Pension funds under pressure

Many German pension funds (Pensionskasse) are currently under pressure. Last year, the German Federal Financial Supervisory Authority (Bundesaufsicht für Finanzdienstleistungen - BaFin) reported that it had 36 pension funds under more intense supervision. As recently as mid-January, BaFin revoked the licences to operate insurance businesses of Kölner Pensionskasse VVaG and Caritas Pensionskasse VVaG, both of which are now in liquidation. Other pension funds were compelled to adjust benefit plans and reduce guaranteed interest rates, most recently Pensionskasse für die Deutsche Wirtschaft (PKDW), which had already reduced its benefits in the past. And there is no end in sight for the interest slump. Not only pension funds but also employers may be forced into action.

Options for pension funds under pressure

Several options are available to pension funds to meet their current financial challenges and safeguard their long-term ability to fulfil their obligations as insurers.

• Changing insurance conditions in conformity with articles of association: Stock corporations have options to improve their financial situation, including capital increases, but this option is not available to pension funds established as mutual insurance associations (Versicherungsverein auf Gegenseitigkeit - VVaG). However, since the lack of an external financing option necessitates internal financing by the members, section197 German Insurance Supervision Act (Versicherungsaufsichtsgesetz - VAG) permits pension funds with the legal form of a VVaG to change their general conditions of insurance, even for existing insurance policies. But a critical prerequisite for this option is that it is permitted by a valid provision of the articles of association. According to section 197(1) in conjunction with section 195(1) VAG, general conditions of insurance can be changed in compliance with the articles of association by a resolution of the members’ meeting. All aspects of a members’ meeting resolution and changes to insurance conditions are subject to judicial review, even if BaFin or an independent trustee has issued a declaration of clearance. This makes it highly advisable to precisely and carefully prepare, vet and implement any changes to conditions of insurance.
  
  
• Reducing benefits in conformity with articles of association: According to section 179 VAG, a pension fund’s articles of association must govern not only the contribution system but also whether subsequent contributions are permissible or precluded. If subsequent contributions are precluded, the articles of association must establish whether it is permissible to reduce benefit entitlements. On the basis of this “restructuring clause”, a pension fund can reduce benefits that become due by lowering its actuarial reserve. In addition to such self-imposed restructuring, under section 314(2) VAG BaFin may order benefit reductions in order to avoid insolvency proceedings if a company will no longer be in a position to fulfil its long-term obligations as an insurer.
  
  
• Changes in conditions and contributions according to sections 163, 164 VVG: If there is no corresponding (valid) provision in the articles of association or if business with non-members is concerned, changes regarding existing business are only permissible within the special boundaries found in sections 163, 164 German Insurance Policy Act (Versicherungsvertragsgesetz – VVG). Such changes must be decided by the management board. Changing premium amounts or reducing benefits also requires the permission of BaFin or the consent of the independent trustee under section 163 VVG. Regardless of any BaFin permission or trustee’s consent, such changes to the insurance policy are also subject in their entirety to judicial review by civil courts.
  
  
• Collecting one-off fees/subsequent contributions and transferring portfolios: However, a pension fund’s options are not limited to premium increases or benefit reductions. The fund may also be able to
  
  
• collect a one-off fee or require additional contributions or even
• transfer its portfolio to a more solvent pension fund (e.g. for a smaller portfolio to leverage synergies).

Restructuring parts of the portfolio is planned as a future option. The German Federal Ministry of Finance (Bundesfinanzministerium) has discussed a draft bill to supplement section 233 VAG. According to the Ministry’s plans, a pension fund’s articles of association will be permitted to provide that benefit reductions can only affect entitlements that are not subsequently financed by means of subsequent contributions.

Conclusion: To avoid premium increases and benefit reductions, pension funds should look into alternative options to strengthen their portfolio well in advance. One possibility would be a portfolio transfer. But pension funds should also be prepared for a worst-case scenario because that is when valid provisions in their articles of association and general conditions of insurance are absolutely essential.

Impact on beneficiaries and liability for employers

Changes to benefit plans or premiums not only affect beneficiaries in the sense of fewer benefits or higher costs for the same benefits but also constitute a liability risk for employers.

According to section 1(1), third sentence German Company Pensions Act (Betriebsrentengesetz – BetrAVG), even an employer that does not directly implement a company pension plan is accountable for the benefits it promises. In other words, an employer owes its employees the originally promised benefits even if it does not itself manage the company pension plan but rather uses an external company such as a pension fund. This applies even if the employer has always made the premium payments in full and on time and even if the pension plan is financed solely by employees by way of salary conversion.

When an employer has issued a premium-linked defined benefit that is common in practice, the benefit level that the employer owes includes the guaranteed interest rate originally designated by the pension fund. This means that changes to the benefit plan, e.g. a reduction in the guaranteed interest rate by the pension fund, have no immediate effect on the employer’s benefit commitment. In the opinion of the German Federal Labour Court (Bundesarbeitsgericht) the provisions of the pension fund’s articles of association, including any provision to change the benefit plan, does not penetrate to the basic employment relationship.

However, if an employer wishes to reduce the benefits to bring them in line with the pension fund’s reduced benefits, it must independently justify such an encroachment on the defined benefits. The employer will be compelled to ascertain how it can legally adjust its defined benefits at all. The critical factors are

• the legal foundation upon which the pension commitment was issued (individual commitment, company agreement, collective bargaining agreement, etc.)
• compliance with the requirements for grounds justifying such encroachment that the Federal Labour Court has developed in the form of its “three-stage theory”.

Conclusion: Employers whose company pension plan is conducted via a pension fund should examine the pension fund’s financial situation and the form of the pension commitment (pension commitment linked to premiums, premium commitment with minimum benefits) in order to be able to react in time to any changes in the pension fund’s benefit plan. If the pension fund has already changed its benefit plan or announced its intention to do so, the employer should check whether it is itself entitled to make a corresponding reduction in its employees’ benefits in order to bring them in line with the pension fund’s benefits. For this, the employer needs justifying reasons. As an alternative, the employer can examine whether a change in the pension systems, e.g. by using an alternative means of implementation, is possible.

Employers can only avoid the risk of subsidiary liability under section 1(1), third sentence Company Pensions Act in the context of a pure premium commitment in a “social partner model” which companies use in cooperation with unions. Outside the social partner model, subsidiary liability cannot be precluded, but employers can preventively minimise such risks by selecting advantageous benefits, means of implementation and wording of pension commitments.