Scheme types and guarantees

To date, the German Occupational Pensions Act (Betriebsrentengesetz – BetrAVG) provided solely for defined-benefit schemes, which still remain an option. In such schemes, the employer is liable to pay a defined benefit amount to the employee. This applies even if the occupational retirement provision is implemented via an external pension provider, for example a Pensionskasse, a Pensionsfonds or a life insurance undertaking (sponsoring body). One advantage of defined-benefit schemes, where the benefits are guaranteed by the sponsoring body, is a certain planning certainty. However, such guarantees also have disadvantages. For example, the pensions are usually relatively small to begin with, since the sponsoring body has to make reliable calculations. In addition, significant restrictions apply to the investment of the capital, with only limited investments in real assets possible.

The BRSG is now adding the pure defined-contribution scheme to the list of possible scheme types. In the case of the defined-contribution scheme, the employer is liable only to pay the contributions to the sponsoring body. Both the German Insurance Supervision Act (Versicherungsaufsichtsgesetz – VAG – only available in German) as well as the BetrAVG make it clear that the sponsoring body may not guarantee employees any benefits in the context of the pure defined-contribution scheme. The pure defined-contribution scheme therefore allows the disadvantages associated with guarantees to be avoided. In particular, higher pensions can be paid out at the beginning than would be the case if there were a guarantee. Through various provisions, the BRSG ensures that pure defined-contribution schemes offer a certain minimum level of protection for employees despite the fact that guarantees are waived.

Collective agreement

A condition for availing of the pure defined-contribution scheme is a corresponding collective agreement. If the parties to the collective agreement agree to occupational retirement provision in the form of the pure defined-contribution scheme, they must participate in its implementation and management and thus take long-term responsibility for the scheme.

It should be agreed in the collective agreement that the employer pay a security contribution to safeguard the pure defined-contribution scheme. This is intended to compensate for the fact that the employer is not liable to pay a certain benefit amount. The amount of the security contribution as well as its specific use are not set out in the legislation. However, the law does stipulate that the security contribution can be used to create a safety cushion within the premium reserve of the sponsoring body which is available to future and current beneficiaries on a collective basis, in order, for example, to compensate for fluctuations on the capital market.

Separation of the investments

Furthermore, for the implementation of the pure defined-contribution scheme there is a comprehensive special supervisory policy in place which must be observed in addition to the other provisions of supervisory law. For example, the sponsoring body must establish separate investment holdings within the guarantee assets (Sicherungsvermögen) for the pure defined-contribution scheme's investments. This ensures that the scheme's investments are separate from all other investments of the sponsoring body and that they – together with the yields generated – only benefit the employees who are participating in the pure defined-contribution scheme.

For all sponsoring bodies which implement the defined-contribution scheme, there is a standard catalogue of permissible forms of investments as well as rules on the diversification of the investments.

Calculating the pension

The sponsoring bodies of the pure defined-contribution scheme must commit to a pension that the beneficiary will receive until their death but which is not guaranteed in terms of its amount. There are provisions in place with regard to how the pension amount is calculated and is to be adapted later on. This helps to avoid arbitrary determinations to the disadvantage of the employee.

The initial pension to be paid out is determined on the basis of the pension capital accumulated at the sponsoring body for an employee during their working life. The pension is calculated taking the payment of interest into account. This interest corresponds at most to the expected return on the investments but can also be chosen more cautiously, in other words reduced by a haircut. Through the haircut, another safety cushion is created for the pension beneficiary. The haircut may only be so high that a funding ratio of at most 125 per cent results. The funding ratio is defined as the ratio of the fair value of the assets attributed to the pension beneficiary to the present value of the pension, which is calculated on the basis of the expected return on the investments, excluding any haircut. In the case of a funding ratio of more than 125 per cent, the pensions must be adjusted upwards; in the case of a funding ratio of less than 100 per cent, the pensions must be adjusted downwards.

In addition to the safety cushion for the pension beneficiaries, a further safety buffer can be formed during the accumulation period by not allocating all contributions and the resulting yields to the individual employees but instead to the employees as a group. This safety buffer can, for example, serve to smooth the individual pension capital of the employees if the capital markets fluctuate strongly.

Risk management

The sponsoring body must, as part of its risk management, take account of the collective and other agreements upon which the pure defined-contribution scheme is based. This applies in particular to the procedures in place for measuring, monitoring, managing and limiting the volatility of the pensions.

The risk management must be consistent with the information which the sponsoring body makes available to the future and current beneficiaries as well as to the parties to the collective agreement. In its risk reports, the sponsoring body must deal separately with the pure defined-contribution scheme.

Information obligations

In addition, there are special information obligations towards BaFin as well as towards the members and beneficiaries. The sponsoring bodies must, for example, submit the underlying collective and other agreements to BaFin as well as inform BaFin regularly on the state of the funding ratio.

Amongst other things, the members and beneficiaries must be informed regularly on the amount of the benefits they are scheduled to receive and reminded that this amount is not guaranteed. This also includes, for example, information on the amount of the total contributions paid in as well as the returns achieved on the investments.

Role of BaFin

Since there are no guaranteed benefits in the pure defined-contribution scheme and fluctuations to the benefits amounts are therefore intrinsic to the scheme, BaFin has a different role here to that which it has in the prudential supervision of sponsoring bodies which guarantee benefits: namely, it monitors the sponsoring bodies to ensure that they comply with all agreements in place with the parties to the collective agreement as well as with the requirements under supervisory law. If this is not the case, BaFin will intervene.