From pension reserves to pension funds:
An opportunity for the German financial market
•
In Germany, the tax situation and liquidity considerations make bookreserve schemes the predominant form of occupational pension plan. But
these harbour liquidity and financing risks for the companies. Pension
funds along Anglo-Saxon lines can help counter these risks.
•
The potential capital market impact is huge. The pension reserves set
aside in companies’ balance sheets between 1982 and 1993 corresponded
to the market value of all equity issues by listed German companies during
that period. Germany’s financial markets would gain in breadth and
depth from the investment of pension reserves on the capital market.
•
Legal and tax obstacles stand in the way of a stronger role for pension
funds in Germany. That is why fundamental changes need to be made
to the regulatory framework along with radical reform of the occupational
pension system.
•
Germany’s tax regulations differ from standard international practice in
many respects. The aim should be to create a level playing field for all
types of occupational pension scheme in terms of taxation. It should be
possible to transfer existing pension reserves to external funds without
this altering the tax position. It would be helpful if the International
Accounting Standards were recognized for tax purposes.
•
The use of securities to back pension reserves in the balance sheet (asset
funding) is an intermediate step towards external funding via pension
funds.
Authors:
Bettina Nürk, Alexander Schrader
Technical assistants:
Christa Brauer, Melanie Fladenhofer, Anke Kühnel, Andreas Löschel
This publication was completed on January 9, 1996.
Price:
DM 15 (incl. VAT)
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Contents
Page
Summary
I.
Introduction
1
II.
The significance of occupational pension schemes
in Germany
3
Direct commitments as an internally funded form
of occupational pension scheme
6
1.
Outline
6
2.
Advantages of direct commitments
2.1. Tax effects of direct commitments
2.2. Liquidity and financing effects of
pension reserves
6
6
7
Problems with direct commitments
7
III.
3.
IV.
V.
External funding of occupational pension schemes
9
1.
Types of scheme and method of financing
1.1. Support funds
1.2. Pensionskassen
1.3. Direct insurance
9
9
10
11
2.
Advantages of external funding
12
3.
Market potential of external funding
13
4.
The limited presence of Pensionskassen in Germany
4.1. Dominance of state pension insurance
4.2. Tax reasons
15
15
16
5.
Limited use of equities as a form of investment
5.1. Restrictive investment regulations?
5.2. Tax obstacles
5.3. Accounting priciples
5.4. “Equity culture” lacking
5.5. D-Mark strength as a reason for the small
proportion of foreign securities
16
18
20
20
21
22
Implementation
23
1.
The transition
23
2.
Capital resources of companies
24
3.
“Asset funding” as a step along the road to
external financing
25
Appendix: Overview of the investment rules of the VAG
27
List of Abbreviations
29
Summary
This study seeks to outline a constructive framework for
occupational pension schemes in Germany, a framework
which would also permit broader funding base for Germany’s
financial markets. It appears that these goals could be
attained by changing to a system in which pension funds
along Anglo-Saxon lines play a much greater role than at
present. This would require fundamental changes to the
legal situation and taxation.
Unlike the state pension system, occupational pension
schemes in Germany are mainly funded through the
accumulation of capital. Estimates put the total amount at
DEM 460.6 bn in 1993. Four types of scheme are possible:
•
Pension reserves can be built up in companies’ balance
sheets (56.3% of total accumulated cover in 1993).
•
Funding can be transferred to a Pensionskasse, a Germanstyle pension fund, which acts as external trustee
(22.9%).
•
A support fund (Unterstützungskasse) can be set up,
also externally (8.7%).
•
Direct insurance, with the company taking out life
insurance on the employee’s behalf (12.1%).
Pension reserves are clearly the predominant form of
financing. The reserves formed by Germany’s corporate
sector harbour huge capital market potential. Those set
aside in companies’ balance sheets between 1982 and
1993, worth DEM 123.1 bn, corresponded to the market
value of all equity issues by listed German companies
during that period.
What makes book-reserve schemes so attractive is the
tax advantages they offer (tax deferrals and tax savings) and
the easy access they provide to long-term capital. However, they also entail liquidity and financing risks, especially
since pension obligations are often not fully disclosed on
company balance sheets. For the economy as a whole,
there is a danger that the resources may be used inefficiently
and the process of structural change may be held up.
One reason why pension funds are so seldom used in
company pension plans in Germany is that the tax rules
discriminate against them. Where capital is accumulated
via pension funds, tax has already to be paid during the
contribution phase. With pension reserves, on the other
hand, taxation does not kick in until later. This leads to a
deferment of tax payments as well as to tax savings for the
employee. In addition, payments to a pension fund withdraw liquidity from the company. In other countries, it is not
usual for company pension schemes to be based on internal
pension reserves. In most cases, such provisions are not
recognized for tax purposes.
The findings and conclusions reached in this study are
summarized in the following points:
1. Empirical evidence shows that in Germany the number
of employees covered by an occupational pension
I
scheme is on the decline. This is mainly due to the
considerable cost burden for the companies. Their
payment obligations have been raised in the past, while
the tax situation and the legal framework have steadily
worsened. This trend continues, with an increase in the
flat rate of tax on contributions to Pensionskassen and
insurance companies from 15% to 20% from January
1996. This contradicts the original intention of the
government coalition, which was to improve conditions
for company pension plans. An improvement is needed
if the provision of occupational pensions is not to dwindle
further.
2. As a rule, the allocation of assets via the capital market
ensures that they are used efficiently. In this respect,
external funding of company pension schemes is better
than book reserves. An intermediate step along the road
to external financing is asset funding, i.e. the use of
securities to back pension liabilities on the company’s
balance sheet.
3. With direct insurance and Pensionskassen, the pension
scheme money flows into the capital market, ensuring
a broad funding base for the financial centre concerned.
However, equities are an investment instrument which
is still little used by the Pensionskassen that exist in
Germany today. There are several reasons for this:
investment regulations are still too restrictive;
Pensionkassen are unable to offset the corporation tax
credit on dividends; Germany’s present accounting
standards are an obstacle. But investment in shares
would make financial sense for Pensionskassen –
particularly with a view to enhancing long-term
performance. It would benefit both the sponsor company
and the insured employee, and it would also strengthen
Germany’s underdeveloped equity culture. In this respect
a further liberalization of the investment regulations to
be observed by Pensionskassen and insurance
companies would be a constructive move.
4. From the company’s point of view, financing its scheme
through a Pensionskasse or insurance company has the
advantage that the subsequent pension payment
obligations do not, as a rule, make any further demands
on liquidity. For the employees, it has the advantage that
their pensions are freed from the risk of default by the
sponsoring firm. Separate management of the cover
stock, e.g. by pension funds, encourages competition
on performance, measured by benchmarking. Earnings
are potentially higher and this ultimately benefits the
employees.
5. Fundamental changes to the tax situation would be
needed in order to clear the way for a system with
pension funds along Anglo-Saxon lines. The tax treatment
of contributions to German Pensionskassen or insurance
companies, and of the benefits paid out, differs very
strongly from standard international practice.
II
Note:
Pension reserves do not necessarily lead to inefficient use of capital. But the involvement of the capital
market – which acts as a control mechanism –
reduces the risk of capital being allocated inefficiently.
Internationally, no tax is imposed during the phase of
capital accumulation. Tax is payable only on the benefits.
6. Legal measures which compel companies to adopt a
particular form of funding are unacceptable – not least,
because they run counter to a market-oriented system.
Instead, the aim should be to create a level playing field
for all types of employee pension scheme in terms of
tax.
7. Regardless of the type of scheme, fiscal recognition of
the International Accounting Standards (IAS) is to be
recommended when it comes to determining the
requisite amount of capital cover. According to the IAS,
future trends in wages and pensions are taken into
account and an appropriate capital market rate has to be
applied as discount rate. After all, the globalization of
financial markets demands greater transparency in
company financial statements and a closer approximation
to international accounting standards.
8. The level of equity at many large German companies
should be no obstacle to a transition – at least if it takes
place gradually – from pension reserves to more
extensive external funding of pension obligations. The
important thing is that this shift should be possible
without raising the tax burden for companies (or
employees). The transition should not, for example,
increase the tax payable on assets.
III
I. Introduction
The question of how, in light of changing demographics,
the state pension system in Germany can be financed in
future is becoming an ever greater problem in social and
economic policy. At the same time, occupational schemes
– the second pillar of the German old-age pension system – have been on the decline for a number of years. The
number of employees who have been promised a company
pension is falling.
The rising costs these schemes inflict on companies are
to blame. The increase is largely due to an ongoing
deterioration in the tax situation and the legal framework.
This trend continues, with an increase in the flat rate of tax
on contributions to Pensionskassen and insurance
companies from 15% to 20% from January 1996. The way
things are developing in practice contradicts the original
intention of the government coalition. At the start of the
current legislative period they had agreed to improve
conditions so that company pension plans continue to
make an important contribution to the old-age security of
the working population.
Occupational pension schemes
on the decline
Tax situation and legal framework are deteriorating
The increase in the flat tax rate mentioned above will
also make external funding of occupational pension schemes
less attractive compared with book-reserve plans. The
latter are already, by a wide margin, the predominant form
of employee pension plan in Germany.
Pension funds are much less common in Germany than
in the Anglo-Saxon countries, for example. This is one of
the main reasons why Germany lacks an “equity culture”.
The enormous capital market potential that lies dormant in
the pension reserves of German companies is illustrated
by the fact that in 1993 these reserves amounted to nearly
DEM 260 bn. That was equivalent to almost 33% of the
total market capitalization of all listed German companies.
Pension reserves set aside in companies’ balance sheets
between 1982 and 1993 corresponded to the market value
of all equity issues by listed German companies during that
period.
Enormous capital market potential lies dormant in pension
reserves
This study seeks to outline a constructive framework
for occupational pension schemes in Germany, a framework
which would also permit broader funding of Germany’s
financial markets. Having plans managed by external
trustees such as pension funds can offer substantial
advantages at both micro- and macroeconomic level,
provided discriminatory legal and tax treatment does not
stand in the way.
Chapter II reviews the development of Germany’s
system of occupational pension schemes and the relative
importance of the different types of plan. These are
presented in detail in Chapters III and IV. These chapters
also examine the reasons why Pensionskassen are relatively
rare, and even falling in number, in Germany, and why they
do not play the same role in the capital markets, especially
the stock market, as, for instance, pension funds in the
1
USA or the UK. The study ends with Chapter V, which
discusses questions in connection with the transition to
increased external funding of occupational retirement plans
via outside trustees, and the conditions that must be
fulfilled before such a shift can take place.
2
II. The significance of occupational pension
schemes in Germany
The German system of old-age income security rests
on three pillars:
1. The state pension scheme (including civil servants’
pensions and the supplementary pensions paid to
other public-sector employees),
The pillars of old-age income
security (Benefits 1993)
DEM bn
317.7
300
200
2. occupational pension schemes, and
3. personal provision for retirement income.
Pensions provided under the state scheme clearly
predominate, accounting for over 70% of total benefits
paid in 1993. Claims to civil-service pensions formed the
second-largest category (over 10%), while the supplementary pensions paid to other public-sector employees
were the smallest (barely 3%). The occupational pension
schemes set up in the private sector paid out DEM 23.1 bn,
which corresponds to a little over 5%. Personal provision
through life insurance came to 10% of the total volume.
400
100
State
pensions
49.2
47.6
Civilservice
pensions
Life
insurance
23.1
Occupational
pensions
13.1
Supplementary publicsector
pensions
0
Source: Federal Government's 1993 Social Report; Betr.
Altersversorgung, 10.02.1995; German Association of Life
Assurance Companies
Deutsche Bank Research
State pensions, civil-service pensions and supplementary public-sector pensions operate on a pay-as-you-go
basis, with the present generation of employees paying
today’s pensioners’ benefits. By contrast, both personal
provision for retirement income through life insurance and
occupational pension schemes are mostly funded. In these
cases, capital is formed by forgoing consumption during
the period in which the rights to a later pension are accrued.
The pension is funded with this capital and the income it
may generate.
The Occupational Pensions Act of 1974 made employee
pension plans an integral part of the German social security
system. They serve to increase and supplement the basic
retirement income provided by the state scheme, and they
are also a major element of company welfare policies. To
a large extent, companies view them as a means of
rewarding employees for long service. As a result, many
firms make full use of the ten-year maximum vesting
period permitted by law. Under this rule, companies may
require employees to work with them for a maximum of
ten years before they acquire a non-forfeitable right to a
company pension (the employee must also be at least 35
years of age). Otherwise, the right becomes non-forfeitable
if at least twelve years have elapsed since the employee
joined the firm and if the promise of a pension was valid for
at least three years.
A distinction can be made between four types of
occupational pension scheme, financed in different ways:
•
A direct commitment from the company, backed by the
formation of pension reserves on the company’s balance
sheet.
•
Contributions are transferred to a Pensionskasse, a
German-style pension fund, which acts as external
trustee.
Four ways of financing occupational pension schemes
3
•
A support fund (Unterstützungskasse) is set up, also
externally.
•
Direct insurance, with the company taking out life
insurance on the employee’s behalf.
The advantages of any one type depend on
circumstances at the individual company, not least on the
choice of benefit plan. A distinction can be drawn between
nominally fixed, defined-benefit (e.g. based on final salary)
and defined-contribution schemes. Only with the latter
group can the employee be required to bear part of the
financing of the company pension plan. Use of the different
types of scheme also varies greatly according to the size of
the workforce and the sector in which the company
operates. The sector patterns are often the result of
historical developments.
Use varies according to size of
workforce and economic sector
According to a survey carried out by the ifo institute in
summer 1993, coverage by company pension plans
– measured by the proportion of employees at west
German industrial companies who had received a preliminary or definitive pension promise – fell from 70% in 1990
to 66% in 1993. In the west German distributive-trade
sector, coverage was down one point to 28% from 29% in
1990. In short, the proportion of the working population for
whom an occupational pension scheme has been set up is
on the decline.
The significance of company pension plans for capital
formation at macroeconomic level is illustrated by the
volume of cover they have accumulated. The table on
page 5 gives an indication of the impetus the external
capital market could receive if the funds put aside as book
reserves were switched into external investments. These
impulses are quantified in Chapter IV. 3.
The most recently published estimates of Aba
(Arbeitsgemeinschaft für betriebliche Altersversorgung),
the association for occupational pension schemes, for the
volume of cover and its distribution among the different
types of pension plan are for 1993. They put the total for
that year at DEM 460.6 bn. Just under DEM 260 bn, or
56.3%, related to direct commitments backed by book
reserves. Pensionskassen formed the second-largest
category, accounting for 22.9%, followed by direct insurance
with 12.1% and support funds with 8.7%. Compared with
external schemes, book-reserve plans lost ground between
1981 and 1993 even though new reserves were created
throughout the period. In 1981 they made up nearly 67%
of total cover. By 1993 their share had therefore dropped
more than 10 percentage points. Direct insurance registered
the strongest growth, increasing its share from 4.9% in
1981 (DEM 10.0 bn) by over 7 percentage points to 12.1%
(DEM 55.7 bn) in 19931). The percentages for Pensions1) However, the figures for direct insurance contain a large element of uncertainty.
Since the insurance companies' statistics do not differentiate between direct
insurance premiums and other premiums deducted from the employee's pay, and it
is almost impossible to draw a clear dividing line between these in practice anyway,
the information on the role direct insurance plays in occupational pension schemes
can only be taken as a rough guide.
4
Pension reserves are the most
commonly used type of scheme
and method of funding ...
kassen and support funds also rose slightly. Pensionskassen
accounted for 20% of the cover in 1981 compared with
22.9% in 1993 (DEM 105.8 bn). The figures for support
funds were 8.2% in 1981 and 8.7% in 1993 (DEM 40 bn).
All in all, there is a visible trend towards external funding of
occupational pension schemes.
... but there is a visible trend
towards external funding
Cover for occupational pension schemes in Germany (DEM bn)
Pension
reserves*
Pensionskassen
Support
funds
Direct
insurance
Total
1981
135.2
40.5
16.5
10.0
202.2
1990
1991
1992
1993
225.0
231.5
249.1
259.1
80.0
89.0
80.4
105.8
35.0
36.2
39.8
40.0
40.0
45.1
53.4
55.7
380.0
401.8
422.7
460.6
Source: Aba estimates
* According to estimates of Deutsche Bundesbank, pension reserves in industry, distributive trade, and transport came to
DEM 271.5 bn in 1994.
5
III. Direct commitments as an internally funded form
of occupational pension scheme
1. Outline
A direct commitment is a binding promise by the
employer to the employee to pay a (retirement) pension
when certain conditions are fulfilled, e.g. when the employee
reaches a certain age. The employer bears responsibility
for the funding. Normally the company will “save” – by
forming book reserves – during the period of employment
the amount which, according to actuarial principles, must
be available when the conditions are met, i.e. in this
example, when the specified age limit is reached.
In case firms should go bankrupt, pension commitments
are mutually insured through the Pensions-SicherungsVerein auf Gegenseitigkeit (PSV). The PSV then pays the
pensions in place of the bankrupt company, though these
payments are not inflation adjusted. The PSV is financed
almost entirely through premiums paid by the companies
which have formed pension reserves or set up a support
fund. Over the 20 years the PSV has been in operation, the
premium has averaged 1.8‰, ranging between 0.7‰ in 1978
and 6.9‰ in 1982 (following the insolvency of AEG). In 1995
the rate was fixed at 2.6‰.
2. Advantages of direct commitments
Book reserve plans provide the companies with a
valuable source of finance. In relation to total assets, the
pension reserves of west German companies in industry,
distributive trade and transport rose strongly during the
seventies and eighties and came to over 9% in 1987 and
1988. The pension reserves on the books of German
companies in 1994 were equivalent to almost half the level
of equity.
One reason why book reserves are so widely used and
so attractive is that they enable the companies to defer
taxes, an effect that is not achieved with the competing
forms of occupational plan. Through pension reserves,
companies also have relatively easy access to liquidity.
These two aspects are discussed in the following sections.
12
Pension reserves*
DEM bn
%
240
200
9
160
% of total
assets (left)
120
6
3
280
80
Pension reserves
(right)
40
0
71 73 75 77 79 81 83 85 87 89 91 93
* West German companies; industry, distributive
trade and transport.
Source: Deutsche Bundesbank
Deutsche Bank Research
2.1. Tax effects of direct commitments
New rules on the treatment of occupational pension
commitments in company accounts came into force under
the Balance Sheet Directives Act of 1985. Since December
31, 1986, direct commitments have had to be shown as
liabilities on the balance sheet. This does not apply to
commitments given before January 1, 1987. Pension
reserves have therefore to be formed for the full amount of
new commitments given from the beginning of 1987.
Since the tax balance sheet must be based on the
commercial balance sheet, pension obligations have also
to be shown as liabilities in the tax balance sheet.
6
Formation of book reserves
obligatory only for commitments
given since 01.01.1987
The reserves – which are calculated on the basis of
actuarial formulae in accordance with tax law – must
correspond exactly to the present value of future pension
benefits at the time pension payments kick in. The main
parameters include the so-called biometric probabilities
(such as the risk of death or disablement) and the interest
rate to be applied. The higher this notional rate of interest,
the higher the rate at which future pension obligations are
discounted, and the lower their present value and the
amount of provisioning in each accounting period. The rate
has been gradually raised from 3.5% to 6% (from January
1, 1982; see the German Income Tax Act, Section 6a).
Allocations to pension reserves are recognized as taxdeductible expense and reduce taxable profit for the
respective period. Once the pension becomes payable, the
accrued reserves have to be released gradually, raising
profit. Pension payments are a form of operating expense
and can therefore be offset against the released accruals.
The formation of book reserves enables the company to
defer its profits tax liability for a very long period (e.g. 30
years or more).
Since pension reserves are, by law, classed as debt,
they are deductible when the taxable unit value of business
assets is assessed. They are neither business assets nor
do they form part of trading capital2). The fact that these
reserves can be deducted for asset-tax purposes saves the
company tax compared with alternative sources of funds
such as shareholders’ equity or other types of debt (loans
etc.). With pension reserve schemes – unlike contributions to Pensionskassen and life insurance companies (see
IV.4.2.) – the necessary capital accumulates tax free.
Profits tax: deferral
Assets taxes: savings
Capital accumulates tax free
2.2. Liquidity and financing effects of pension reserves
By forming pension reserves the company is able to
retain liquidity which would otherwise go to external
trustees. This self-financing effect is greatest at the start
of the scheme. As time passes and the first benefits are
paid, it decreases. Total liquidity is not actually reduced
unless the disbursement to service the pension claims
exceeds the allocation to the reserves. The financing
available from pension reserves is advantageous for the
company also in that it does not entail any disclosure
obligations or an examination of creditworthiness, nor can
pension reserves be called.
Easy access to liquidity
3. Problems with direct commitments
Pension schemes are a substantial cost factor for
companies. Occupational pensions now account for nearly
one fifth of total ancillary personnel costs (i.e. collectively
bargained and company-specific items). It is therefore
essential that pension obligations be financed efficiently
2) If partnerships form pension reserves for managing partners, however, these
must be included in the capital on which trade tax is based.
7
and predictably. The system of direct commitments backed
by book reserves no longer meets these requirements.
The inadequate reflection of future pension obligations
in many companies’ balance sheets gives rise to a liquidity
risk which should not be underestimated, especially for
smaller firms.
When a company forms pension reserves, no external
control mechanism ensures that the funds are used in the
most efficient way. Whether efficient or inefficient,
companies can, by setting aside reserves, retain liquidity
and withhold it from the capital market. But this does not
provide any gains for the economy as a whole. A healthy,
profitable company can raise the funds it needs for
investment projects in the capital market at any time at
normal market conditions. When turning to the capital
market, a company will check whether the return it can
obtain on internal investment really is higher than the
market yield, making it worthwhile to invest in the company.
Self-financing through pension reserves, on the other
hand, allows companies to pursue loss-making investments
and strategies which may be justified only if profits and
losses can be offset internally. This preserves inefficient
company structures and hampers structural evolution in
the economy.
8
Liquidity risks
Possible inefficiencies at the
macroeconomic level
IV. External funding of occupational pension
schemes
One approach which would appear helpful in solving the
problems related to pension reserves as identified in
Chapter III.3. is increased recourse to external capital
formation – e.g. through pension funds. The following
sections look at the different forms of externally funded
occupational pension scheme and their advantages from
both a microeconomic and a macroeconomic standpoint.
They also contain examples illustrating the potential capital
market volume attainable through external financing.
1. Types of scheme and method of financing
Externally funded occupational pension schemes require
the services of an outside trustee. In Germany, this can be
a support fund (Unterstützungskasse), a Pensionskasse or
an insurance company.
1.1. Support funds
Support funds are legally independent pension
institutions which usually exist in the form of an
“eingetragener Verein” (registered association) or a
“GmbH” (private limited company). The sponsor can be a
single business or several companies jointly. Contributions
must be paid by the employer alone. The employer himself
decides at what intervals he pays his contributions. If his
earnings situation is unfavourable he can refrain from
transferring funds or reduce his allocation. No one has a
legal claim to benefits from a support fund (although the
Federal Court of Labour has meanwhile largely abolished
the exclusion of a legal claim). This means that companies
are not released from liability for the obligations of the
support fund, so these pension commitments also have to
be insured with the PSV.
Company allocations to the fund are deductible as
operating costs. The benefits paid out later by the fund
have to be declared as taxable income by the recipient
(after deducting a basic allowance). No tax burden is
incurred in the period during which the rights to a later
pension are accrued.
Contributions to support funds
paid by employer alone
No tax incurred during the
pension accrual period
Because they are considered social institutions, support
funds are – under certain conditions – exempt from
corporation tax, property tax and trade tax. This is also the
reason that the workforce or the staff council of the
sponsor company has a say in their management. One
prerequisite for tax exemption, among others, is that the
assets held in the fund do not exceed an amount specified
in Section 4d of the Income Tax Act by more than 25%.
Otherwise, the support fund is required to pay tax on the
excess.
Owing to the formal exclusion of a right to benefits,
support funds are subject to no investment directives from
a regulatory authority, i.e. they can invest their monies
without restriction. This also means there are no limitations
9
on returning funds to sponsor companies as loans. Apart
from investment in real estate, lending back to the sponsor
is the most important form of investment for support
funds. Investing in the capital market plays an insignificant
role.
A support fund is usually unable to provide full capital
cover for pension commitments since company allocations
are recognized for tax purposes only until the assets
accumulated cover two annual pensions per prospective
beneficiary. The funds can (partially) offset this disadvantage
by investing in real estate since property is entered in the
balance sheet at the assessment value and thus has a
much lower book value than its actual market value. It
remains to be seen whether Germany’s constitutional
court ruling on the taxable unit value of assets will impact
this practice.
Loans and real estate are the
most important forms of investment for support funds
Tax structure limits prefinancing via support funds
Since pre-financing via support funds has tax limitations,
some companies have also set up covered support funds
(by reinsuring a support fund with a Pensionskasse or a life
insurance company).
There were 5,163 support funds in Germany in 1993. Of
these, 1,641 were “pure” support funds, i.e. the support
fund was the sole form of occupational pension scheme
used by the sponsor company.
1.2. Pensionskassen
Pensionskassen (German-style pension funds) are also
legally independent institutions for retirement benefits. As
with support funds, the sponsor can be a single business
or several companies which are either independent or
belong to the same corporate group. Unlike support funds,
contributions can be made jointly by employers and
employees. Companies can deduct the allocations as
operating costs for tax purposes. In contrast to support
funds, Pensionskassen grant pensioners a legal claim to
their benefits. As a mutual benefit association, the funds
fall under the supervision of the insurance authority, so the
provisions of the Insurance Supervision Act (Versicherungsaufsichtsgesetz - VAG) apply to their capital
resources and investment behaviour. Loans to the sponsor
company or companies are possible to an only limited
degree. Therefore, investing in the capital market plays a
much bigger role for Pensionskassen than for support
funds. There were 150 Pensionskassen in Germany in
1993 under the supervision of the Federal Supervisory
Office for Insurance Companies (Bundesaufsichtsamt für
das Versicherungswesen)3). Their number has been on the
decline for years (1990: 168), while the funds’ overall
capital investment and total assets have risen.
Transfers to the Pensionskassen are usually set as a
percentage of the wages liable for contributions. The rate
3) There are also serveral other small Pensionskassen under the supervision of the
Länder governments. In 1993, the total was 26.
10
Pensionskassen under supervision of insurance authority
Number of Pensionskassen on
the decline
can apply equally to all members insured, or vary according
to age. Premiums must be fixed in such a way that the
Pensionskasse/insurance company can form the necessary
cover capital. The maximum notional rate of return which
German Pensionskassen and insurance companies are
currently allowed to apply is 4% (before the VAG
amendment on July 29, 1994: 3.5%).
Since the employee acquires a legal claim vis-à-vis the
Pensionskassen, the employer’s contribution is treated as
part of his taxable wages (the employee’s portion comes
from after-tax income). The tax is usually paid by the
employer. In this case a flat rate can be applied, which from
1996 is 20% up to a maximum contribution of DEM
3,400.4) This rate does not, however, contain the solidarity
surcharge and church tax. On contributions above this
amount, the employee’s individual tax rate is applied.
When the benefits are drawn, the pensioner must pay tax
only on the income accrued, i.e. on the interest earned on
the invested funds.
Traditionally, Pensionskassen have always been
considered social institutions. They are therefore exempt
in principle from corporation tax, trade tax and property tax.
This is only true if pension fund assets do not exceed an
amount defined in Section 5 (1) 3 (d) of the Corporation Tax
Law (KStG) (i.e. the pension fund assets must not exceed
loss provisions). Furthermore, as social institutions, the
Pensionskassen are subject to co-determination, usually
on the basis of (full) parity of representation. So far, this is
found primarily at management board level since most
Pensionskassen still have no supervisory board. However,
the VAG amendment raised the standard of qualification
required of management. This new arrangement will
probably result in a general shifting of co-determination
from the executive board to the – if need be, still to be
established – supervisory board.
Employer contributions subject
to income tax
As social institutions, Pensionskassen are in principle exempt
from tax and subject to codetermination
1.3. Direct insurance
With direct insurance an employer takes out individual
policies or a group policy with a life insurance company on
behalf of his employees. In a so-called Gehaltsumwandlungsversicherung, the insurance premiums are paid by
the employee alone. “Pure” direct insurances and insurance
policies based on employee deductions are, however, not
reported separately in insurance company statistics.
“Pure” direct insurance and
insurance premiums deducted
from wages not reported separately in the statistics
Like with the Pensionskassen, contributions to direct
insurance can be split between employer and employee.
The funds allocated by the employer are to be treated as
taxable income under the same conditions as apply to
Pensionskassen, and they can also be considered operating
expense which reduces profit. The pensioner is liable for
tax on future benefits only with respect to the share related
to accrued income. Naturally, the VAG regulations apply to
4) A 15% flat rate on a maximum DEM 3,000 applied until the end of 1995.
11
insurance companies in the same way as they do to
Pensionskassen.5)
2. Advantages of external funding
From a microeconomic standpoint, external types of
pension scheme and methods of funding offer the advantage
that the company can minimize the liquidity risk related to
its obligation to render benefits to the pensioner.6) Therefore,
above all smaller companies decide to form (group)
Pensionskassen7) or take out direct insurance on behalf of
their workforce. The risk that they might have to shoulder
the responsibility for pension benefits after all – although
so far this has never happened – could be reduced further
in the case of Pensionskassen, if the latter were allowed to
increase their assets to more than the volume permitted by
Section 5 (1) 3 of the KStG. This could play a role when a
fund’s investment generates a very high return. If the
“excess” assets were not (as currently) subject to taxation,
the Pensionskassen could themselves smooth over
fluctuations in earnings performance by building up a
“liquidity cushion”. Given a very good investment
performance, the contributions paid by companies and the
insured could be (temporarily) reduced. A basic condition
for tax exemptions for excess assets of a pension fund
would, however, have to be that the assets are used
exclusively in the interests of company social policy and
thus to the benefit of the members covered by the fund.
Moreover, setting up group Pensionskassen gives
smaller companies in particular the opportunity to reduce
administrative costs through outsourcing. In addition, with
Pensionskassen and insurance companies, companies are
able to include the workforce in the financing of retirement
benefits. This advantage continues to gain significance
above all in view of the growing costs to companies of
occupational pension schemes. Another possible advantage
is that employees take more interest in and have greater
appreciation of the retirement plan if they themselves are
involved in the financing. Gearing the scope of the pension
commitments to earnings performance might also help.
From a macroeconomic standpoint external funds
have the advantage that their investments can be diversified
among different instruments, projects and countries.
Earnings risks are reduced and opportunities exploited
fully. Turning to the capital market allows efficient fund
allocation and limits the danger of capital being invested
5) Therefore, they are usually not required to insure against insolvency with the
PSV.
6) This does not apply to a support fund, as the sponsor company is liable for the
former’s commitments. With Pensionskassen there is the possibility to rule out a
subsidiary liability of the sponsor company in the articles of association (in
agreement with the Federal Supervisory Office). However, if the fund is unable to
adjust pension benefits to match purchasing power – as prescribed by labour
law – the sponsor is required to step in. So far, though, the “excess” returns
generated by the funds have always sufficed to cover the adjustments.
7) As a rule, group Pensionskassen are set up for several companies of the same
sector, but they can also be designed to cover more than one sector.
12
Minimization of liquidity risk
Ability to include the workforce
in the financing and reduce
costs
Diversification and efficient
fund allocation
unwisely. By selecting promising investments and
companies the risk is lowered that outdated, unprofitable
corporate or production structures are preserved.
In addition, the bond and equity markets stand to gain
breadth and depth on the demand side through the external
investment of occupational pension schemes’ funds. At
the same time, financing via the capital market becomes
more attractive owing to reduced flotation costs (higher
securities prices on rising demand). Hence, this will also
increase the supply of securities.
Furthermore, external forms of funding provide a better
framework for dismantling the obstacles to mobility which
the statutory ten-year maximum vesting period can create.
Workforce mobility and flexibility are considered key factors
for the competitiveness of the German economy today.
With Pensionskassen it is relatively easy to have pension
claims transferred from one company to another when
switching jobs, which is also an advantage from the
employee’s viewpoint. For example, with group pension
plans, it is possible to change jobs among the individual
member companies without having to waive any accrued
pension claims. Moreover, some Pensionskassen in
Germany, such as the BVV Versicherungsverein des
Bankgewerbes a.G., give every employee the right at the
start of his employment with a member company to
extend his insurance policy on a voluntary basis if he moves
on to a non-member company. Direct insurances also offer
the possibility of voluntary extension of a policy at the
employee’s expense, but this requires the employer’s
approval.8)
Still with regard to the employee, funding via an external
trustee such as a Pensionskasse offers the “theoretical”
advantage (not used so far in Germany) that the insured
party can be given an option to choose between different
portfolio alternatives. For example, some US companies
give their employees the opportunity to select a plan from
several pension funds offering alternative risk and earnings
profiles. The insured can base their selection on their
individual risk preferences. The funds thus compete along
market lines on the basis of earnings performance to win
the right to invest the assets of the sponsor companies’
employees. External management by separate institutions
is the prerequisite for benchmarking, i.e. the insured are
able to judge the performance of the investment by
comparing with a standard yardstick.
Broad funding base for the
capital market
Dismantling of obstacles to
mobility
Scope for performance
competition and benchmarking
3. Market potential of external funding
The following quantifies the market potential which
would emerge by shifting the capital accumulated in the
8) Even reserve-financed direct commitments allow arrangements which make it
easier to transfer claims from one company to another. For example, a member
company of the Bochum Verband usually has to recognize the service years of an
employee listed with the Verband which were spent at another member company.
However, there is no formal requirement to do so. In the same way, already formed
pension reserves can only be transferred between member companies of the
Verband if both companies agree to do so.
13
past as book reserves into outside funds. Three scenarios,
which relate to the degree of externalization, are played
out.
Radical solution: externalization of all pension
reserves
If all the capital cover for occupational retirement
schemes formed through book reserves at German
companies were externalized, that would create additional
capital market potential of close to DEM 260 bn (1993
figures). This corresponds to nearly 33% of the market
capitalization of German public limited companies in 1993.
Such a shift would trigger a substantial need for additional
equity and debt capital in the corporate sector.
Market potential of close to
DEM 260 bn with full externalization of book reserves
Gradual externalization of pension reserves
If all the book reserves formed on balance between
1982 and 1993 had been accumulated in an external
Pensionskasse and invested in the market, this would have
given an additional stimulus of DEM 123.1 bn to the capital
market for this period. For comparison, pension reserves
set aside in companies’ balance sheets between 1982 and
1993 corresponded to the market value of all equity issues
by listed German companies during that period. If these
newly formed book reserves had in actual fact been
transferred outside the company, the share of funds not
reported as pension reserves and thus potentially available
to the capital market would already have accounted for a
good 70% of total cover capital in 1993. This compares
with the just under 44% actually posted. The scenario of a
gradual transfer – for cover capital to be formed in future – appears the best suited to allow a gradual turn to
external forms of funding. This transition will be discussed
in greater detail in Chapter V.1.
Conversion of the pension system
There is currently no sign that Pensionskassen in
Germany will be able to attain the same importance as
pension funds in the United States or the United Kingdom.
This would require that much of the financing for Germany’s
state pension system (including the pensions for the civil
service) be converted to a capital-cover basis.
In 1994, the ratio of pension fund assets to gross
domestic product (GDP) came to 56.6% in the USA, and
76.5% in the UK. If the US reading were transposed to
Germany, this would give an asset pool of close to DEM
1,900 bn for the same period, equalling nearly two-and-ahalf times the market capitalization of German public
limited companies in that year. Naturally, such calculations
are only relevant with substantial reservations. The American
and British state pension systems play a relatively smaller
part than the German system in comparison with the
private and corporate schemes, much of whose cover
capital is managed by external trustees.
14
Potential stimulus of DEM 123.1
bn to capital market through
externalization from 1982
4. The limited presence of Pensionskassen in Germany
The table on page 5 shows that Pensionskassen rank
second as a form of financing occupational pension schemes
in Germany and – in terms of the cover capital accumulated – are by far the most significant type of external
trustee. They are the focal point in the following discussion.
This appears justified since support funds lack certain key
features which, in our opinion, must be present in order to
speak of “genuine” external funding of occupational
schemes. These include:
•
•
•
The liquidity is entirely withdrawn from the company, i.e.
the cover capital earmarked for a corporate pension
scheme is removed from the company’s disposition and
deposited, in the main9), with external funds;
Future benefits are fully pre-financed, which with support
funds is only possible through full backing by a
Pensionskasse or an insurance company, but not with
such a fund alone;
Allocations to the external trustee are made at regular,
previously agreed intervals in amounts which cannot be
determined arbitrarily by the sponsor company. This is
the only way to build a corporate pension scheme
steadily in the long term.
The table and the chart on this page illustrate the scale
of the pension fund assets accumulated in selected OECD
countries as well as their distribution within the EU.10)
What emerges is that the significance of pension funds
varies substantially from one country to the next. In the EU,
asset management by pension fund is confined mainly to
the UK and the Netherlands. Pensionskassen tend to play
a minor role in Germany compared with these countries
and the USA and Japan. Different reasons are at play.
Support funds not a “genuine”
form of external funding
Pension fund assets in selected
OECD countries, 1994
Total
USD bn
% of GDP
United
States
3 760
56.6
Japan
1 118
24.0
UK
775
76.5
Netherlands
264
80.4
Switzerland
191
73.6
Germany
124
6.1
France
57
4.3
Ireland
20
38.6
8
3.5
Belgium
Source: InterSEC Research Corp., Stamford
Deutsche Bank Research
The EU market for pension funds*
NETH 22.0%
BEL 0.6%
Southern Europe
2.2%
Total:
USD
1,203 bn
4.1. Dominance of state pension insurance
One major reason for the limited presence of
Pensionskassen in Germany is the dominance of state
pension insurance in Germany’s old-age security system,
which is financed on a pay-as-you-go basis. Pension funds
play a small role in several other countries such as France
or Italy for the same reason.
UK
59.6%
GER 8.8%
DEN 2.2%
FRA 3.4%
IRE 1.5%
Source: Pragma Consulting NV/SA
* in terms of assets in 1993
Deutsche Bank Research
Germany has meanwhile seen a few attempts to fund
pension commitments to civil servants at least partially by
the formation of cover capital. For example, the state of
9) Some Pensionskasse/insurance company funds can be made availabe to the
sponsor company in the form of corporate holdings or loans; however, this must be
in compliance with the investment regulations laid down by the VAG (see appendix).
10) The 1994 figures for Germany include not only the Pensionskassen but also the
support funds. Moreover, it must be borne in mind that – depending on the
definition – international statistics may also consider as pension (fund) assets
funds which do not serve as capital cover. The USD 124 bn cited for Germany also
include the capital investment of the Versorgungsanstalt des Bundes und der
Länder (VBL), which is financed by a modified pay-as-you-go procedure (capital
investment in 1993 approx. DEM 14 bn).
15
Schleswig-Holstein has already allocated the initial
instalment for a pension fund. Rhineland-Palatinate intends
to establish a pension fund for newly hired civil servants in
autumn 1996. However, neither of the two states has so
far attempted to find a long-term solution to ensure complete
cover for pension commitments.
4.2. Tax reasons
Given the current tax legislation in Germany, book
reserves represent a better alternative – particularly from
the employee’s standpoint – than Pensionskassen. When
pensions are funded via Pensionskassen the Tax Office
lays claim to a portion of the employer contributions,
deeming them wage income in the period during which
pension rights are accrued. The employer usually pays the
tax at a flat rate. The employee pays his contributions from
after-tax income. In contrast, employer expenditures for
direct commitments (formation of book reserves) and
support funds are not subject to income tax. A tax debt
arises for the pensioner only when the benefits are actually
disbursed. 40% of the pension payments (maximum of
DEM 6,000 in the tax period) is, however, free of income
tax. This practice of benefits-only taxation thus has the
advantage not only of a substantial tax deferral for the
employee, but also often results in an ultimate tax saving.
This holds especially if the beneficiary’s tax situation
differs from during the contribution period (say, for example,
if his tax rate has fallen because his income is lower as a
whole, or thanks to age relief). Considering the interest rate
advantages achieved by deferring the tax, his tax burden
will always be reduced de facto.
Unlike normal practice in Germany, other countries
usually refrain from taxing contributions to pension funds,
i.e. no tax is incurred in the accrual phase. The benefits are,
by contrast, taxable.11) Like in Germany, company
contributions to pension funds (or similar trustees) are
deductible as operating expense. Frequently, the
employee’s contributions can also be deducted for tax
purposes. In Germany, the tax conditions for Pensionskassen and insurance companies have deteriorated
seriously with the increase in the flat rate on allocations to
managed pension schemes from 15% to 20%. Factoring
in the solidarity surcharge the rate has risen to 21.5%;
including the church tax, to even more than 23%.
5. Limited use of equities as a form of investment
Pensionskassen in Germany cannot wield the same
influence on the equity markets as pension funds in the
USA or UK, if only because they are smaller in number (cf.
adjacent table). Moreover, German Pensionskassen are
generally somewhat reluctant to invest in stocks, as
witnessed by the small proportion of shares in their portfolios
Taxation in the pension accrual
phase
Tax regulations contradict
standard international practice
Distribution of share ownership
in % (1990)
USA
All companies
UK
Germany
44.5
62.9
64.0
Financial institutions 30.4
– Banks
0
– Insurance
companies
4.6
– Pension funds
20.1
– Other
5.7
52.8
4.3
22.0
10.0
} }
48.5
12.0
Non-financial
companies
14.1
10.1
42.0
Households
50.2
28.0
17.0
5.4
6.5
14.0
0
2.5
5.0
100
100
100
Non-residents
Government
Sources: Stephen Prowse: Corporate governance in an
international perspective, BIS Economic Papers, No 41 - July
1994.
11) In some countries, though, the earnings portion is also exempt from tax.
16
Deutsche Bank Research
in comparison with funds in other countries (cf. table
below12) and adjacent table).
In 1994 Pensionskassen registered with the Federal
Supervisory Office for Insurance Companies held only
2.5% of their financial assets directly in equities. Holdings
of investment fund units, which included equity funds,
accounted for one-fifth, however.13)
In summer 1995 DB Research carried out a telephone
survey of the 40 largest Pensionskassen in Germany. Of
the 40, 27 gave comparable information and 13 did not
provide usable data. This gives a response rate of 67.5%.
The participants were asked about equities and foreign
equities (direct and indirect holdings) as a proportion of
total financial assets. These proportions are shown as a
frequency distribution on the chart on page 18. Participants
(corporate Pensionskassen only) were also asked to give
the proportion of assets invested in the shares of their
sponsor companies.
Investments of German
Pensionskassen (%)
Type of investment
1993
1994
Real properties and
equivalent titles
7.0
7.1
Mortgage, land charge
and annuity land charge
claims
10.5
10.2
Registered bonds
20.7
19.8
Claims backed by
promissory notes and loans 10.4
10.8
Debt register claims on
the Federal and regional
governments
0.7
0.1
0.1
Corporate holdings
0.2
0.2
25.7
26.7
Fixed-income securities
Equities
2.3
2.5
20.1
20.9
Time deposits and savings
deposits at credit institutions 2.1
1.0
Other
0.1
0.1
100.0
100.0
Shares in security funds
The results of the survey show the average (weighted
according to the financial assets of the individual funds)
proportion of equities to be 12%. As the survey only covers
the 40 largest Pensionskassen, this figure should be a few
percentage points higher than the average for all
Pensionskassen. Smaller Pensionskassen in particular
usually have a lower proportion of equity investments.
Investment behaviour differs widely. The majority of the 27
Pensionskassen which gave information said the proportion
of equities in their portfolios was 5% or less. 20 out of 27,
i.e. 74%, gave a figure of 10% or less. Still, three
respondents said more than 20% of their portfolio was
invested in shares; of these three, two said the figure was
over 30%.
0.6
Loans and prepayments
on insurance policies
Total
Source: Federal Supervisory Office for Insurance Companies
Deutsche Bank Research
In response to the question about foreign equities as a
proportion of total financial assets, more than half of the
Pensionskassen said they held none at all. Over 80% of
Asset allocation of European pension funds, 1994 (%)
Domestic
equities
Germany
United Kingdom
Netherlands
Switzerland
6
56
9
8
Foreign
equities
3
26
20
5
Domestic
bonds
72
7
49
54
Foreign
bonds
4
5
7
5
Real
estate
Cash
13
4
13
19
2
2
2
9
Source: Global Investor, February 1995.
Deutsche Bank Research
12) Figures on investment in equities include calculated holdings through mixed
funds and equity funds.
13) This figure includes investments in real estate funds, equity funds, bond funds
and mixed funds.
17
Equity investment at selected German
Pensionskassen in summer 1995
(No. auf Pensionskassen where equities
account for x% of investments)
Total equities
Shares held by a Pensionskasse in its sponsor company
– if that company is a listed public limited company –
usually make up between 1 and 1.5% of total financial
assets or correspond to the share of the sponsor’s stock in
a portfolio based on the DAX. The highest figure given here
was 4.5%.
8
6
4
2
The most important requirements of the VAG are given
in the appendix. The general limit for investments in the
EEA is, for risk capital such as equities, equity funds and
mixed funds, for example, 30% of tied assets15). Of that,
20% (i.e. 6% overall) can be invested in foreign shares and
the units of funds which invest mainly in shares of foreign
companies. The 6% limit on foreign shares can be raised
de facto if a Pensionskasse or insurance company sets up
an investment fund. As long as the proportion of foreign
paper (meaning non-EEA securities) accounts for less than
50% of this fund’s investments, it can be called a domestic
fund. Thus, in an extreme case the proportion of foreign
shares can be pushed up to almost 50% of the total
allowance for equities, i.e. 15% of tied assets. An exception
clause allows the respective limits to be raised by another
5%.
14) The EEA comprises the EU member states, Norway, Liechtenstein and Iceland.
15) This limit may be exceeded if permission is given in individual cases.
18
x>30
20<x ≤30
10<x≤20
5<x ≤10
2.5<x≤5
0<x≤ 2.5
0
5.1. Restrictive investment regulations?
foreign equities
16
14
12
10
8
6
4
2
10<x ≤15
2<x≤5
1<x≤2
0<x ≤1
0
x=0
One point which emerged from the telephone survey
was that the individual Pensionskassen held quite different
views on the degree of constraint imposed by the
investment regulations contained in the Insurance
Supervision Act (VAG). Before the VAG was amended,
German Pensionskassen and insurance companies were
for the most part only allowed to invest in Germany. The
amendment brought them freedom to invest in all EU
member states and the other members of the European
Economic Area (EEA)14). Since then all requirements
previously limited to Germany have applied to the EEA.
Rules which hitherto covered all countries other than
Germany are now valid for non-EEA countries only. On
account of the higher risk expected from the relaxation of
the investment regulations, Section 53c (2a) of the amended
VAG says that all Pensionskassen now have to satisfy
solvency requirements which previously applied to
insurance companies only, by December 31, 1999. The
extra capital resources needed for this will generally increase
the financial burden on the Pensionskassen in the coming
years.
14
10
x=0
What is the explanation for the average German pension
fund’s reluctance to invest in equities compared with its
foreign counterparts?
16
12
5<x ≤10
respondents said foreign shares accounted for less than
2% of their portfolios. Only two Pensionskassen had
decided to invest between 10 and 15% in foreign shares.
Deutsche Bank Research
Despite deregulation of
investment requirements in
1994 ...
However, the principle that assets must be invested in
the currency of the obligations they cover – which is still
formulated relatively strictly in the VAG – may restrict the
proportion of foreign securities held. According to the VAG,
80% of tied assets must be invested in the currencies of
the obligations they cover, i.e. usually in DEM16). The aim
of this principle is to eliminate or dampen the effect of
currency fluctuations on earnings, and – above all – to
stop Pensionskassen or insurance companies falling into
the trap of investing funds and not being able to withdraw
them fast enough in a currency crisis. However, now that
capital flows have been liberalized within the EEA, such
restrictive cover requirements are no longer necessary
and, besides, are not compatible with the spirit of the single
market. Moreover, the insistence of Germany and certain
other EU member states on 80% cover in the same
currency as the obligations is a sizeable obstacle to passing
common guidelines for pension funds in the EU. It may be
noted in passing that the creation of European Monetary
Union will substantially increase the scope for investment
outside Germany.
The rule that shares and profit participation rights held
by a Pensionskasse in any one company may not exceed
10% of that company’s capital (Section 54a (2) 5) also
seems too restrictive. It could put smaller companies at a
disadvantage, as the cost of researching and managing
small share stakes often exceeds any expected profits,
which means that the investment is not worthwhile for the
Pensionskasse or insurance company. A change in this rule
would not affect the basic regulations in the VAG which
aim to ensure sufficient diversification of investments and
apply to the assets of a Pensionskasse or insurance
company.
... they should be liberalized
further
The above-mentioned DB Research survey showed the
proportion of equities (direct and indirect holdings) in the
portfolios of most Pensionskassen to be well below the
limit set by the VAG. Only very few are at the limit or near
it. In this respect, the legal investment requirements do not
restrict the “average” German Pensionskasse. Of course
this does not apply to all of them. Some have greatly
expanded the proportion of equities in their portfolios in
recent years, and this trend can be expected to continue.
As a result, the prescribed limits will become a problem for
more and more Pensionskassen. As there are no reasons
for not deregulating the VAG further, Pensionskassen and
insurance companies wanting to invest more of their funds
in equities should be allowed to do so.
It should not be underestimated how much increased
investment in equities could improve performance for
Pensionskassen. They tend to be long-term investors17).
Compared with bonds and short-dated time deposits,
16) Before the VAG was amended this rule was much stricter (95% of tied assets
had to be invested in the currencies of the obligations they covered).
17) The exception is Pensionskassen which have a high number of beneficiaries
and either a low intake of new pension holders or none at all. Each year these funds
must have a large proportion of their cover funds available for paying benefits.
19
stocks generally offer chances of higher returns in the
longer term (10 years and over) if performance is measured
on the basis of dividends/interest payments and capital
gains and losses. Investing in shares admittedly involves
a higher risk than fixed-income securities, but mixing
equities and bonds in a portfolio enables institutional
investors such as Pensionskassen and insurance
companies to reduce the overall volatility risk to their
portfolios and achieve a better performance than would be
possible with bonds alone. The addition of a small amount
of equities from outside Europe and emerging markets can
in principle allow them to participate in the performance of
dynamic growth markets and thus achieve improved
performance at the same time as a broader diversification
of the portfolio.
Investment in equities offers
better performance opportunities
If Pensionskassen were to enhance performance by
investing more in the equities market, it would directly
benefit the insured, as the extra earnings would fund
higher benefit payments. This advantage goes hand in
hand with the broader funding of the German stock market
which would result from increased investment in equities.
5.2. Tax obstacles
For tax-exempt Pensionskassen, which most German
Pensionskassen are, investing in shares presents the
problem that they cannot offset the corporation tax credit
they receive on dividends against tax. Thus – unlike taxpaying investors in Germany – they cannot use this to
lighten their tax load (the same problem arises with taxexempt support funds). This puts them at a disadvantage
compared with tax-paying stock-market investors in terms
of return. Tax-exempt Pensionskassen also have the
problem of not being able to offset investment income tax
deducted at source against tax due. As only half the
investment income tax is refunded, this also produces a
final taxation charge. Pensionskassen can avoid this effect,
however, by transferring their investments to an investment
fund. This is one reason why Pensionskassen hold only a
very small portion of their assets directly in equities and
prefer to invest in them (indirectly) through an investment
fund.
Burden of corporation tax and
investment income tax
5.3. Accounting principles
According to the principle of prudence on which German
accounting rules are based, share price losses must be
shown on the balance sheet immediately (according to the
lower of cost or market principle, the book value must be
written down if it is higher than the quoted price on the date
of the balance sheet), whereas price gains must not be
disclosed until they are realized, i.e. when the shares are
sold. This means that opposing movements in the prices
of individual shares cannot balance each other out. Only
price losses (even if temporary) are reflected in the financial
accounts, reducing profit and assets. The performance of
Pensionskassen is measured on the annual balance sheet
20
Measuring performance on
balance-sheet cut-off date
reduces incentive to invest in
shares
cut-off date. This forms the basis used by actuaries,
trustees and the Federal Supervisory Office. Long-term
performance measures, e.g. the average of the past three
or five years, or the moving average of the past 10 years,
as used in the USA, for example, thus usually play a minor
part. This is another factor standing in the way of more
widespread investment in equities.
These problems can be reduced if management of the
assets is transferred to an investment fund. As these funds
are permitted to offset opposing price changes in various
securities against each other, a drop in the price of an
individual stock does not necessarily affect the value of the
Pensionskasse’s assets, though it may have a diluted
effect through a drop in the price of the investment
certificates. As investment funds can also retain price
gains (and losses) over several accounting periods and
“pass them on” to the Pensionskasse some years later,
they can help to smooth out earnings development at the
Pensionskassen.
Efforts on the part of German Pensionskassen to keep
earnings development as steady as possible are also
hindered by the fact that the German market for most
shares is narrow. Apart from DAX stocks, most shares can
suffer significant price fluctuations if a large-scale transaction
is carried out. That means institutional investors cannot
count on being able to manage their German equity portfolios
flexibly, which detracts from the attractiveness of this
form of investment for them. The problem could be reduced,
however, if greater breadth and depth of demand for
equities (were more Pensionskassen to invest in shares)
stimulated the supply side, thereby increasing liquidity on
the German capital market as a whole.
German market for most shares
is narrow
5.4. “Equity culture” lacking
The low level of investment in stocks and shares by
Pensionskassen is to a large extent a reflection of the
severe lack of an “equity culture” in Germany. Investing in
shares is still widely considered (too) speculative and risky.
More attention is often paid to short-term price fluctuations
than to long-term performance, which results mainly from
price gains, as well as dividends. Pensionskassen are
usually subject to co-determination, which has to date
primarily affected the composition of their executive boards.
Thus the investment behaviour of Pensionskassen reflects
the attitude of the insured or their representatives, which
is mirrored in the small proportion of shares in the monetary
assets of German households (1994: 5.5%).
Pensionskassen and their managers are faced with
expectations on the part of the insured, who generally
prefer steady profit development. Irregular development
would result in an irregular distribution of profits to the
insured over time and is therefore seen as unfair.
Risk-averse investment attitude
on the part of the insured
Goal of steady profit development
21
5.5. D-Mark strength as a reason for the small
proportion of foreign securities
Investment abroad can help to boost returns – sometimes considerably – as diversifying investments lowers
risk and as foreign markets, especially equity markets,
often offer higher capital gains in the local currency than the
German market. Developed countries with ageing
populations can participate in the growth of the developing
countries of eastern Europe, southeast Asia or Latin America
by investing capital there. But German Pensionskassen
and insurance companies are little inclined to invest abroad,
whether in stocks or other securities. A fundamental
reason for this is, apart from the aversion to risk already
mentioned, the strength of the DEM. In the past few years
the German currency has appreciated so strongly against
most other currencies – among them the pound sterling
and the dollar – that capital gains on foreign markets have
usually been more than wiped out. Only in very few
countries has this factor had little or no effect in recent
years.
22
V. Implementation
1. The transition
Our proposals are aimed at securing and improving the
provision for old age offered by occupational pensions as
part of the pension system as a whole. External financing
through Pensionskassen, for example, not only provides
good provision for old age, but also allows broader funding
of the German financial markets. The two belong together.
Ensuring an efficient occupational pension system based
on Pensionskassen requires similar conditions to those
enjoyed by pension funds of the Anglo-Saxon type. This
raises the problem of how to pass from one system to the
other.
It is impossible to project or plan such a transition in
detail. It will be the result of voluntary action on the part of
companies. The ideas and suggestions given in this study
form a basis for discussion on the transition. The main
guiding principles are:
•
a level playing field in terms of tax for the different forms
of pension,
•
the possibility of transferring existing pension reserves
to external Pensionskassen or insurance companies
without affecting the tax situation,
•
protection for existing pension systems and
•
the principle of voluntariness.
If no one form of pension scheme enjoys tax advantages
over another, companies can choose the one which best
suits their business. Here it is important to stress the
established principle that setting up an occupational pension
scheme must be a voluntary decision. There can be no
pressure for or against any particular system. This implies
taking measures to protect the existing types of scheme,
partly to ensure the cost-effectiveness of the occupational
pension system. Such considerations mean companies
cannot be forced to release their pension reserves and
transfer their obligations to a Pensionskasse.
A transition to increased external funding of pension
obligations can therefore take place only gradually. This
would mean transferring future cover funds to external
trustees instead of book reserves. The principle of
voluntariness leads to a “market test” for each form of
pension scheme. In the past this has mainly come out in
favour of book reserves, partly as a result of differential tax
treatment of the various types of scheme. If the principle
of equal tax treatment for the four different types of
pension were made law, Pensionskassen would become
more attractive on account of their many advantages, as
discussed above.
Guiding principles for the transition
Principle of voluntariness
Market test with equal tax
treatment
Companies wanting to release pension reserves and
transfer them to external trustees, must be allowed to do
this without incurring any extra tax costs. In particular it
23
must be guaranteed that the tax effects of releasing
reserves on the one hand, and paying contributions for the
first time to a Pensionskasse, on the other, balance each
other out. Such an arrangement could unleash for the
financial markets capital which has already been tied up in
the company. In an ideal situation companies would take a
long-term decision to fund all new pension obligations by
accumulating capital externally and to transfer a large
portion of existing pension reserves to external trustees.
Transfer without extra tax costs
Pensionskassen and insurance companies can make
larger contributions to cover funds for the same pension
commitment than is possible with book reserves. This is
because contributions to pension reserves are calculated
at a discount factor of 6% p.a., while the rate for contributions
to Pensionskassen and insurance companies is between 2
and 2.5 percentage points lower. As Pensionskassen can
achieve a higher return on their assets than the maximum
discount rate allowed (3.5% or 4%), they can achive a
surplus. This enables Pensionskassen to finance increased
pension benefits (because of inflation and/or wage
developments) from this capital “cushion”. This provides
indirect compensation for the fact that in Germany – unlike
in the USA, for example – it is not permissible to base the
calculation of funds needed to cover pension obligations on
expected future wage and pension developments.
In view of the need for equal tax treatment, however,
this solution appears inadequate. The goal should be to
recognize the IAS for tax purposes in the calculation of the
required cover for all types of pension scheme. This would
allow contributions to cover funds to be calculated on the
basis of projected wage increases and pension adjustments.
It would at the same time be desirable to use an appropriate
capital market rate as discount factor, in accordance with
the IAS. The interest rate used should accord with the term
of the pension obligations. If, for example, the insured of a
Pensionskasse are all young employees, it would be
appropriate to use a long-term capital market rate (e.g. on
30-year government bonds).
This would satisfy the requirement of a completely level
playing field in terms of tax and accounting practice for all
types of pension scheme. Contributions to cover funds
calculated on the basis of the capital market and future
expectations are likely to be nearer to the actual present
value at the time when benefit payments begin than is
currently the case with the German practice of forming
reserves. That would avoid decisions being distorted by tax
considerations, and companies would be able to choose
the most economical alternative.
2. Capital resources of companies
The widespread practice of using pension reserves as
a source of internal funding is closely linked to the growth
of the German economy in the fifties and sixties. Companies
needed large amounts of capital but the capital markets
24
Market rate and IAS desirable
basis for calculation
Level playing field in terms of
tax and accounting practice
were underdeveloped. Equity capital was particularly hard
to raise. Pension reserves provided a comfortable and longterm source of capital, which was indispensable for financing
growth.
However, the general economic conditions and the
state of development of the capital markets have undergone
profound changes in the past few decades. The fastmoving globalization of the financial markets and the
increasing international diversification of the ownership
structure demand that companies provide a greater degree
of transparency and orientation towards international
accounting standards and shareholder value. Large amounts
of short or medium-term liquidity on balance sheets attract
criticism, particularly from foreign investors. Transferring
assets backing pension obligations to external managers
could help, as a positive spin-off effect, to bring German
balance sheets more into line with international practice.
It is often said that German companies are undercapitalized compared with companies abroad. According
to a study published by the Bundesbank in October 1994,
this contention should be seen in relative terms, if
fundamental differences in the methods for defining equity
are taken into account or eliminated. Unlike before, at least
the large German groups now have a solid capital base. A
Bundesbank survey of the annual accounts of west German
companies in 1990 showed that the average proportion of
equity in the balance sheets of companies in the
manufacturing, construction, retail and wholesale sectors
was 22.7%. Incorporated companies had a ratio of 25.5%
(incorporated companies with annual sales of DEM 100 m
and over: 27.3%). Moreover, book-reserve schemes are
the predominant form of pension system at the larger
companies.There exists, therefore, a good basis for
transferring pension reserves to external trustees such as
Pensionskassen. Of course this is not necessarily the case
for small and medium-sized firms. Smaller incorporated
companies, partnerships and sole traders often have equity
ratios of 10% or less.
Pension reserves financed
growth in the fifties and sixties
More transparency and orientation towards international
accounting standards
Capital base of Germany
companies1) in 1990
– in % of total assets –
Total Companies
with sales
of less than
DEM 5 m
Companies
sith sales of
DEM 100 m
and over
All
companies
22.7
5.1
25.8
Incorporated
companies
25.5
7.7
27.3
Partnership
13.1
5.7
16.3
Sole traders
9.8
-0.3
15.9
2)
1) Manufacturing, construction, distributive, trade.
2) Sales of DEM 10 m and over.
Sources: Deutsche Bundesbank.
Deutsche Bank Research
Thus, large German companies do not need pension
reserves for financing purposes as much as they used to.
This means there is potential for moving at least some of
the capital earmarked for financing company pensions to
external trustees.
3. “Asset funding” as a step along the road to
external financing
The Bundesbank pointed out in 1992 that in the eighties
a number of large companies were beginning to shield their
pension reserves from the risks of company earnings by
investing part of the equivalent assets in securities. This
permits a broad diversification of investments in terms of
both financial instruments and markets.
A prime example of asset funding is provided by Siemens
Kapitalanlagegesellschaft (SKAG), in whose investment
25
funds the Siemens group invests its available liquidity,
particularly long-term funds. The market value of its total
available assets was DEM 19 bn in 1994. 14% was invested
in pure equity funds. 12% was held in mixed funds, so the
overall investment in shares would have been above 14%.
Over 74% was held in funds investing solely in bonds.
Siemens’ reserves for pensions and similar obligations
totalled DEM 16.67 bn, according to its 1994 annual report,
compared with DEM 16 bn in 1993. Thus assets managed
by SKAG equalled around 114% of Siemens’ pension
reserves at the end of 1994. That put the group in a
situation where it was “overfunding” its pension reserves.
26
Overview of the investment rules of the VAG
Appendix
According to the rules on insurance supervision, all
claims arising from an insurance contract must be covered
by corresponding assets. These can only be managed with
the participation of an external trustee. In addition, there
are also so-called other tied assets, which are reserves for
other payments (e.g. premium refunds). In the case of
Pensionskassen, other tied assets play a very small role for
tax reasons. Together, these two categories form tied
assets, to which the investment rules of Sections 54 and
54a of the VAG refer. Besides tied assets, there are also
non-tied assets, which correspond in principle to shareholders’ equity.
According to Section 54 of the VAG, “the assets of an
insurance company are to be invested, taking into account
the type of insurance business and the structure of the
company, in such a way as to achieve the highest degree
of security and profitability, whilst maintaining liquidity at
the insurance company at all times and preserving an
appropriate mix and diversification”. The Federal Supervisory Office for Insurance Companies takes this regulation
to mean that not more than 50% of assets can be invested
in any one type of instrument and that assets must be
spread over at least three types of investment.
The most important regulations of Section 54a:
– A maximum of 25% of tied assets may be invested in
real properties (and equivalent titles, shares in real
estate investment companies etc.).
– Fixed-income securities: a maximum of 2.5% of tied
assets may be invested in unlisted bearer bonds. For
listed bearer bonds issued in an EU member state, the
general investment principles apply, i.e. 100% of tied
assets may be invested in fixed-income securities if they
meet certain criteria (as previously). Unlike before the
amendment, however, this now applies to investments
in the entire EEA. Outside the EEA, 5% of assets can be
invested in bonds if the latter are traded on an exchange
in the EEA or an organized market, or are officially listed
outside the EEA. This limit previously applied to all
foreign countries.
– A maximum of 30% of tied assets may be invested in
risk capital such as equities18), profit participation rights,
corporate holdings and security funds (other than pure
EEA bond funds). (This limit can be extended on request,
in accordance with Section 54a (5) of the VAG). At most
20% of the equity portfolio, i.e. a maximum of 6% of tied
assets, may be held in shares and profit participation
rights of companies based outside the EEA. Shares and
profit participation rights in any one company may not
18) Shares must be fully paid and officially listed or traded on an organized market
at a stock exchange in the EEA. Shares which are listed on an official market
outside the EEA can be used for the investment of other tied assets.
27
exceed 10% of the share capital of that company. No
more than 7.5% of tied assets (i.e. a quarter of the
above-mentioned 30%) may be invested in corporate
holdings – including holdings in investment companies
– which are not composed of listed shares.
– Pensionskassen are given extra scope for investment by
the exception clause in Section 54a (2) 14, which allows
a further 5% of tied assets to be invested in instruments
not covered by the other investment regulations of the
VAG (here, too, there are exceptions: consumer loans
and investments in intangible assets, for example, are
not permissible).
– For granting loans and investing funds at credit
institutions, the general investment principles apply.
The principle of mixing and diversifying is stressed
explicitly in the VAG. It is reflected in the individual investment regulations in the form of special diversification rules.
According to Section 54a (4b), investments in one debtor
may in principle not exceed the sum of 2% of tied assets
and 25% of the insurance company’s capital resources
(overall, this must not exceed 5% of tied assets).
28
List of abbreviations
Aba
Arbeitsgemeinschaft für betriebliche Altersversorgung e.V.
DAX
Deutscher Aktienindex
DEM
Deutsche Mark
EEA
European Economic Area
EStG
Einkommensteuergesetz (Income Tax Act)
EU
European Union
GDP
Gross Domestic Product
IAS
International Accounting Standards
KStG
Körperschaftsteuergesetz (Corporation Tax Act)
PSV
Pensions-Sicherungs-Verein auf Gegenseitigkeit
SKAG
Siemens Kapitalanlagegesellschaft mbH
USD
US dollar
VAG
Versicherungsaufsichtsgesetz (Insurance Supervision Act)
29
© 1996. Publisher and Author: DB Research GmbH, P.O. Box 10 06 11, 60006 Frankfurt am Main, Federal Republic of Germany.
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32
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