The current challenges are succinctly summed up in the main theme of this year's WTW bAV conference “Pensions in motion” ("Altersvorsorge in Bewegung"). Companies, service providers, politicians and, above all, employees are faced with several important questions, opportunities, and risks. Detailed presentations and intensive discussions at the WTW conference in Frankfurt on 1 October 2024 aimed to provide answers and yard sticks to some of those questions.
We have selected five of these questions and put them to the two moderators of the conference, Hanne Borst and Nikolaus Schmidt-Narischkin, for their personal views:
1. The BRSGII we have seen this year, the brand-new draft law of the so called “Toncar – Rente” was already addressed at the conference and collective partnering models between employees and employers (“Sozialpartner-Modell”) were discussed. Under the premise of "what's in it for you" - how do you see the development and sustainability of occupational pensions in that regard?
The statutory pension insurance system is increasingly taking on the role of a more basic form of old-age provision. Occupational pension schemes are increasingly important as a means of securing living standards of pensioners. Up to now, occupational pension schemes have not been sufficiently widespread, especially in small and medium-sized enterprises and among lower income levels. The BRSG II aims to significantly increase the prevalence of occupational pension schemes. One focus is on the “Sozialpartner-Modell”. The "relevance requirement" for collective agreements has therefore been significantly modified. Enabling more Collective agreements allows companies (in other sectors) to join an existing “Sozialpartner-Modell” by means of a collective agreement, if the parties to the collective agreement in question agree. Above all, this would make it possible to use a “Sozialpartner-Modell” throughout an entire trade union’s coverage area, in many cases across several sectors, instead of the current form of one partnering model per sector.
In addition, the subsidy for low-income earners in accordance with Section 100c of the Income Tax Act was increased and a dynamization of the salary thresholds was introduced. The further spread of occupational pension schemes has thus received an important boost. This regulation will be in force from 1 January 2025, even though the BRSG II will not be in force at that time. This is highly commendable!
It is regrettable that the possibility for companies to opt out has been limited to companies operating in sectors not covered by collective bargaining. We see that automatic enrolment in a company’s pension scheme, with the possibility of active opt-out, is an important lever for the acceptance and spreading of occupational pension schemes in other countries, such as the UK and Denmark.
It is an open question whether the BRSG II will have a positive impact on the spread of company pension schemes. In any case, the government draft contains new evaluation provisions with the threat of an obligation if there is no "recognizable" increase in the prevalence of occupational pension schemes.
2. A recurring theme throughout the conference was the need for 'financial literacy' of German citizens. Why is this so important, and what are the opportunities for companies and advisers to provide support in this area?
International conflicts, wars, challenging economic conditions and changing climate are making employees feel insecure. Research carried out by WTW shows that an increasing number of workers have little or no opportunity to build up a financial reserve. Compared to employees who can save for emergencies, these people are more likely to experience chronic stress and burnout.
Accordingly, when it comes to financial resilience, workplace pensions are high on the wish list of employees across all industries and regardless of generation, gender, or income. Indeed, they can make a significant contribution.
Through the improvement of general financial literacy, employee awareness of their personal pension situation increases. For example, employees can make a realistic assessment of their pension situation in old age by using pension gap calculators. As part of digital access channels, so-called employee portals, more and more companies are offering such services. There is much to be said for making knowledge available digitally, as this is the only way to identify options for action in a meaningful way: What are the tax advantages associated with deferred compensation, and how can the use of the employer's contributions be optimized? Why is it worthwhile to start saving for retirement early?
3. The focus on collective buffers in occupational pensions was very interesting, where do you think the journey is going?
It was only with the law on strengthening occupational retirement provision (Betriebsrentenstärkungsgesetz) and the introduction of the “Sozialpartnermodell”, that it became possible to only have defined contributions without performance guarantees. This was led to more intensive thinking about so-called "buffering models" (“Puffermodelle”).
The decoupling of the actual investment from the duration-dependent specifics of the portfolio (entitlement vs. pension phase or the ageing of the portfolio in the entitlement phase) is the basic principle of all collective buffer models. The aim is always to use the longest possible investment horizon, which often extends beyond the start of the payout period. This smoothes the investment horizon and promises higher returns for comparable risk.
Traditional direct commitments are also receiving new impetus from the development of the principle of collective investment, as practiced in pure defined contribution plans, with its risk buffers built up over time through investment returns.
Particularly challenging capital market situations, such as the one we will see in 2022, could prove to be particularly disadvantageous for people approaching retirement. This is because the allocation of different asset classes in even the most modern pension plans is individualized and depends on the age of the beneficiaries (so-called life cycle models). The discounts in 2022 were not only high, they could not and cannot be made up for by the artificially shortened investment horizon for older plan participants and the resulting overweighting of interest-bearing securities. These capital market fluctuations could be better countered by aligning investments with the investment horizon of the collective rather than the individual, as practiced in the social partner model.
Overall, the scope for structuring direct commitments outside the social partner model seems greater than ever.
4. Further interest rate cuts are likely given the economic outlook. Investment strategies need to be constantly adapted to the volatile capital market environment. In this period of lower interest rates and persistent core inflation, how are clients responding? Are they adjusting their asset management strategies appropriately?
Yes, (pension)- investors are responding to the changing environment. Well in advance of the expected interest rate cuts, a significant proportion of market participants have hedged against significantly higher interest rates from 2023 at the latest by increasing funding levels (as rates rise and liabilities fall). IFRS investors do this via LDI strategies, pension funds via CDI strategies and pension funds through an increase in their direct portfolios. There has been no significant reduction in exposure to alternative investment strategies. This exposure was painstakingly built up during the period of low interest rates, and has been replaced by a return to (more profitable) traditional asset classes. Alternatives are here to stay - investors have become 'comfortable' with their complexity and now have the governance structures in place - either built or bought in.
5. Several workshops and client case studies at the conference highlighted the record level of funding in German pension vehicles, be it a pension fund or a CTA. In other countries, companies use such funding levels for risk mitigation purposes, for example through buy-ins or buy-outs. In your experience, what is the situation like in Germany?
Indeed, the funding or outsourcing of pension liabilities has become more favorable since the end of the low interest rate environment. According to the German Pension Finance Watch for the second quarter of 2024 , the funding ratio of DAX pension funds was almost 85% at mid-year. There are various options for de-risking. These include the creation of plan assets by means of a trust model (CTA) or the transfer of pension obligations to a pension fund. The option of transferring pension obligations to an external risk carrier by means of a spin-off and subsequent sale of a pensioner company is becoming increasingly attractive. This makes it easier for companies to transfer pension obligations and fully discharge the legal liabilities in the long-run at economically justifiable conditions. With this, the pensioner company has a unique selling point. In the past, the purchase of a direct liquidation insurance policy was also an option for full discharge. However, this option was generally unattractive due to the low interest rate guarantee of currently 0.25% and the lack of flexibility in the insurer's interest rate setting.
Despite their advantages, pensioner companies are not yet as widespread in Germany as they are in other countries. However, they are becoming more and more important, especially in the context of M&A transactions or for German subsidiaries of foreign group companies. In addition, the transformation of many industries and demographic change are increasingly prompting companies to ask themselves whether transferring the pension obligations of retired and vested employees would not better suit the company's orientation.
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