occupational pensions in germany − time for action, ruediger blaich of aegon global pensions
TRANSCRIPT
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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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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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