Company pension plans in a low-interest phase: challenges and opportunities for reorganization
By Dr. Lars Hinrichs, LL.M. (Stockholm), and Christine Hansen
Interest rates are at an historic low with no light at the end of the tunnel. Does this mean the end for company pension plans? This article highlights options for and pitfalls to reorganizing company pension plans from a German labor-law perspective.
The starting point: a careful analysis of the status quo
Reorganizing an existing company pension plan is not an easy task. It requires a careful legal analysis of the existing systems to determine if leeway for future changes exists. The instruments offered by German law to implement any changes to an existing plan mainly depend on the legal basis of the plan (individual grant or collective agreement). Pension grants to senior and key employees are often made individually in an amendment to the employment contract. The employer may, however, also grant pensions to all employees or groups of employees collectively (Gesamtzusage). Alternatively, pension plans can be included in collective agreements with a union or, more commonly, with a works council.
The legal analysis also forms the basis for determining the relevant stakeholders and the process. Modifying a company pension plan in a collective agreement requires the involvement of the union or competent works council that concluded the agreement. If agreement on the company pension plan was with the works council, the employer will also have to determine to what degree the works council needs to be involved (three levels exist in Germany: group, company and the local site level). Works council involvement may also be required if the company pension plan was collectively granted to employees (Gesamtzusage). Modifying such a collectively granted pension plan can trigger participation rights of the works council under the German Works Constitution Act (§ 87, Section 1, No. 10 Betriebsverfassungsgesetz, BetrVG).
Option one: closing access to plans for new employees
An obvious way to reduce ongoing costs of a company pension plan is closing it to new entries. The decision to close the plan does not require any particular justification. It is not even necessary to consult with the works council about the closure. It will suffice to terminate the collective agreement containing the pension plan with the works council or union while observing the respective notice period. For pension plans based on individual pension grants, the employer will simply not grant any pension to the new employee. Where pensions have been granted to certain groups of employees, the employer should expressly state in the employment contract that he or she will discontinue this practice. Otherwise, employees may argue they are entitled to participate on the grounds of equal treatment or an in-house practice.
Option two: clarifications and closure of loopholes
Another option that does not require particular justification is the clarification of open issues and closure of loopholes in an existing company pension plan. Taking these actions might reduce the employer’s risk exposure should a potential ensuing court proceeding see a labor court decide for the (more) disadvantageous interpretation of the unclear provision of the pension plan. In the interest of legal certainty, the relevant stakeholders should be included in the clarification process depending on the legal basis of the pension plan. Should the pension entitlement be set forth in a collective agreement, the employer should include the clarification in a supplemental agreement with the applicable works council or with the labor union as the case might be.
Areas typically affected by such clarifications include:
- Age for statutory pension entitlement: Old pension entitlements granted prior to the German Annuity Adaptation Act (Rentenanpassungsgesetz) in 2007 still often refer to the age of 65 as the relevant age for old-age pension entitlements. Due to the increase in the statutory pension age to 67, employers generally have an interest in (continuously) linking the company pension entitlement to the statutory pension age. The German Federal Labor Court (Bundesarbeitsgericht, BAG) stated in a decision in 2012 that these old-age pension entitlements need to be interpreted in such a way that employees are only entitled to the company pension plan when reaching the statutory pension age.
• Intransparent valuation parameters for the calculation of the pension entitlements: Intransparent valuation parameters can often be found in defined benefit plans that do not clearly define the remuneration components to be considered as basis for the calculation of the individual pension benefit.
- Age thresholds for waiting periods violating the General Equal Treatment Act (Allgemeines Gleichbehandlungsgesetz, AGG): According to the jurisdiction of the German Federal Labor Court, age thresholds as a prerequisite for pension entitlement have to be considered a violation of the General Equal Treatment Act and therefore invalid if employees less than 50 years old are excluded from participation in the company pension plan. Modification of the age threshold in accordance with the General Equal Treatment Act ensures the future validity of the plan.
- Reduction of premature pension benefits: According to § 6 of the German Company Pensions Act (Betriebsrentengesetz, BetrAVG), beneficiary employees are generally entitled to premature payment of the pension benefits once they are entitled to the statutory pension without deduc-tions – even if the company pension plan does not contain a respective provision regarding entitlement to such premature payment of the company pension benefits. It is therefore recommended that companies include an explicit provision regarding the reduction of premature pension benefits in the company pension plan.
Option three: financial compensation for pension entitlements
The employer may seek to rid him- or herself of the burden of low interest rates by paying lump sum compensation to employees eligible for a company pension. The German Company Pensions Act (§ 3, BetrAVG) does not generally permit paying off employees once employment has come to an end. Active employees, on the other hand, may agree to receive financial compensation for waiving their pension entitlements provided the waiver is not in any way connected to a termination of the employment relationship. A waiver of vested pension entitlements in a termination agreement is therefore invalid.
In exceptional cases, German laws permit paying off company pensioners. Such an exception may, inter alia, apply to:
- Company pensioners who started receiving their company pension prior to January 1, 2005, and who agree to financial compensation
- “Petty” pension entitlements or small amounts that can be paid off by the employer without obtaining prior consent
- Pension grants to board members of a German stock corporation (Aktiengesellschaft), according to a decision of the German Federal Labor Court dating back to 2009. Whether the same applies to managing directors of a German limited liability company (Gesellschaft mit beschränkter Haftung) has not yet been decided but does seem consequential.
Option four: suspending pension adjustments
Under the German Company Pensions Act (§ 16, BetrAVG), an employer is obliged to adjust regular pension benefits every three years. The adjustments are gener-ally dependent on the development of the consumer price index or the net salaries of active employees.
There are several exceptions to this rule, though. The employer may opt for an annual flat adjustment of 1%. More interestingly, the employer may even be entitled to partly or fully suspend pension adjustments if the economic situation of the company does not permit such adjustments. The employer must, however, follow a certain process that includes providing proper information to the company pensioners about the suspension and the economic situation of the company. In particular, the employer is required to provide comprehensible documentation of the company’s economic performance.
Option five: modification to the benefit plan
The legal requirements for any modification to the benefit plan will depend on the legal basis of the company pension plan and the company’s economic situation: Modifying an individual pension grant generally requires the employee’s consent. The German Federal Labor Court took the view that an agreement resulting in a reduction to future benefits must meet the requirements for paying financial compensation (§ 3, BetrAVG). Paying the employee one-off compensation is therefore only permissible while the employee is still “on board.” Reducing the pension entitlements of former employees or ongoing pension payments is therefore generally not an option (for exceptions, see option three above).
Some individual pension grants contain language referring to a collective agreement or allowing a modification through such a collective agreement. Where this is the case, the employer may seek to negotiate a more favorable agreement with the works council. The same applies when the pension plan has been collectively granted to all employees or a group of employees (Gesamtzusage). The German Federal Labor Court held in 1986 that these collectively granted pensions can be modified by an agreement with the works council if (and only then) the modified plan is generally not less favorable to employees.
Any modification to a collective agreement with the works council has to be proportional. The German Federal Labor Court developed a three-step test for proportionality specifically for company pensions in order to protect the legitimate expectations of employees:
- Intervention into vested rights protected against insolvency: Only mandatory reasons can justify intervention into vested rights. The German Federal Labor Court accepted such interventions only in exceptional cases, such as an employer’s preinsolvency situation.
- Intervention into the vested amount that includes a prorated dynamic increase: Pension entitlements that are calculated on the basis of the amount of remuneration most recently earned by the employee generally contain a dynamic increase that depends on the future development of the calculation parameters. An intervention into the dynamic (which usually means a lower future increase) must be justified with good reasons. The employer must generally demonstrate that the existing pension plan jeopardizes the continued existence of the company based on a forecast period of at least three years.
- Intervention into the increments that only depend on (continuous) employment with the employer: For interventions into employees’ rights that only relate to the increased value of the pension entitlement due to continuous employment with the employer, the employer needs to demonstrate objective reasons for the modification to the pension plan and to explain the alternatives to the intervention as well as the reason for their omission.
A successful cost-effective reorganization of company pension plans depends on proper consideration of the applicable legal parameters. At the same time, a legal assessment has to follow the employer’s strategic and economic decision about continued execution of the company pension plans. The legal parameters establish the proper instruments for the reorganization, but are no substitute for the parameters that define the strategic concept.