A look at Germany’s new ‘pure’ DC plans

On Jan. 1, 2018, Germany introduced pension legislation aimed at strengthening workplace pensions by creating a system of collective defined contribution plans. And yet, a year later, not a single plan has been introduced based on the reforms.

Speaking at an event in Frankfurt in November 2018, a board member from IG Metall, Germany’s largest union (with two million members), said the issue is on the agenda for its annual meeting later in 2019. Indeed, industry representatives don’t anticipate seeing any follow-through on the reforms before 2020 or 2021 at the earliest, according to Peter Koenig, managing partner at Delta Management Consulting in Wiesbaden, Germany.

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“It is anything but clear how the new pension deal should look in practice,” he says, noting the reputational risk for first-movers is considered very high.

The main reason for the delay is that employers are required to collectively bargain before introducing the new plan, says Norbert Pieper, spokesperson for Bafin, Germany’s federal financial supervisory authority. “We need the social partners, those parties that have a collective agreement between the employer and the employees, to participate in the implementation and the management of defined contribution, which means defined contribution ought to be part of a collective agreement between the social partners, and this has proved rather difficult.”

However, Pieper says Bafin has had several conversations with interested parties, as well as with potential pension providers. “So there is seemingly interest to provide defined contribution, but due to the challenges, we’ve not had social partners implement a concept of defined contribution and have not offered any contracts based on defined contribution.”

Why reform?

A defined benefit pension system has existed in Germany for some 150 years, says Koenig, noting the nature of that pension deal was very clear. “Employees defer part of their compensation to their life as pensioners, employers provide security in the form of [minimum] return guarantees for those contributions and the government allows for tax deferrals and supervises the guarantee provisions.”

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But with the future of DB plans uncertain around the globe, Germany began mulling over the idea of new pension legislation aimed at strengthening retirement security. “The idea was the low interest rate environment wouldn’t allow for further expansion of coverage in [Germany’s] traditional DB system, since the provision of guarantees has become very costly,” says Koenig, referring to the fact that several DB pensions fell below the 100 per cent solvency ratios required by law in 2018.

“The expectation was that the removal of the guarantee burden from plan sponsors would lead to an increase of [coverage], in particular from small and mid-sized company sponsors . . . where pension coverage is traditionally rather low,” he adds.

Germany’s new pension promise

According to the German association for occupational pensions, the country’s pension promise can now be separated into four categories:

Traditional defined benefit

Contribution-oriented DB with an annual minimum return guarantee

Contribution-oriented with a minimum guarantee of the sum of nominal contributions at retirement

‘Pure’ DC
Defined contribution with no guarantees, embedded in an agreement between social partners

The challenges, benefits of ‘pure’ DC

The new DC plans are facing two major hurdles, according to Pieper. “On the one hand, social partners must participate in the implementation and the management of defined contribution, especially as far as the investment policy is concerned. And it’s a political issue because of the occupational tension and, in this case, defined contribution [isn’t] usually part of any kind of negotiations between the social partners.”

Indeed, while the plans can only be introduced through collective agreements, unions have yet to realize how workplace pensions could be built up without guarantees while remaining safe and attractive to plan members, says Klaus Stiefermann, secretary general of the German association for occupational pensions. “In this respect, a certain learning process is still needed, which must then also be imparted to the employees. This is not easy and takes time.”

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Like the rest of the world, German employees highly value the guarantees of DB pension plans, says Heinke Conrads, head of retirement for Germany and Austria at Willis Towers Watson. “Their elimination under the pure DC regime will require more and better communication.”

And when it comes to negotiating collective agreements, unions may have other priorities, says Pieper, such as working hours or pay. “So the occupational pension might be an issue that’s not as important as payments [right now].”

Another possible explanation for the delay is that the new legislation covers a number of other issues, including changes to taxation and social insurance, says Koenig, though he notes the industry is busy implementing these.

The changes to social insurance means there are now subsidies for low-income workers saving into a company pension plan, says Stiefermann. “They receive a 30 per cent subsidy to finance company pensions. Company pensions are no longer fully eligible for social assistance in old age, which means company pensions are also worthwhile for low-income earners.”

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Another major benefit of the reform, according to Pieper, is there are no set interest rates. “The company that provides defined contribution [plans] is very much free in its investment policy,” he says. “So it has at least the option to potentially generate higher investment incomes. And this is, I think, the major benefit for policyholders.”

The trend away from DB plans will continue to gain momentum, says Stiefermann, and in many cases, will inevitably clear the way for DC plans. “This will be seen as negative by parts of the workforce. In the end, however, the alternative in many cases would be no pension commitments at all. Certainly, the trend towards concentration already evident in recent years will continue.”

Canadian perspective

To translate the concept of Germany’s new DC plans into the Canadian pension landscape, they’d be described as target-benefit arrangements, according to Greg Hurst, a pension consultant based in British Columbia. “It’s not mandatory, and uptake is muted by the requirement that employers must collectively bargain as a pre-requisite to participation. It is my understanding that benefits will be paid in a manner described as a defined ambition approach that allows for variations in benefit levels depending on investment.”

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The design and administration will also be similar to target-benefit plans in a multi-employer context, he adds. “Under this design, the plans are DC from an employer perspective but DB — with potential for adjustment based on actuarial experience — from a plan member perspective.”

This is attractive for employers, says Hurst, because they aren’t “exposed to funding risk or fiduciary obligations for plan administration.”

The biggest barrier to the new regime is the collective bargaining requirement, he notes. “It seems unlikely that employers not otherwise participating in or contemplating collective bargaining would have interest in participating.”

Alethea Spiridon is managing editor of Benefits Canada.