Germany: Out of the rain

Kristen Paech explains why Germany has come through the rough times and is now attracting a lot of attention from those looking for pensions business

The pension liabilities of German companies listed on the domestic stock exchange DAX declined for the first time in five years to €246bn in 2006, while pension assets grew by 15%. In addition, the average level of external funding of pension liabilities in these companies rose from 56% in 2005 to 65%, a growth rate that would see the DAX companies fully funded by 2010 if it were to continue.

Although this level of funding is un-likely to persist – and more recent market turmoil has of course made the future even more uncertain – these statistics from Towers Perrin are indicative of the step-change that’s occurring in the German occupational pensions market.

Companies are becoming more professional in the way in which they manage their pension obligations, including a stronger focus on risk management, and are increasingly willing to look outside the domestic market in a bid to boost returns.
Recent years have also seen a transition away from on-balance-sheet towards off-balance-sheet funding via plan assets as well as the restructuring of schemes from DB to DC style approaches.

Companies have been transferring book reserved pension liabilities to financing vehicles such as pensionsfonds and pensionskassen or setting up Contractual Trust Arrangements (CTAs) to earmark assets for their internally financed pension schemes. CTAs are recognised as pension funds under international (IAS) and US (FAS) accounting standards, but remain on-balance-sheet liabilities under German accounting standards (HGB). Volkswagen, E.ON, BASF, Bertelsmann and Lufthansa have all set up CTAs in the last five years, mainly for financial reporting purposes.

The move has sparked a rise in pension assets which is catching the eye of foreign asset managers and consultants alike. “The value of unfunded pension obligations which so far do not have designated pension assets to cover them amount to almost €200bn in obligations from direct pension promises and they are still growing,” explains Detlef Mann, manager, pension solutions at HSBC Investments Deutschland.

“We are expecting a large market with growth potential over the next few years and want to get our share.”
Hartmut Leser, head of business development, Germany, at Aberdeen Asset Management adds: “Germany still relies a lot on the pay-as-you-go public pension system, which is broke, so we are being forced to build up an asset-based pension system going forward. “This means there is likely to be more asset growth in our country than for example the UK where the pension system is already well funded.”

As a result, the consulting market in Germany has changed dramatically in the last ten years with global consultants such as Watson Wyatt and Mercer joining established local players like FERI and RMC.

Olaf John, head of distribution, Germany and Austria at Lehman Brothers Asset Management, says the consulting market has thus become competitive and influential. “In the past the challenge was to convince clients to pay for independent investment advice, which most investors still obtained from their ‘house bank’,” he says.

“The challenge today for the consultant is competition, with some 20 investment consulting firms active in the market.”
Global asset managers are also showing strong interest in Germany, in part due to the relaxation of regulations which previously required managers operating in the country to have a fully fledged asset management firm known
as a KAG registered locally. Heiko Dahse, investment director, European business development at Standard Life Investments says the introduction of the master KAG has opened up the market.

“Rather than setting up their own KAG in Germany which costs a lot of money and requires €3-5bn in order to make it worthwhile, foreign asset managers can now use existing KAGs for the administration of plan assets,” he says. “That’s been a big sea change and makes the life of foreign asset managers wanting to move into Germany much easier.”

However barriers remain, especially for alternative managers wanting to capitalise on the growing institutional asset base.

Pensionskassen, which are employer provided pension insurance funds, are subject to strict investment guidelines regulated and supervised by the Financial Services Authority, known as Bundesanstalt für Finanzdienstleistungs-Aufsicht (BaFin). Under the insurance regulations, hedge fund investment is capped at 5% and pensionskassen cannot invest in assets such as commodities unless they invest through indices or classify the investment as a hedge fund. This could be set to change though, with imminent new investment guidelines , Anlageverord-nung 2007, expected to expand the limits on hedge funds and asset backed securities and include REITs.

Scheme innovation
With most of the DAX companies having set up a CTA, a number of mid-cap companies are following suit. According to Stefan Oecking, worldwide partner and consulting practice leader, Mercer Human Resource Consulting, some
€80- €100bn of the €230bn in direct pension promise liabilities are currently funded via CTA vehicles.

The advantage they have over other funding vehicles is their flexibility – they are not subject to investment restrictions by supervision as pensionskassen, for example, and thus companies are able to allocate across the entire investment universe.

However Oecking believes the balance is shifting: “The CTA is more liberal from the company’s perspective. It does not have as much regulation and has no supervision so a lot of companies tended to prefer the CTA as a funding vehicle.
“But we see a clear trend in the market to use the tax advantage of contributions paid into a pensionsfonds so I would expect that an increasing volume of plan assets will be collected within pension funds. Bosch, Telekom and, more recently, Siemens and RWE are prominent representatives of this trend.”

CTAs are still considered unfunded schemes under German law and as with all direct pension promises in Germany are subject to a compulsory insolvency insurance paid to the Pension Insurance Association (Pensions-Sicherungs-Verein – PSV).

The shift from a direct pension promise to pensionsfonds, on the other hand, has been tax incentivised, so while the pensionsfonds must contribute to the PSV, they pay only one fifth of the amount.

Thomas Jasper, principal and member of the German management team, Towers Perrin, says some companies are seeking the best of both worlds. “Companies are now creating a pensionsfonds inside the CTA to combine the flexibility of the CTA, which is not regulated, with the advantages of the pensionsfonds, especially with respect to financing the obligations to retirees,” he says.

“As it is more complicated from a labour law perspective to transfer liabilities with respect to active scheme members, companies are transferring the liabilities of retirees to pensionsfonds while the obligations of their active staff remain in the CTA.”

Mann at HSBC Investments Deutschland says the attractiveness of this route depends on the size of the company as well as the proportion of active and retired pension scheme members. For a large company, the savings on
PSV contributions might counter the initial costs of transferring members to the pensionsfonds, whereas for a small company this is often not the case. “We will face the same situation as with the CTA trend,” Mann comments. “First the large DAX companies will make a move and later on the second tier, mid-cap companies may follow.”

However Susanne Jungblut, leader of the benefits practice at Watson Wyatt in Munich, adds: “It may be that more companies will follow but at the moment it’s only the DAX companies, and I would not say it’s a general trend in the market.”

Written by Kristen Paech, a freelance journalist