40% of employees are not entitled to corporate pension:
major reform of German Corporate Pension Act is coming up this year
By Dr. Marco Arteaga
DLA Piper LLP, Frankfurt
Germany is rushing towards a major reform of its Corporate Pension Act, known as the German “Betriebsrentengesetz (BetrAVG)”. Similar to the large industry pension funds in the Netherlands that have accumulated almost €1 billion in assets, or the pension reform of 2008 in the UK that led to the setup of the National Employment Savings Trust (NEST), or Switzerland’s 1985 Corporate Pension Act (Gesetz über die Berufliche Vorsorge or BVG) that has accumulated more than CHF 700 billion to the present day, Germany is now also heading towards large, potentially nationwide industry pension funds. On January 26, 2015, the German Ministry of Labor and Social Affairs (BMAS) presented a far-reaching new proposal that may potentially change the landscape for German corporate pensions completely. It bears the title “The new Social Partner’s Model for Corporate Pensions”. The bill is expected to pass the Bundestag (the German Parliament) within the current legislative period, perhaps even still this year. The urgency for such a reform is obvious, for at present, only some 60% of German employees possess any occupational pension entitlements whatsoever in addition to their social security pension. It is therefore mandatory to assume measures that will lead to a much broader dissemination of corporate pensions. Whatever this bill will ultimately contain, it is likely that it will have an impact on all German employers, regardless of size and industry, and also regardless of whether or not they currently entertain any corporate pension plan. One can expect that all employers and companies in Germany will be affected.
In the year 2002, the German pension landscape already underwent a fundamental change of paradigm. Due to the demographic development with further decreasing birth rates and continuously increasing life expectancies, the decision was made to substantially decrease social security pensions over time. Soon afterwards, the regular retirement age was raised to 67. In turn, to compensate for the foreseeable income gaps for future pensioners, corporate pensions and private savings were boosted. The plan –> The reform will establish new freedoms of choice, especially with respect to the possibility of limiting the employer’s cost exposure and financial risk. © Fesus Robert/iStock/Thinkstock/Getty Images25 – Labor law – BLM – No. 1 – March 5, 2015 was that these sources of retirement income should compensate for the decline in social security pensions. With respect to income levels up to the social security ceiling, the social security pensions on average had accounted for some 80% of an average pensioner’s household income. The aim was to keep retirement incomes stable overall. This reform was named “Riester-Reform” after the then minister of Labor and Social Affairs, Walter Riester. Still, as of today, corporate pensions only play a rather minor role in Germany’s complex system of retirement provisions. The average corporate pension in Germany lies in the order of €100 per month, accounting for less than 10% of an average pensioner’s household income. The fact that these developments call for further reform steps is evident as it has now become obvious that the entirely voluntary framework that solely leaned on tax advantages and social security contribution reductions does not lead to a sufficient distribution of supplementary old age pensions coming from occupational pension schemes. The 40% of employees in Germany that are still not entitled to any corporate pension is too large a number. In the light of this dissatisfactory statistic, there is great risk that particularly lowincome households will not achieve adequate pension levels in the future should the government not step in and take action. And the environment for legislative action is favorable, for there is a broad consensus across nearly all political parties that corporate pensions are the instrument of choice in order to solve the upcoming retirement income problem in Germany. One of Germany’s largest and most influential unions, the metal industry’s IG Metall, has conducted an extensive broad survey amongst young employees. The outcome clearly demonstrated that particularly young people trust their employer and his pension plan more than private savings, investment funds and even the social security pension. Corporate pensions are therefore viewed as the instrument of choice to resolve this situation.
Key elements of the upcoming reform
The corporate pension reform aims at establishing large pension funds through according collective labor agreements between the social partners, such as unions on the one hand, and employers’ associations on the other hand, for example. The intention is to include small and medium-sized businesses (SMBs) in such collective agreements as corporate pension arrangements are least proliferated in this segment. The plan is to grant the social partners very far-reaching liberties to arrange many areas of the corporate pension regime according to their specific industry needs and preferences. Employers should be ”lured” into such new pension arrangements by allowing, for the first time in Germany, the introduction of fully fledged “defined contribution” plans, where the employer is liable for his contribution and nothing else (“pay and forget”). This is a novelty to the German corporate pension landscape as up until now, employers were always liable for any funding shortfall within their external funding vehicle. Today, corporate pensions bear a considerable financial volatility and the full cost can virtually not be anticipated in advance. In short, corporate pensions can be a nightmare to CFOs at a time when one of the dominating financial paradigms in our modern economies can perhaps best be summed up with the words “no surprises”. The proposal foresees that the new type of pension funds would be cogoverned by both unions and employers’ associations. The fund itself would be a member of Germany’s Insolvency Protection Fund for corporate pensions, the Pensions-Sicherungs-Verein (PSV). Thus, in case of bankruptcy of the pension fund, the fulfillment of the pension commitments would still be secured. Furthermore, these pension funds would need to be operated under the legal status of a “Pensionsfond” or a “Pensionskasse”, and would thus also be supervised directly by Germany’s Financial Supervisory Authority, BaFin, the German equivalent to the FSA. >> However attractive the upcoming reform might be, it is no secret that the federal government views this reform as its “final offer” to the economy to arrange for these corporate pension plans on a voluntary basis. << Regarding the plan, under the design of such funds, social partners are to be granted a very broad playing field. They can foresee lifelong pensions, lump sum payments, any kind of biometric risk coverage and they would also be entitled to drop the requirement of full indexation of ongoing pension payments that currently exists in the German Corporate Pension Act. Moreover, the funding regime will be left to the social partners’ discretion –>26 – Labor law – BLM – No. 1 – March 5, 2015 as well. These funds could be employerfunded, employee-funded or co-funded. In short, anything will be possible. One of the most remarkable novelties in the ministry’s proposal—at least from a labor lawyer’s perspective—is the plan to allow employers and employees who are not members of the according union or employers’ association, respectively, to opt into such a pension regime and to appreciate its benefits, including the limitation of the employer’s liability by using the defined contribution type plan. Of course, this requires that the pension fund itself also permits such participation of non-members of unions and employers’ associations. In other words: the pension fund’s bylaws have to allow employers and employees who are not members of any social partner to become members of their fund. And of course it is unclear if they will decide to do that: on the one hand that would allow for a strong and rapid growth of the pension fund leading to more financial stability and better risk dispersion. On the other hand, many union members and members of employer associations could view this as “cherrypicking” and ask the question why, instead, these individuals and companies do not simply join the union or the employers association, respectively.
The proposal presented by the German Ministry of Labor and Social Affairs very cleverly establishes substantial additional negotiational leeway for the social partners. The intention is to entice them—still on a voluntary basis—into establishing large, cost-efficient, ideally industry-wide corporate pension funds. The ministry rightfully puts collective solutions in the foreground, as they are much more apt to provide high risk coverage in the event of death or disability compared to individual private insurance solutions. From an employer’s perspective, particularly speaking for small and medium-sized businesses the opportunity to limit their own liability to just their contributions must be highly attractive because currently these firms have to vouch for these obligations indefinitely and without any financial limitation. It can therefore hardly be seen as a surprise that at present, firms’ corporate pension plans virtually do not exist in this size. Should this reform become a reality, establishing a pension plan would be simple for these employers, for all they would have to do is to make a single signature in order to become a member of the pension fund and then to pay the contributions. All the rest would be handled by the pension fund. Clean, simple and with no further obligation. That said, however attractive the upcoming reform might be, it is no secret that the federal government views this reform as its “final offer” to the economy to arrange for these corporate pension plans on a voluntary basis. Government officials have been heard saying that the next step might then well be a compulsory corporate pensions or savings system similar to the compulsory solutions in the UK or in Switzerland.
All officers, consultants and pension lawyers, including work council and union members who deal with corporate pensions in Germany, should be aware of this rapidly upcoming change in the pension environment. It is likely that the reform will establish major new freedoms of choice, especially with regard to the possibility of limiting the employer’s cost exposure and financial risk. In turn, from an employees’ perspective, this pension reform may well create the framework that could provide for levels of risk and pension coverage not seen. It seems likely that the times of large volatility of pension liabilities and pension cost will be nearing their end. It therefore appears to be recommendable to postpone any major introduction of a change to existing pension plans, or new ones, for that matter, until the new legislative framework lies on the table. There is a good chance that this will all come to fruition in this calendar year.