by Markus Roth
1. Practical importance of occupational pension
Among countries in Europe and worldwide, occupational pensions take on different degrees of importance. Available data highlighting these differences vary. According to statistics of the Organization for Economic Cooperation and Development (OECD), for 2007, assets in occupational pensions averaged 75.5 per cent (in 2005: 86.7 per cent) of the gross national product. This average was exceeded in 2007 and in 2005 by Iceland (134.0 per cent and 123.2 per cent, respectively), the Netherlands (132.2 per cent and 124.9 per cent, respectively), and Switzerland (119.4 per cent and 117.4 per cent, respectively). Other countries relying heavily on occupational pensions, but with more fluctuating figures according to the OECD, are Australia (105.4 per cent and 58.0 per cent, respectively), the United Kingdom (86.1 per cent and 66.2 per cent, respectively) and the United States (74.3 per cent and 98.9 per cent, respectively). The OECD statistics put the comparable figure for Germany at only 4.1 per cent and 3.9 per cent, respectively. Figures by Watson Wyatt Worldwide show pension assets for the year 2010 at approximately 14 per cent of the gross national product. According to the statistics of the German Association of Occupational Pensions (Arbeitsgemeinschaft betriebliche Altersversorgung (ABA)), this figure rises to 16 per cent of the gross national product if pension obligations based on a figure in the balance sheet are included.
These differences in occupational pensions reflect the different designs of the national pension systems and correspond with the development of the financial markets of the different countries. The practical significance of occupational pensions will continue to grow due to the demographic change and the ongoing problems of public pension schemes. This is especially the case for those continental European countries, such as Germany, in which occupational pensions have thus far been of minor importance for the overall pension system.
2. Forms of occupational pension
Private pension schemes are divided into defined benefit schemes, defined contribution schemes and hybrid pensions. Predetermined, guaranteed pensions (defined benefit schemes) are found primarily in the form of fixed pensions and annuity promises. In defined contribution schemes, the pension of the retiree depends on the funds paid in by employer and employee and, especially, on the outcome of the asset management by a separate occupational pension institution. A distinguishing feature of defined contribution schemes is that the employer does not guarantee pension payments. As is often the case with profit insurance contracts, frequently only parts of the expected future pension are guaranteed. In Germany, most occupational pension schemes via direct insurance contracts, Pensionskassen and pension funds, are characterized as hybrid pensions. The German Occupational Act departs from the international practice and trend in not recognizing defined contribution schemes as occupational pensions. Defined contribution schemes are recognized in Germany by the Federal Supreme Labour Court only as a fringe benefit according to general labour law provisions. An explicit statement by the employer that no guarantee is provided is additionally required. Forms of occupational pensions are regulated according to national law. In Germany, the Occupational Pensions Act provides for five different possibilities to fulfil such pension promises—the direct pension promise, the support fund, direct insurance, the traditional Pensionskasse and the newly introduced pension fund.
3. European regulations and regulatory proposals
The Directive on the activities and supervision of institutions for occupational retirement provision (Pension Fund Directive, Dir 2003/41) is the most important European occupational pension scheme provision. The Pension Fund Directive is described in detail elsewhere (pension funds). Further applicable directives are the Directive on safeguarding the supplementary pension rights (Dir 98/49) and the Directive on the protection of employees in the event of the insolvency of their employer (Dir 80/987). The Directive on safeguarding the supplementary pension rights of employees and self-employed persons moving within the Union aims to protect the free movement of employees, especially by securing vested occupational pension rights in the case of a job change within the European Union. The Directive to protect workers in the event of insolvency of their employer provides for the establishment of a guarantee institution to protect outstanding claims resulting from contracts of employment or employment relationships, especially pension entitlements. The Directive does not require the guarantee of the full pension entitlement. Member States may limit the payments by the guarantee institutions. Only the minimum level called for by the Directive is mandatory. The draft Portability Directive proposed a more comprehensive system. However, this Directive is currently not being further pursued.
The draft Portability Directive of the Commission was designated to improve the portability of supplementary pension rights. The draft Portability Directive’s stalemate is especially a result of German resistance. The European Commission has continued its efforts first with an amended proposal for a directive on minimum requirements for enhancing worker mobility by improving the acquisition and preservation of supplementary pension rights. This proposal is currently on hold but might be taken up again by the new Commission. In addition to the aforementioned draft directive, interested parties are working on legislation for pan-European pension plans.
4. External coverage of pension promises
Internationally and especially in Anglo-American countries, the pension rights of employees are secured with separate estates, with the assets being held in trusts. Both US and English pension laws provide for pension obligations to be held in trust. According to international practice, the OECD Guidelines on Funding and Benefit Security in Occupational Pension Plans provide that pension obligations are to be covered with separate assets. When looking to the trust as the legal basis of this concept of occupational pensions, it is not surprising that the Netherlands and Switzerland, as countries with a strong focus on occupational pensions, have signed the Hague Trust Convention.
The fact that Germany relies solely on occupational pension liabilities covered by a figure in the balance sheet puts it in a special position compared to other continental European countries. This is especially true when comparing Germany to those countries which give great weight to occupational pensions. For the Netherlands, it is argued that pension funds operate on the basis of the principles of fiducia cum amico (the disinterested trustee), thus being the continental European counterpart of the trust. In Switzerland, coverage with separate assets is obligatory. Other countries in Europe that merely cover pension obligations with a figure in the balance sheet are Austria, Italy, Spain and Sweden. Yet, these forms of occupational pension do not play a significant role in those countries. According to the European Federation for Retirement Provision, in Europe, the occupational pension obligations covered only by figures in the balance sheet totalled €313.9 billion in 2006, with Germany making up about 87 per cent (€273.47 billion) of that figure.
In the practice of German occupational pension law, the international accounting standards and in particular IAS/IFRS have been a real driving force for innovation. For consolidated financial statements, accounting in accordance with IAS/IFRS is mandatory for some German companies. Primarily for purposes of obtaining better ratings, these companies are funding their occupational pension obligations with assets. For the DAX 30 companies, more than two-thirds of the occupational pension liabilities are funded with separate assets. This allows these companies to ‘shorten’ their balance sheets. The occupational pension obligations must be reported as such in the special accounting for pensions but need not be disclosed in the general balance sheet as debt. These companies can therefore report a higher return on the remaining capital. Practically, such ‘shortening’ of the balance sheet by using separate assets for covering occupational pension liabilities will no longer be restricted to companies reporting according to international accounting standards. The new Bilanzrechtsmodernisierungsgesetz (Modernizing Accounting Act of 2009) extends this possibility to companies falling under the accounting standards of the Commercial Code.
5. Enrolment, forfeiture, vesting and portability
On an international scale, enrolment in occupational pension schemes, vesting periods and the transferability of occupational pension claims against employers or occupational pension institutions such as pension funds (portability), vary according to the national regulation. A mandatory enrolment into an occupational pension scheme is codified in Switzerland, with a very high level of participation also existing in the Netherlands. The automatic enrolment in an occupational pension scheme results in a significant increase in the participation of workers in occupational pensions and is therefore one of the hotspots of behavioural finance. For Germany, an automatic enrolment was proposed by the 64th German Jurists Forum (Deutscher Juristentag, DJT), Section on Retirement, in Bonn. In England, a statutory provision calling for automatic enrolment (Pensions Bill 2008) was based on the report of the English Pensions Commission.
Forfeiture describes the loss of pension rights of workers particularly in early termination of employment. The German Occupational Pensions Act limits forfeiture to a five-year period. In England, the Pension Schemes Act of 1993 provides that a plan must allow for non-forfeiture after two years at the latest. The maximum period of two years can be accounted for in several periods. In Switzerland and the Netherlands, occupational pension promises are vested immediately, which in Switzerland accords with the mandatory nature of the enrolment in occupational pension schemes. Different vesting periods according to different occupational pension schemes are familiar to Austria and especially to the United States. In the US, this operates through the distinction between defined benefit and defined contribution, as well as through a vote of the employer between a progressive vesting over a longer period and a complete vesting in a shorter single period.
The European Commission, probably inspired by the British regime in the Pension Schemes Act of 1993, intended to shorten the vesting period in Europe to two years in order to unify the period for the acquisition of pension rights, with a minimum age to be set at 21 years. The proposal for a directive of the European Parliament and the Council to improve the portability of supplementary pension rights (draft Portability Directive) provided a graduated system. According to the draft Portability Directive, employees should become members of the pension scheme after one year of employment or, where appropriate, when they reach the required minimum age of 21 years. After memberships of no more than two years, the pension rights should be vested and the employees acquire pension entitlements. The graduated vesting period that exists in the United States is incompatible with the draft directive. The amended proposal for a directive on minimum requirements for enhancing worker mobility by improving the acquisition and preservation of supplementary pension rights (draft Supplementary Pensions Directive) then prescribed a minimum age of 21 years. Vesting should generally occur after one year; however, in deviation from the general rule, until the age of 25, vesting occurs after five years. The European Parliament proposed to further shorten the expiration dates but the prospects of these regulations are not clear.
When an employee terminates his employment and his pension rights are vested, the question arises whether he can transfer his pension rights. Such portability of occupational pensions includes the transfer of related assets to the new employer or a new institution providing for occupational pensions. Nationally and internationally, transfer rights have various forms. The question is whether a contractual position is transferable in the first place. Internationally, transfer rights, and thus the portability of occupational pensions, are more likely in the event of an early termination of employment after vesting occurs and when there was a defined contribution scheme. In Switzerland and Germany, the portability of occupational pensions in the case of an early termination of the employment contract is codified. Different practices for the transition of pension obligations can be found, for example, in England, where share and asset deals are distinguished.
6. Adjustment of occupational pensions
The issue of adjusting pension payments to inflation or the earnings of investment management occurs especially after retirement. In England, the Pension Schemes Act of 1993 provides that an early leaver of an employment contract may not be treated worse than the plan retirees. So-called long service benefits on the basis of a pension plan participant who remains in the same position until retirement may not be treated more favourably than so-called short service benefits, which may be obtained upon early termination of the employment relation. The proposal for a directive of the European Parliament and the Council to improve the portability of supplementary pension rights (of 20 October 2005) follows the English system in the Pension Schemes Act of 1993 by providing that Member States may take such measures as they deem necessary to ensure a fair adjustment of dormant pension rights so as to avoid penalizing outgoing workers. According to the preamble, this could be achieved through an adjustment of dormant rights in line with a variety of reference levels, including inflation, wage levels or pension contributions that are in the course of being paid, or the rate of return on assets under the supplementary pension scheme. The Commission’s amended proposal now synchronizes dormant pension rights with the rights of active workers or pensioners, thereby leaving room for different regulatory models.
The position regarding adjustment of pension payments after retirement is not unified internationally, the United States, for example, lacking such requirement. In the 1990s, only 10 per cent of the traditional defined benefit plans of medium and large American companies provided an adjustment to rising costs of living. In contrast, national legislation in Europe requires such pension adjustments. The English Pension Schemes Act has already been mentioned in this regard. The minimum interest rate for occupational pension in Switzerland leads to an adjustment of occupational pensions. In Germany, the Occupational Pensions Act requires adjustment of defined benefit plans in the payout phase in principle, with the employer having to take inflation into account for such adjustments. Special rules apply for income-dependent benefits designed especially via insurance companies and pension funds. As of recently, occupational pensions may provide a flat-rate increase of 1 per cent per year. This makes it easier for the employer to calculate future pension payments, but it transmits the inflation risk largely to the employee. In the case of a premature departure, the German occupational pension law does not require any adjustments until retirement.
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