by 2040, 100% of pension income will be taxed.

The at tax rate of 20% that employers used to pay for contributions into a direct insurance

contract was abolished (for new pension promises).

The portability of and vesting rights for occupational pensions was improved.


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2 An unsustainable system

TheGerman reformshave clearly had an impact. Private pensionsavings (the thirdpillar) haveincreasedandthenumberofpeopleenrolledinanemployer-sponsoredretirementplanhasgrown

(from38%ofallprivate-sectoremployeesin2001to51%in2007).Thisismainlybecauseemployees

nowhavethelegalrighttoconvertpartoftheirsalaryintoapensionpremium,andbecauseof

bettervestingrightsandtheimprovedportabilityofoccupationalpensions.Nevertheless,80%of

alloccupationalpensionplansarestillnancedentirelyorpartlybytheemployer,accordingtothe

centralFederationofEmployersAssociations(BDA).

However,despitethepositiveeffectofthelatestpensionreforms,theywillnotbeenoughtoensurea

comfortablestandardoflivinginretirementfortodaysworkers.Thisisnotwidelyunderstoodbythe

broaderpopulation.Peopleareinvestingtoolittle,toolate.

Whilestatebenetswillremainthemainsourceofincomeinretirementforsometime(currently

accountingforaround80%ofaGermansretirementincome),manypeopledonotknowthatthe2001

67%replacementrateforthestatepensionisbasedonahypotheticalpensionerwhohaspaidinto

thesystemfor45yearswithoutinterruption.Fewpeopletthatmouldtoday,duetolongerperiods

of tertiaryeducation, fragmented jobhistories,moreshort-termcontracts, low-paidtraineeships,

periodsoffreelancework,timespentraisingchildrenorcaringforanillfamilymember,etc.The

pensionlevelofhigherearners(denedasthoseearningabovethestatutorysocialsecurityceiling

of66,000inwesternGermany)willbeevenlower.

Thesustainabilityfactorintroducedaspartofthereformsof2005willalmostinevitablyleadtoa

furthersubstantialreductioninbenetsinthefuture,althoughthegovernmenthasstipulatedthat

thepensionreplacementrate(forsomeonewhohasworkedfor45yearsuninterrupted)shouldnot

fallbelow43%.Thesustainabilityfactorenablesthestatetolimittheburdenofprovidingpensions

butitalsoconsiderablyincreasestheriskthatindividualswillnotreceivethepensionthattheythink

theywillreceive.

Source:TowersWatsonAge 63

45%51%

57%

Age 65 Age 67

0

5.000

10.000

15.000

25.000

20.000

Net pension

Net annual income

2

2.5

22

1

0.1

26

1

1.4

87

1

2.9

28

2

2.5

22

2

2.5

22

Figure 1: Old-age provision from state system for normal earner for different retirement ages


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Toillustratethepotentialpensiongaps,TowersWatsonhascalculatedthata45-yearoldaverage

earnerwithagrossannualsalaryof30,000(22,522aftertaxes)willreceive51%oftheirlastgross

salaryifretiringatage65.Thiswillbebarelyenoughtocoverbasiclivingcosts.

Whilethestandardoflivinginretirementneednotbethesameasduringonesactiveworkinglife,

costswillincreaseformanyretirees.Youngretireestendtospendmoremoneyonhobbiesandtravel,

whileolderretireesmayneedmoreservicesandnancialresourcesformedicalcare.

TheunsustainabilityoftheGermansystemisevenmoreevidentwhenseenwithinaEuropeancontext.

RecentresearchonthepensiongapperpersonacrossEurope(denedasthedifferencebetween

theincomeneededtolivecomfortablyandtheactualincomeindividualscancurrentlyexpectto

receiveatretirement)hasshownthatthepensiongapispresentlythehighestintheUnitedKingdom,

followedbyGermanyinsecondplace.AGermanretiringbetween2011and2051wouldhavetostart

nowsaving11,600extraayearinordertohaveacomfortableretirementincome,accordingtotheircalculations.

Source:AvivaEurope/Deloitte

LT IT PL RO CZ ES FR IE DE UK

0

2

4

6

thousandsperannum

8

10

14

12

HU

1.9

3.0 3.13.4

3.7

4.6

7.0

7.9

9.1

11.6

12.3

Average annual pensions gap per person for individual retiring 2011 2051 ()

Figure 2: The Pension Gap for individuals

MercerprovidesanotherperspectiveofGermanyspensionproblem.In2009,itcompared11countries

basedonthreecriteria:

Adequacy(levelofbenets,taxsupport,benetdesign,thedegreetowhichhighlevelsofsaving

areencouraged,etc.)

Sustainability(coverageofemployeesinprivatesystem,assets/funding,governmentdebt,etc.)

Integrity(pensiongovernance,prudentialregulation,communication,etc.).


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TheseindicatorswerecombinedtoarriveatanoverallgradefromAtoE,withAthebestscore.

GermanyreceivedaD,puttingitatthebottomofthelist.ADgradeindicatesthatthepension

systemhasmajoromissionsorweaknesses.OneoftheweaknessesidentiedforGermanywasitsstrongrelianceonthebookreservesystem.

Grade Index value Countries Description

A >80 Nil

A rst class and robust retirement income system that

delivers good benets, its sustainable and has a high level

of integrity.

B 65-80Netherlands, Australia,

Sweden, Canada

A system that has a sound structure, with many good

features, but has some areas for improvement that

differentiate it from an A-grade system.

C 50-65 UK, USA, Chile, Singapore

A system that has some good features, but also has

major risks and/or shortcomings that should be adressed.

Without these improvements, its efcacy a and/or long-

term sustainability can be questioned.

D 35-50 Germany, China, Japan

A system that has some desirable features, but also has

major weaknesses and/or omissions that need to be

adressed. Without these improvements, its efcacy and

sustainability are in doubt.

E


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3. The need for occupational pensions

ItisclearthatGermany isnotyetreadytomeetthechallengesof itsagingpopulation.Thebestwaytostrengthenthesystemistobuildatrulyfundedoccupationalpensionsystem(secondpillar)

withmoreretirementincomecomingfromtheemployerandemployees.Currently,around80%ofa

Germansretirementincomecomesfromthestatepensionandonly6%fromtheemployer.According

toASID,(AlterssicherunginDeutschland),only4.2millionpeopleabovetheageof55(privateand

publicsectors)werereceivingasupplementarypensionfromtheiremployerin2007.

Closingthepensionsavingsgapswillrequiremorereformsandchangesinconsumerbehaviour.The

questionis:whatrolecancompaniesplay?Andisitintheirintereststomaketheeffortintherst

place?

While further reforms are clearly the responsibility of the government, companies can play animportantroleinbuildingthesecondpillarbyimprovingthenancialeducationoftheirstaff.Financial

educationbytheemployershouldbedrivenbythreegoals:

1. Activelycommunicatewhyemployeesshouldsavemoreforretirementandadapttheirpersonal

budgetsifneededinordertodoso.

2.Inform employees of the unique advantages of saving for an additional pension through the

employer.

3.Encourageemployeestosignupforasupplementarypensionthroughtheemployerandmakeit

easytodoso.

Communicationshould alsobebroad-based.As pointedoutearlier, itsnot just low and average

earnerswhofacepensiongaps.Thereductioninthepensionlevelfromthestatewillbehighestfor

highearners.Inshort,everyoneisaffected.

Dened Benet plans in declineOver the past20years, traditionalnal salaryor DenedBenet(DB) planshavebeen insteep

decline.Theseplansusedtobeofferedasavoluntarybenetandwerenancedcompletelybythe

employer.Asthehighcostsofmaintainingtheseplanshavebecomeevident,employer-nancedDB

planshaveeithercloseddowncompletely,beendrasticallyreducedinsizeorhavebeenclosedtonew

entrants.

Salary conversion: new impetus for corporate pension provisionAgainstthisbackground,thegovernmentneededtondanotherwaytostimulatetheprovisionof

occupationalpensions.Theanswercamewiththe2001reforms,whichintroducedthelegalrightof

employeestorequiretheiremployerstoestablisharetirementplanontheirbehalf.

Underthisplan(knownasEntgeltumwandlung),employeescanconvertuptoamaximumof4%of

theirgrosssalaryandwages(uptoamaximumof2,640peryearin2010)intoapensioncontribution,

subjecttotherulesofthecollectivelabouragreement.The4%contributionisaformofdeferred

income.

Importantly,theportionofgrosssalarythatisconvertedintoapensionpremiumisexemptfrom

social securitycontributionsandtax. Initiallythis exemptionwasduetoexpire in2008. In2007,


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thelegislatorextendeditindenitely.Thishasgivenallstakeholdersmoreplanningsecurityandis

expectedtocontributetothefurthergrowthofoccupationalpensions.

TheconceptoftaxrelieffordeferredincomeisnotnewinGermany.But,priorto2001,itwasofferedatthediscretionoftheemployer.Today,employeeshavealegalrighttothisbenet.

Theintroductionofthe4%deferredcompensationplanhaschangedcorporatebehaviour.Employer-

nanced pension plansare increasingly being combinedwith salary conversion tomake itmore

attractiveforemployeestoparticipateandbuildupa supplementarypension(throughmatching).

AccordingtoresearchcommissionedbytheGermangovernment,co-nancedplansrosefrom27%

ofallplansin2001to41%in2004.Bycontrast,thecreationofnewpureemployer-nancedplans

hasbeenclosetonilsince2001.

Executive pensions on the riseThe shift to DC is also shifting more attention to the need to design attractive, innovative executive

pension packages. As already mentioned, the level of retirement income one can expect to

receive from the state is decreasing for everyone, but especially for those with salaries above the

social security ceiling of 66,000 (West Germany). Benets from the state are also capped. The

4% of gross earnings that can be converted into a pension premium under the German salary

conversion plan is simply not attractive enough for many high-income executives. If companies

want to attract and retain management talent, they need to have something more.

Pension liabilities for directors and executives are putting a strain on many companies. According

to research by the Hans Bckler Foundation (which is closely related to the main labour union

umbrella group DGB), DAX companies total pension reserves for their former directors amounted

to around 2 billion in 2009, with an average increase to pension reserves of 7 million per

year.

The nancial burden of building pension reserves for directors and other senior managers is

likely to be similar at non-DAX companies and multinational companies that wish to attract and

retain skilled specialists and executives.


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4 Stimulating occupational pensions a moral

imperative?Thoughemployersarerequiredtoofferasupplementarypensionplanattherequestofanemployee,

theyarenotrequiredbylawtocontributetoit.Understandably,manycompaniesaretryingtocut

costintheaftermathoftheglobalnancialcrisis.Butthe4%deferredcompensationplanistheonly

wayforGermanworkerstosaveforasupplementarypensionfromgrosswages.Thisisparticularly

benecialforlowtomediumearners.

Inaddition,theexemptionfromtaxandsocialsecuritycontributionsfromthisplanautomatically

cutscost for theemployerbecause,liketheemployee, the employeris alsoexempt frompaying

contributionsforsocialsecurity.Foranemployeewhotakesfulladvantageofthe4%conversion,the

companyssavingsperpersonareroughly525(20%of2,640)peryear.

Byencouraging enrolment in a salary conversion plan, the employer also saves interest on tax

payments (SteuerstundungseffektmitZinseszinswirkung)aswellas taxeson capital andassets

(Gewerbekapitalsteuer).GiventherapidlyagingpopulationinGermany,itmakessenseforemployers

tore-channelthesesavingsasamatchingcontributionintoasupplementaryretirementplanfortheir

employees.Thiswillnotonlyboostemployeesatisfactionandmotivation,butitsalsoaneffective

waytoreduceturnoverinthefuture.

Althoughemployeesarenotrequiredtosignupforsalaryconversion,thereisaneedforthemto

dosoinordertocompensatefortheeffectofdecreasesinstatebenets.Employersshouldassume

theirresponsibilityandbeproactiveinhelpingtheiremployeestobuildanadditionalpension.

A new deal between unions and employers?Stimulatingoccupationalpensionsshouldnotonlybedrivenbyemployersbutalsobythelabour

unions.Anoccupationalpensionisacrucialbuildingblockintheoverallcompensationpackage.Both

unionsandemployerorganisationsshouldrecognizethatincreasingincomefortodaysworkerswill

becomelessimportantandhighercontributionstowardold-ageprovisionmoreimportant.Thiswill

benetcurrentandfuturegenerationsofworkers,andisthereforealsomorejust.

Whenconsideringpotentialtrade-offsbetweenemployercostsandemployeeswagesinthefuture,attentionneedstobepaidtomaintainingthestabilityofworkerstotalfutureincome.

Followingthegradualincreaseoftheretirementageto67(withallnewretireesstartingat67from

2025),itisalsoclearthatnotallemployeeswillbeabletoorberequiredtoworklonger.However,

withoutsufcientpensionsavings,itmaybedifcultforsomeemployeestoleaveemployment.An

attractiveand adequateemployeebenets offering, includingasupplementarypension,willhelp

motivateemployeesandincreaseemployersexibility.


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Becoming an employer of choiceOfferingasupplementarypensioncanhelpemployersattractandretainhighlyskilledtalent.This

isparticularlyurgentnowthatGermanyisemergingfrom theglobal economiccrisis.Companiesalreadyfaceaskillsshortage,includingengineersandscientistsforresearchanddevelopment.The

competitionforqualiedstaffwillcontinuetoincreasesharply.Theskillsshortageisalong-term

trendthatisbeingmadeworsebytheshrinkingworking-agepopulation.Employeebenetsarean

essentialtoolinthewarfortalent.

Yetresearchindicatesthat employers often underestimatethe importanceofemployeebenets.

AccordingtoTowersWatsonslatestreportonglobaltalentmanagement,86%oftheemployees

surveyedsaidapensionfromtheemployerwasanimportantconsiderationindecidingwherethey

worked.However,only30%ofemployerssurveyedagreedthatabetterpensionwouldinuencean

employeescareerchoice.Clearly,theresamismatchinperception.


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5 Communication is key

Whilethebenetsofsalaryconversionfortheemployeeandemployerareundisputed,toofewpeopleareenrolledintheseplansatpresent.

AccordingtotheGermanFederationofEmployersAssociations(BDA),around20millionworkers

in 400 collective labour agreements are eligible for the 4% salary conversion plan. Since the

introductionoftheseplansin2001,thenumberofpeopleenrolledinoccupationalpensionplans

hasclearlyincreased,butparticipationisnotashighasitcouldbe.Onemajorreasonforthisisthat

employersarenotprovidingsufcientinformationtotheiremployees,andsomanyemployeesare

unawareoftheirrighttoparticipateinsuchaplan.

Asurveyconductedthisyearamong1,000peoplebytheInstituteforManagementandEconomic

Research(IMFW)incooperationwithHannoverscheLebenfoundthat: aroundhalf the respondents had not receivedany information fromtheiremployerabout the

possibilityofsettingupanoccupationalpensionplan;

ofthisgroup,70%werenotevenawaretheyhadalegalrighttoit;

thislackofawarenesswasparticularlypronouncedamongthoseearning1,000-2,000netper

month.

This attitude isvalidated inresearchthat isregularlycommissionedby the Germanministry for

labourandsocialaffairs.Theresearchersaskcompaniesforthereasonstheyhavenotintroducedan

occupationalpension.Thedominantreasonnamedisalwayslackofinterestbyemployees.

0 20%

11%

6%

8%

18%

43%

65%

40% 60% 80% 100%

Does not knowemployees have right

to salary conversion

Other reasons

Staff turnover too high

Topic too complex

Costs for companyto high

Lack of interestby employees

Source:TNSInfratest,DIA2010

Figure 4: Reasons for not introducing an occupational pension in private sector


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Educating and encouraging employeesAslongascompaniesdontcommunicatethebenetsofsupplementarypensionstoemployeesand

encouragethemtousethem,employeeswillremainuninformedanddisinterested.Take-upcouldberapidlyincreasedifemployeesweremadeawareoftheuniqueadvantagesofanoccupationalplan

overothersavingsforms(includingstate-subsidisedprivatepensions),namely:

employeeshavealegalrighttosalaryconversion

employersareabletomakematchingcontributions,enablingsavingstogrowtwiceasfast

occupationalpensionsaresubjecttolegalcompensationforination

theytypicallyofferhigherreturnsthanprivatesavings(eventhoseproductsthatenjoytaxrelief,

suchastheRiesterRente)

thesalaryconversionplanistheonlywayinGermanytosaveforasupplementarypensionfrom

grossearnings.

Companiesshouldtaketheinitiativetocommunicatetheuniquesellingpointsofsalaryconversionandturnlackofinterestintoenthusiasmandaction.Companiesandlabourunionshavearesponsibilityto

educateandinformworkersaboutpensiongapsandtoencourageenrolmentsothatemployeescan

savesufcientresourcestobeabletoenjoyacomfortableretirement.

Itmaybehopedthatfuturegovernmentreformsmakeitobligatoryforemployerstoinformtheir

employeesaboutthepossibilitiesofthesalaryconversionplan.Inaddition,Germanymaylookto

followtheexampleofseveralothercountries,includingAustraliaandtheUK,whohaveintroducedor

areintroducingauto-enrolmentinordertoincreasetheuseofoccupationalpensionplans.


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6 The rise of external nancing vehicles

Insettingupnewretirementplansbasedonsalaryconversion,Germancompanieshaveanumberofchoices.

Germanoccupationalpensions(thesecondpillar)canbedividedintotwosub-pillars:directpension

promisesandindirectpensionpromises.Intotal,therearevewaystosetupcorporatepension

provision. Eachmethodhas very different functionsand offers its own distinct advantages and

disadvantages.Around85%ofsmalltomedium-sized(Mittelstand)companiesuseacombinationof

vehicles,accordingtoresearchbyAllianz.

Fornewplansbasedonsalaryconversion,directinsuranceisthemostpopularnancingmethodfor

theMittelstand,followedbythecaptivepensionsociety(Pensionskasse).

0 20%

For salary conversion schemes For employer-financed plans

13%

17%

17%

82%

54%

40% 60% 80% 100%

Direct insurance

Pension captives

Directpension promise

Pension fund

Support fund

0 20%

26%

73%

7%

33%

24%

40% 60% 80% 100%

Source:Allianz,2010

Figure 5: Use of pension nancing vehicles by Mittelstand

The rise of pension funds and CTAsOfthevepensionvehicles,thepensionfundshowsthemostpotentialandthehighestgrowth.The

pensionfundwascreated10yearsagoasaninternationallyrecognisedalternativetotheinsurance-

basedcaptivepensionsociety(Pensionskasse).Approximately14bnofpensionassetsarecurrently

heldinpensionfunds.Thereasonfortheirrapidgrowthistwofold.Theypayreducedleviesforthe

GermanPensionInsuranceAssociation(PSV)andoffermorefreedomininvestmentchoice.

However,thepensionfundissubjecttoacaponthetransferoffutureaccrualsatarateof2,500

peryear.Asaresult,itismainlyusedasavehicleforpastaccruals.Inordertobeabletomanagethe

liabilitiesoffutureaccruals,companiesareincreasinglysettinguppensionfundsincombinationwith

ContractualTrustArrangements(CTA),whichallowtheaccrualoffutureliabilities.


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FivewaystonanceoccupationalpensionsinGermany

1. Direct pension promise: The employer is directly responsible for meeting the pension

promise. The employer accrues for pension liabilities on the balance sheet and pays pensionsfrom cash ow. Most companies insure their direct pension promises through an insurance

company.

Indirectpensionpromises:

2. Pension societies (Pensionskassen): The second largest nancing method. Pension

societies are outsourced and legally independent entities. These can be used either for a

single company or an entire industry sector. The pension society takes out an insurance

contract for the employee and builds up capital from which the pension is paid. Pension

societies are regulated by the Ban, the German nancial regulator. As a result, the employer

is not required to pay into the Pension Insurance Association (PSV). Plan participants have a

claim against the pension society. Until 2000, the role of the pension society was restricted

to company and industry pension societies. Since 2002, various competing pension societies

have been established, mainly by insurance companies.

3.Supportfund: Like Pensionskassen, these are outsourced, externally-funded pension plans.

Unlike Pensionskassen, employers must pay into the PSV as the plan participants have

a pension claim against the corporation instead of the fund. A company can pay in almost

unlimited amounts of contributions tax-free. This is particularly attractive for higher incomes.

For example, if an executive earns 500,000 the company can pay 200,000 into the support

fund on his or her behalf. The only requirement is that the previous years contribution is the

minimum that needs to be paid in the following years. Like a pension society, a support fund

can also be set up for a larger company, and smaller companies can become a member of a

larger support fund.

4. Direct/primaryinsurance:Companies take out an insurance contract directly with an insurer

on behalf of the employee. The administrative burden is low and no PSV contributions are

paid.

5. Pension funds: Created in 2001 as the fth nancing method in order to create an

internationally recognized alternative to the other insurance-based nancing vehicles. Pension

funds account for just 3.2% of total pension assets. Transferring a companys existing direct

and support fund commitments can bring some tax relief. The transfer of future accruals intoa pension fund is limited to 2,640 per person per year. Voluntary transfers from pension

captives into the pension fund are not allowed. There are around 17 billion in pension funds,

15 billion of which are held by 8 company pension funds with the remainder offered by

insurers to clients. Regulations for pension funds are regarded as rather rigid.

Asenrolment insalaryconversion plans increases andcompanies seek todesign attractive new

pensionsplansfortheirexecutives,externalnancingvehiclessuchaspensionfunds,directinsurance,

supportfundsandpensioncaptivesocietieswillbecomemoreimportant.

TotalpensionassetsintheGermansecondpillaramountedtoEUR453.8billionin2008 1.This,too,

isrelativelysmallcomparedtootherEuropeancountries.

1AccordingtotheGermanWorkingGroupforOccupationalPensions(aba)


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Book reserved plans a model in declineInthelightoftheeconomiccrisisandincreasinglongevity,companiesneedtoreconsidertherisks

oftheircurrentplans,inparticular,theirdirectpensionpromises.Thedirectpensionpromiseisstill

themostwidespreadnancingvehicleinGermany,accountingforoverhalfofallpensionassetsin

Germany.YettheeconomiccrisisandtheintroductionofnewGermanaccountingstandardshave

exposednewriskstocompanies,makingbookreservinglessattractive.

Inaddition,theincreasedcontributionratesforthePensionInsuranceAssociation(PSV)arealso

promptingmanycompaniestoturntoexternalnancingvehicles.Allcompaniesthatmakeadirect

pensionpromiseandbuildpensionreservesmustbeamemberofPSV,whichnancesitselffrom

contributionsandpaysoutpensionsincaseofinsolvency.Butinthewakeofthenancialcrisis,the

PSVcontributionraterosetoarecord14.2%ofpensionliabilitiesin2009comparedto1.8%in2008

and3%in2007.Asaresult,IBMGermanyhasrecentlyannounceditsplantosetupapensionfundto

avoidthehighpensionsolvencyleviestothePSVandtransferfundsandmembersfromitspension

supportfundtothepensionfund.

IBMGermanynotedthatwhilethePSVwasanimportantsolidarityprinciplefortheGermaneconomy,

ithadled,atatimeofincreasinginsolvencies,towellmanaged,healthycompanieshavingtocome

totheaidofthosethathaverunintodifcultiesandhavenotlikeIBMsufcientlyprovidedfor

pensionliabilitiestheyhavetakenon.ThehighPSVrateshavealsoputadentincompanyearnings.

Germanyisuniqueforitshighrelianceonthebookreservesystem.Germanaccountingrulesrequire

thatcompaniesthatmakeadirectpensionpromisebuildpensionreservesonthebalancesheet.The

employerpaysthepensiondirectlyfromcashowwhenthepensionliabilityfallsdue.Bookreserves

canbeestablishedforbothDBandDCplans.

DirectpensionpromisesareofteninterpretedoutsideGermanyasbeingunfunded.Infact,theyare

internallyfundedandintegratedwithbusinessassets.Directpensionpromisesmustberecognized

0

200

400

600

800

1000

1200

Belgium France Denmark Germany NL UK

4.6

12.3

454

1202

578

209

12248

245 (54%)

14,4 (3.2%)

37 (8.2%)

49,8 (11%)

107 (23.6%)

Direct pension promises (book reserves)

Pension fund societies

Direct insurance

Support funds

Pension funds

Source:EuropeanFederationforRetirementProvision(EFRP),2010AnnualReport,aba

Figure 6: Size of 2nd pillar in selected European countries in EUR billion (2008)


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attheirfullvalueasaliabilityonthebalancesheetand,aswithanybalancesheet,theassetsand

liabilitiesmustbebalanced.Thedifferenceisthattheoffsetdoesnotguaranteeautomaticaccounting

liquidityonanaccrualsbasis.

Clearly, the book reserve system is very different from the way pensions are nanced in other

countries.AsRaimundRhielofMercerhascommented,

The high incidence of unfunded pension liabilities among German companies reects a major difference

between the balance sheets of typical German companies and their Anglo-Saxon counterparts. The

German perspective is that non-German companies hide their pension liabilities in external pension

funds. The foreign perspective of German companies is that they maintain unfunded or unsecured

pension plans.

Despitetheexistenceofothermethodsforexternalpensionfunding,manycompaniespreferthe

internalbookreservesystembecauseithasalwaysbeensimpleandtax-effective.Buildingpensionreserveshasalsobeenpopularbecauseitservedasacheapformofdebtandaneffectivesourceof

liquidityforthecompany.

Time to derisk?Whilebookreservinghasofferedadvantagesinthepast,newGermanaccountingrules(BilMoG)

whichwentintoeffectin2010aredilutingthoseadvantages.BilMoGaimstoalignGermanaccounting

standardsmorecloselywithIFRS,andparticularlywithIAS19(whichconcernstheaccountingof

retirementbenetsandwhichmanylargeinternationalcompaniesalreadyapply)andtoincreasethe

acceptanceoftheGermancommercialbalancesheetabroad.

BilMoG making pension liabilities more transparentBilMoGhasmajorconsequencesforthevaluationofpensionliabilities.Liabilitygapswillbecome

moretransparentunderBilMoG. Inthepast,the Germancommercialbalance (HGB)wasthought

tounderstatethevalueofpensionprovisionsbecausecompaniesdidnothavetotakepensionand

salaryincreasesintoaccount.ThisledtotheperceptionthatGermancompaniesprovidedincomplete

andmisleadinginformation.

Companiesmustnowvaluetheirpensionliabilitiesusingmorerealisticeconomicassumptions.For

example,inthepast,employerscouldaccrueforpensionliabilitiesusinga6%discountrateandcoulddeductunfundedaccrualsforpensioncostfromtaxableincome.TheinterestrateunderBilMoGfor

discountingpensionprovisionswillbelower(currentlyaround5.2%),whichwillincreaseliabilities.In

somecases,theincreasecouldbesignicant.Companiesnowalsohavetotakesalaryandpension

increasesintoaccount.

Onaverage,bookreservesaccountfor10%oftotalassetsforatypicalMittelstandcompany.The

denedbenetobligation(DBO)underBilMoGcouldbetwiceashighasontheGermancommercial

balancesheet(HGB).

The adjusted and increased accruals could reduce net prot, impacting the basis for dividend

payments.Inthecaseofasignicantincreaseinpensionliabilities,companieswillbeallowedto

amortizetheadditionalaccrualstopensionreservesover15years.Thiscouldimprovetheviewofthe

balancesheetandimproveequityratios.


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7 Building sustainable pensions eight guidelines

Although itis clearthatcompaniesneed totakeanotherlookathowtheyprovidepensions, thesolutionsavailableare varied,andwhich solutions individualcompanieschoosedependson their

specicsituationandneeds.Thereisnosimpleonesizetsallsolution.However,itispossibleto

providesomeguidelinesonhowcompaniesshouldapproachtheirpensionsinordertomakethemt

forthefuture.

Source:AEGONGlobalPensions

Figure 7: Designing a new plan?

Matching through support fund

(employer financed)

Salary conversion through direct

insurance

(employee financed)

For all employees For executives

Reinsure DB elements one to one:

Lump-sum payments to survivors,

Disability, AD&D cover, Etc.

Keep (or move) old-age pension

to DC basis

Guideline1: Improvecommunicationtoyouremployees.Iseveryoneinyourcompanyenrolledin

salaryconversion?Followingtheintroductionofthesalaryconversionplanin2001,

therewas a need for information and education, and the works councils played a

signicantrole.Thisledtosomeinnovativeconcepts.Nowthatthetaxexemptionfor

thisplanhasbeenexpandedindenitely,salaryconversionshouldgetanextraboost.

Guideline2: Dontjustthinkofpensions:whatotheremployeebenetsdoyouoffer?

Guideline3: Examinetheneedforexecutivepensionsinyourcompany.Carryoutathoroughanalysis

ofcurrentbenetsyouareoffering.

Guideline4: AnalyseyourcurrentDBandDCplansforrisks.Therearemanysolutionsavailableto

deriskdependingonthenatureofthecompanyandmanyotherfactors.Somesolutions

areeasierforsmalltomediumsizedcompanies.SettingupaCTAhasbecomemore

popular,butitsnotthebestsolutionforalltypesofcompanies.

Guideline5: Check your liquidity situation. Does the liquidity of your assets match liquidity of

liabilities?Isittimetosetupsegregatedplanassets?

Guideline6: Examineyourtalentmanagementneeds.Howmanyexpatsdoyouhave?Whatsortof

retirementplanisinplaceforthem?Dotheyneedabetterpensionsolutiontoreect

theirinternationalmobility?Dotheyneedaninternationalretirementplan?

Guideline7: Isittimetopoolyourcompanyscross-borderpensionassetsasawaytoderiskand

improvepensiongovernance?

Guideline8: AnalyseimpactofBilMoGonyourcompanyspensioncommitments,keyratios,funding

eeds,etc.Isthereaneedtoderisk?


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8 Time to act

Germanyisnotuniqueinfacingseriouschallengeswithitspensions,buttheGermanpensionsystemitselfisunique.Assuch,Germanyrequiresadifferentsetofsolutionsfromothercountries.However,

thisdoesnotmeanthattherearenotlessonstobelearnedfromlookingacrossborders.Astherole

ofthestateinprovidingpensionsdiminishes,companiescanandshouldstepintothegap.By

lookingtocountrieswheresimilarprocesseshavetakenplace,itispossibleforcompaniestolearn

fromexperienceselsewhere.

Bothemployersandemployeesneedtorealisethatchangeisinevitable,ifpeoplewishtobeableto

retireonanythingliketheincometheyhavebecomeaccustomedto.Forindividuals,thepersonal

riskofnothavinganadequatepensionisclear(althoughtheymaynotyetbeawareoftheenormous

potential shortfall that they face),but the reputationaland operational risk tocompanies isalso

signicant.However,thepresentsituationalsopresentscompanieswithaclearopportunitytotakeresponsibilityforhelpingandstimulatingtheiremployeestosavefortheirretirement.

The German pension system is clearly at a moment of change. Major internationally operating

companiesaremovingawayfromthetraditionalbookreservesystemandlookingtoprovidepensions

inotherways.Smallandmedium-sizedbusinessesmaynotbesoquicktofollow,buttheytooshould

belooking againto seewhat theycan doto assist theiremployees andhelpbuilda sustainable

pensionenvironmentinGermany.

Figure 8: Time to derisk? A game plan for non-DAX companies

REINSURE

Does company have high liquidity?Go to Step 2 >

Step 1 Step 2

OUTSOURCE

A. Past service + previous reinsurance> Pension fund

B. Future service > Group support fund

Book

reserved plans

Source:AEGONGlobalPensions


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Acknowledgements

Iwouldliketothankthefollowingpeopleforprovidingtheirknowledgeandinsight.RdigerBlaich

DianeBaumann

Corporate communications consultant

HarryBrand

Regional director, HDI Gerling Leben Vertriebsservice

JrgLiely

HDI Gerling Leben Vertriebsservice

ThurstanRobinson

Communications manager, AEGON Global Pensions

MartijnTans

Director marketing, AEGON Global Pensions


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References and notes

AllianzGlobalEconomicResearch,EconomicTrendReport,DiedeutscheRentenversicherungnachderRiester-Reform,Ausgabe3,July2003

AllianzGlobalInvestors,Mittelstands-StudiezurbetrieblischenAltersversorgung,Ausnanzierung

vonPensionsverpichtungenalsHerausforderungderZukunft,July2010

ArbeitsgemeinschaftfrbetrieblicheAltersversorgung,E.V(aba),aba-online.de

AvivaEurope,aviva.com/Europe-pensions-gap/executive-summary

BDA,kompakt,BetriblicheAltersvorsorge,January2010

BDA,EntgeltumwandlungfrbetrieblicheAltersvorsorge:Beitragsfreiheiterhalten,Doppelbelastung

verhindern!,June2007

BDA,BetrieblicheAltervorsorgestrken,ReformvorschlgezurbetrieblichenAltersvorsorge,May

2009

BevlkerungDeutschlandsbis2050,11.koordinierteBevlkerungsvorausberechnung,Statistisches

Bundesamt,November2006.

Brsch-Supan,A.,Reil-Held,A.andWilke,C.HowanUnfundedPensionSystemlookslikeDened

BenetsbutworkslikeDenedContributions:TheGermanPensionReform,May2007,Universityof

Mannheim

Brsch-Supan,A.,Reil-Held,A.,andWilke,C.,ZurSozialversicherungsfreiheitderEntgeltumwandlung,

UniversityofMannheim,May2007

Bruninger,D.,DeutscheBankResearch,BetrieblicheAltersversorgung:RaumfrweitereExpansion,

30June2010

Cresswell, N., Horneff, W., and Wildner, S., Towers Watson, Germany: risk and occupational

pensions.

deMeza,D.,Irlenbusch,B.andReyniers,D.,FinancialCapability:ABehaviouralEconomicsPerspective,

preparedfortheFSA,July2008

Ernst&YoungandBDI(FederationofGermanIndustries),GermanAccountingLawModernization

Act(BilMoG)

EuropeanFederationforRetirementProvision(EFRP),2010AnnualReport

GDV,NachderReform,DasbringtdieneueRente,2002

GermanpensionliabilitiessettosurgeasBilMoGtakeseffect,29June2010,IPE.com

Hainz,G.,andThurnes,G.,Germany:BilMoGreformsringthechanges,IPE.com,April2010

HDIGerling,Trendstudie:bAVimMittelstandinZeitenderFinanzkrise,

Kinzer,M.,ReshufingthecardsinGermany,anoutlineofrecentreformsinGermanlifeinsurance

market,TowersWatson.

Kinzer,M.,TowersWatson,ReshufingthecardsinGermany,www.watstonwyatt.com/europe

MelbourneCentreforFinancialStudiesandMercer,MelbourneMercerGlobalPensionIndex,October2009.


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MinistryofFinance,DasAlterseinknftegesetz:Gerechtfrjungundalt,June2005

OECD,PensionsataGlance2009,Germany

Ottowa,B.,IPE.com,Germancompanieskeepingworkersinthedarkonpensionschemes,September

2010

Prast,H.,andThomas,C.,BehaviourandBiases:Implicationsforthegovernmentaschoicearchitect,

Introduction,2009.

PriceWaterhouseCoopers,10MinutenBilMoG:PensionenundCTA,November2008

Raimund Rhiel, Whats new in Germany: Funding via CTA and Pensionsfonds, June 22, 2007,

Mercer.

Recktenwald, S., Betriebliche Altersversorgung: Ohne geht es nicht! Soziale Verantwortung fr

Unternehmen/Win-winSituation,TowersWatsonGermany,Benets!Magazine

Ergnzender Bericht der Bundesregierung zum Rentenversicherungsbericht 2008 gem 154Abs.2SGBVI(Alterssicherungsbericht2008),MinistryofLabourandSocialAffairsAlterssicherung

in Deutschland 2007 (ASID 07), Zusammenfassung wichtiger Untersuchungs-ergebnisse, TNS

Infratest

Williams,J.,IPE.com,DAXcompaniesamassEUR2bnpensionreservesforformerdirectors,July9,

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Williams,J.,IPE.com,GermanpensionliabilitiessettosurgeasBilMoGtakeseffect,June29,2010


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AEGONGlobalPensions

AEGON Global Pensions is part of AEGON, an international life insurance, pension and investmentmanagement company that operates in 20 countries and serves more than 40 million

customers.

The specialists of AEGON Global Pensions and our partners in Germany can help your company

design attractive new employer pension plans and de-risk existing plans. We act as a single point

of contact for multinational companies, providing access to a wide range of pension solutions and

expertise around the world, including theInternational Retirement Plan for expatriates, derisking

of dened benet plans, cross-border asset pooling (available in Germany as from 2011), Total

Retirement Outsourcing (TRO) in the US, and single- and multi-pension solutions.

We can also help multinationals with headquarters in other countries that wish to include Germany

as part of their international pension strategy.

HDI-Gerling, an AEGON Global Pensions partner in Germany, offers a wide range of external

funding methods (reinsurance plans, full reinsurance, partial reinsurance) and outsourcing

solutions (pension fund for accrued rights, support fund for entitlements to be accrued, support

fund for beneciaries). It also provides advice on the impact of BilMog as well as labour and tax

law on pension liabilities. It can help set up a CTA model.
http://aegonglobalpensions.com/base/Templates/Standard.aspx?id=9007&epslanguage=enhttp://aegonglobalpensions.com/base/Templates/Standard.aspx?id=4995&epslanguage=enhttp://aegonglobalpensions.com/base/Templates/Standard.aspx?id=11913&epslanguage=enhttp://aegonglobalpensions.com/base/Templates/Standard.aspx?id=11913&epslanguage=enhttp://aegonglobalpensions.com/base/Templates/Standard.aspx?id=11913&epslanguage=enhttp://aegonglobalpensions.com/base/Templates/Standard.aspx?id=11913&epslanguage=enhttp://aegonglobalpensions.com/base/Templates/Standard.aspx?id=4995&epslanguage=enhttp://aegonglobalpensions.com/base/Templates/Standard.aspx?id=9007&epslanguage=en


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Contact details

AEGONGlobalPensionsRdigerBlaich

Erich-Schmid-Str.13

71638Ludwigsburg

Deutschland

Tel.:+4971416483980

www.aegonglobalpensions.com

[email protected]

Disclaimer

Thisresearchpapercontainsgeneralinformationonlyanddoesnotconstituteasolicitationoroffer.

Norightscanbederivedfromthisresearchpaper.AEGONGlobalPensions,itspartnersandanyof

theirafliatesoremployeesdonotguarantee,warrantorrepresenttheaccuracyorcompletenessof

theinformationcontainedinthisresearchpaper.

AEGON,October2010

Documents

Occupational pensions in Germany − time for action, Ruediger Blaich of AEGON Global Pensions