Vinayaka Pandit, Head of Analytics and HR at VEDRA Pensions
1. Why do you think the topic of company pension schemes is so relevant right now, and which current developments make it particularly interesting?
It’s said all the time: Due to demographic trends, the level of benefits in the pay-as-you-go statutory pension scheme is falling or can only be maintained by increasing tax subsidies. As a result, occupational pension schemes will play an increasingly important role. Legislators have recognized this, at least in principle, as evidenced by the ever-increasing frequency of amendments and additions to the German Occupational Pensions Act since its introduction in 1974.
However, there does not seem to have been a major shift in attitude yet among neither employers nor employees. For example, the "true” defined contribution pension scheme newly introduced to the German occupational pension market in 2018, which does not have a guaranteed interest component and is generally much less costly and easier for employers to administer than the traditional defined benefit schemes, has not yet gained much traction. This is probably due to resistance from all sides to abandoning a supposedly safe, albeit expensive, product in favor of a cheaper, riskier one. At the same time, such a pure defined contribution scheme would offer employees opportunities for uncapped investment returns that were traditionally fixed. Whether or not this paradigm shift will actually happen is one of the most exciting questions for me in the field of occupational pension schemes in the coming years.
For me, it further plays a major role whether there will be any substantial streamlining of the currently quite complex occupational pension landscape with its five implementation channels. Although they are subject to different accounting and tax regulations, in my view the design of the individual products doesn’t differ significantly enough to justify this complexity, especially for companies. More simplicity would make the subject easier to understand and create more trust on all sides.
2. About 20 years ago, you first consulted on the topic of the pensioner company. Has the market developed as you expected or even predicted at the time, or have there been any surprises?
At the time, the market for pension buy-outs in Germany was not significant. Some insurers offered a product called direct liquidation insurance. As the name suggests, the original purpose of this solution was to enable a company without business activities to be liquidated after transferring its remaining pension obligations to an insurer. Coupled with a prior reorganization according to Company Restructuring Law, it was possible to achieve a legal release from liability, as is achieved by today's pension buy-out solution. However, due to the conservative assumptions used by the insurance industry in accordance with legal requirements, this solution was not very attractive in terms of pricing. Very few transactions of significant volume took place. I saw no reason to forecast growth in this market segment.
The situation only changed significantly when interest rates began to fall in the mid-2010s as a result of the ECB's monetary policy. The sharp rise and volatility in pension obligations made companies quite aware that, in addition to their core business, they were in many cases also operating a kind of life insurance business for their own active and former employees due to the unfunded pension commitments. This encouraged the creation of a pension buy-out market, as the low bond yields observed – which are used to value pension obligations – could be reasonably outperformed by an appropriate asset allocation. This prompted service providers to develop innovative products, often priced below the recognized pension provision on balance sheets. Depending on their design, these products often allow outsourcing to be carried out without or at least without any significant P&L losses for the transferring company.
3. In countries such as the USA, Canada and the UK, pension risk transfers are an established instrument with well-documented strategic advantages. Why do you think they are not yet more widely utilized in Germany? What challenges or issues have you encountered in your consulting work on this topic to date?
In my view, there are regulatory as well as cultural reasons for this. On the one hand, the insurance industry, which is supervised by BaFin, is required to use more conservative assumptions in terms of mortality and interest rates than companies are when accounting for pension obligations. This, in principle, increases the cost of outsourcing to an insurer or pension fund.
In addition, the historically anchored duty of care that employers adopt towards their employees in Germany plays an important role. This results in a 'subsidiary liability' in the context of any company pension scheme, meaning that if a chosen external provider defaults, the company is liable for the transferred obligation. Therefore, even after outsourcing, there is a residual risk for the employer. The duty of care aspect is also one of the main reasons for the long-standing prevalence of direct pension commitments in German occupational pensions where the employer pays the beneficiary directly without an external provider. To go for the type of clear cut that would be associated with a pension buy-out therefore requires a new cultural mindset.
Over the last 5 to 10 years, the pension buy-out has emerged as an attractive instrument to outsourcing a pension obligation along with all associated risks and administration, notably without a subsidiary liability. However, companies find it difficult to take this step as it calls for entrusting their former employees to an acquiring service provider for decades to come. Therefore, when considering a risk transfer, it is important not only to choose the right product or solution, but also to have a trustworthy partner for the long term.
4. As an actuary, what other trends do you think we should be aware of?
With respect to life expectancy and disability in particular, there have been some recent events which were not foreseen and will only become measurable over a longer period of time.
In addition to the pandemic, which has caused some statistical outliers in terms of mortality, these also include, say, a sharp increase in mental health conditions as well as an overall increased resistance to certain medications. There are also political developments to consider, such as a possible significant decline in funding for medical research, which seems conceivable given the current political climate, for example in the USA. Furthermore, regional and socio-economic differences make it difficult to draw a uniform picture.
These events and circumstances make it more difficult to identify future trends from existing data in the short term. However, they also provide starting points for a more differentiated approach to the topic.
5. What made you decide to work for VEDRA Pensions? What appeals to you most about this role?
In my previous position at a Big Four company, I had the privilege of getting to know VEDRA Pensions as a service provider over several years, working on various pension buy-out projects together. We clicked from the beginning, and that is important to me.
Joining VEDRA gives me the exciting opportunity to help shape the growing pension buy-out market in Germany, working alongside experienced experts. My focus is not only on sustainable solutions for the market but also establishing and deepening strategic collaborations and dealing with existing and potential regulatory issues. As an actuary, I find this an exciting and multifaceted field of activity, both professionally and personally.
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