Financing and outsourcing of pension obligations
Pension obligations and the German company balance sheet
- Many German companies have made financial commitments to their employees within the scope of a company pension scheme. The most widely used method is the book reserve scheme, with corresponding pension provisions reported on the balance sheet. Support funds with fixed-sum endowments are also still widespread, however. “Unsecured” pension obligations have far-reaching repercussions for the balance sheet structure and harbour not inconsiderable risks.
- German taxation law takes a restrictive view as regards the recognition of pension provisions, since they reduce taxable profit. Risks stemming from longevity, salary developments and pension indexation are not adequately considered. In addition, the current prescribed discount rate of 6% p.a. in no way reflects a realistic market interest rate. As a result of the Accounting Law Reform Act (BilMoG), first applied to financial years starting in 2010, pension obligations receive a more market-consistent valuation under commercial law. This means that, with the application of a market-consistent interest rate, salary and pension increases are also taken into account.
- With a changeover to international financial reporting (IFRS/US-GAAP), an increase in pension provisions of approx. 20% to 25% is to be expected, due to underlying methodologies and valuation bases consistent with markets and real-world conditions.
- Yet even international financial reporting methods still underestimate the fair value (market value) of pension provisions, a figure representing the total costs and risks. The fair value can in fact be up to 40% higher if costs such as risk premiums (e.g. longevity), German Pension Insurance Association (PSVaG) contributions or administrative and asset management costs are taken into account.
Solutions, pension obligations and the German company balance sheet
- Closely mirroring existing international financial reporting standards, the new balance sheet regulations on offsetting pension provisions and “plan assets” introduced by BilMoG offer companies new solution options for reducing (what are generally higher) pension provisions. The preconditions specified by BilMoG for these kind of offsettable plan assets are their status in terms of proof against insolvency and exclusivity of purpose. Plan assets may therefore not include assets required for business operations (e.g. property used by the company). In contrast to IFRS, BilMoG does not require the transfer of plan assets to an independent legal entity. In summary, BilMoG enables balance sheet effects to be achieved merely by pledging a securities account or a reinsurance policy for the purposes of reinsuring plans for shareholding managing directors. For larger groupings, the trustee solutions (CTA, contractual trust arrangements) familiar from international accounting form an especially suitable approach to pension obligation funding that is needs-based, has low impact on liquidity and can be handled as a balance sheet item.
- Considered against this background, the outfinancing of pension obligations means companies find themselves facing a highly diverse set of issues and challenges from markedly different subject areas: What pension risks do I face – and how should I handle them? Could asset solutions reduce my risk or would it be preferable to employ a risk transfer utilising insurance solutions? And what is the rate of liquidity outflow for each of my solution options?
- Pension risk analysis: TPC offers a comprehensive, company-specific analysis and forecast of longevity risk, plus an assessment of the period of obligation and volatility as regards pension obligations. We utilise actuarial tables for death, invalidity, etc. (inter alia the Heubeck tables) to make annual calculations as to whether or not pension payouts must be made and what sums these involve. Depending on the number of simulation paths follows, this produces a range of scenarios and associated payment flows. The next step is then to simulate the various outfinancing variants and their repercussions for P&L, liquidity and the company balance sheet.
Finally, we then provide comprehensive support for the implementation of the most efficient solution for your business.