Client Alert on occupational pension provision II

Adjustment test for current company pensions in times of inflation

The current economic trend of stagflation in Germany is taking its toll on citizens and companies alike. While the initial focus is naturally on burning issues relating to the necessary readjustments for the purpose of maintaining business operations, the most long-term and usually most costly obligations of companies, pension obligations, must not be overlooked. The essential management of the implementation of pension commitments includes, in particular, the review of any necessary adjustment of current pension benefits in line with economic developments. § Section 16 of the German Company Pensions Act (BetrAVG) requires pensions to be reviewed every three years. What are the considerations for this in your company? Posters asked, “Do you just adjust or do you already check?” We encourage you to do the latter and have compiled the essential basics on the 16 exam in our Client Alert to help you. We would like to draw your attention to essential requirements and possible scope for discretion in favor of a legally secure and balanced adjustment audit, which is likely to be carried out even more intensively than before for all companies in the future.

1. starting point: § 16 BetrAVG
§ 16 para. 1 and 2 of the German Occupational Pensions Act (BetrAVG) regulate the employer’s obligation to review the necessity and possibility of adjusting current occupational pension benefits. The duty to examine does not per se result in an obligation to make a positive adjustment decision. This is decided by weighing the interests of the employer in a suspension, in particular due to its economic situation, and the pension recipient in an increase. The purpose of the standard is the appropriate distribution of the risk of monetary depreciation of company pensions due to the rising cost of living.

2. subject of the adjustment
In the absence of a special agreement on dynamization, pension entitlements are not yet subject to adjustment, but only current pension benefits. These are company retirement, disability or surviving dependents’ pensions promised to an employee on the occasion of his or her employment. Ongoing benefits are regularly recurring payments, regardless of the payment period (month, quarter, year, etc.) as well as the duration of the benefit, provided it serves the purpose of the supply. Installment payments are therefore also covered, but not lump-sum payments, with which the obligation is met by means of a one-time payment and the further investment and safeguarding is then the responsibility of the pension beneficiary. The employer liable for the adjustment is always the employer liable for the pension, not an external pension provider in the case of indirect implementation paths. The obligation to pay for the services of the external pension provider under Sec. 1 para. 1 sentence 3 BetrAVG also includes the full adjustment (subsidiary liability).

3. test time optimized?
The examination shall be conducted in accordance with the mandatory minimum requirement in § 16 para. 1 BetrAVG to be held every 3 years. The period begins when the current benefits are first claimed. For reasons of practicability, the employer is not required to adhere to rigid individual examination dates. It may combine the adjustment tests due in one year and perform them at a specific time within one year (bundling of the test date). In this case, the period until the first test may be shortened as desired, but extended by a maximum of 6 months. The test for initial adjustment must take place after 3 years and 6 months at the latest. Thereafter, the usual cycle of 3 years applies. The review period covers the entire period from the start of the pension to the adjustment date. The full inflation since the start of the pension must be taken into account if this has not already been offset by previous adjustments.

4. matching adjustment set?
According to the case law of the German Federal Labor Court (BAG), the interests of company pensioners are considered to be taken into account if the loss of purchasing power suffered by the company pensioner in the period between the individual pension commencement date and the review date is compensated. Thus, a past-related assessment is made. The extent of the increase can be measured with legal certainty for company pensioners with a first pension claim after December 31, 2002 according to the consumer price index (CPI) determined by the Federal Statistical Office, § 16 para. 2 No. 1 BetrAVG. The CPI of the month preceding the pension commencement date or the review date shall always be decisive.
Alternatively, the employer may limit the compensation for the loss of purchasing power to the real wage development of employees comparable to the individual company pensioner in the relevant review period, Section 16 para. 2 No. 2 BetrAVG. Net wage development presupposes a decided group formation and allocation and is therefore not legally secure outside of collective bargaining systems.
More favorable standards than the statutory (minimum) adjustment standard may also be agreed for the benefit of the beneficiaries. Apart from that, exceptions according to § 16 para. 3 BetrAVG only for new commitments for which an adjustment of 1% p.a. has been agreed and for defined contribution plans with minimum benefits. In the case of direct insurance policies and pension fund commitments, relief applies for the adjustment under the conditions set out in the current version of Section 16 (1) of the German Income Tax Act. 3 No. 2 BetrAVG.

5. crediting of previous adjustments?
If the employer has made adjustments in the past that have turned out to be higher than would result from the calculation of the applicable price index, these increases may be taken into account. At the time of the mandatory review, only the adjustment requirement that has occurred since the start of benefits is to be compensated, i.e. inflation over the entire period of pension payments. Insofar as this cost-of-living increase has already been compensated, the adjustment required following a subsequent audit may be correspondingly lower. As a result of extra-mandatory adjustments in the past, a pension increase level has then already been achieved that has so far exceeded the rate of inflation.

6. economic situation – scope for assessing the existence of a suspension situation?
In addition to the interests of the pension beneficiary, the employer may also take into account its own economic situation, Section 16 para. 1 Hs. 2 BetrAVG. In principle, the pension beneficiary has a claim to adjustment, which the employer can (only) reject or reduce in amount under the conditions specified in Section 16 of the German Occupational Pensions Act (BetrAVG). The term “economic situation” within the meaning of Section 16 of the German Occupational Pensions Act (BetrAVG) includes an indeterminate legal term that is subject to limited review by the courts. According to case law, an adjustment of current pensions should not be made if the additional costs resulting from the adjustment place an excessive burden on the Company.
An excessive burden is deemed to exist if, on the basis of a forecast on the reporting date, it can be assumed that it will probably not be possible for the employer to cover the cost-of-living adjustment in the future from the increase in value of the company and its earnings. The employer should not be expected to accept a long-term weakening of the company associated with an encroachment on its assets. The economic situation is assessed as a forward-looking factor for which past economic development can be used as an indicator, insofar as this allows conclusions to be drawn about future development. The backward view has to cover a (minimum) 3-year period. Exceptionally, it may be necessary to refer to a longer period if the subsequent development of the economic situation leads to justified doubts about the reasonableness of the employer’s forecast. Future developments may be taken into account if they have already become sufficiently concrete at the time of the audit; any unexpected changes may only be taken into account in the next adjustment audit. An appropriate return on equity consists of a basic interest rate (current yield on public bonds) plus a risk premium of 2 percentage points. The financial statements of the Company prepared in accordance with German commercial law are used as a basis, adjusted for business corrections. A substance preservation report provides binding information.

7. adjustment decision – scale and documentation legally sound?
The employer shall make the adjustment decision at its reasonable discretion. It is important to consider the interests of both sides without discretionary error and to bring them together in an appropriate balance and to properly record the adjustment decision made. According to § 16 para. 4 of the German Occupational Pensions Act (BetrAVG), this requires the pension recipients to be informed in writing and informed of the right of revocation and the revocation period. In the case of (partial) suspension, a substantiated explanation of the company’s inadequate economic situation is also required. Only in the case of a rightfully omitted adjustment, there is no obligation to make up for it. There is an irrebuttable presumption that the adjustment was rightly omitted if the company pensioner does not object in writing within 3 calendar months of receipt of the formally and materially correct notification. In contrast to the catch-up adjustment, the retrospective adjustment refers to the question of the retroactive increase of the company pension at an earlier adjustment date according to the economic situation at that time. If he is obliged to increase the company pension retroactively, the amounts of the increase accrued since the earlier reference date must be paid in arrears. With regard to the retrospective adjustment, the entitlement to review and decision expires after 3 years from the adjustment date only if the pension recipient was duly informed. If the pension recipient considers the decision to be incorrect, he or she must assert this before the next adjustment date.
Due to the longer reprimand periods in the event of improper fulfillment of the obligations under Section 16 para. 1 BetrAVG, care must be taken. The statutory limitation period for the pension master right is thirty years. The individual pension claim, which also includes the adjustment amount, is subject to the statute of limitations pursuant to Sec. 18a Sentence 2 in conjunction with Sec. 18a Sentence 3. § 195 BGB in 3 years to the end of the calendar year (§ 199 para. 1 no. 1 BGB). Since the statute of limitations does not begin to run until the claim arises, the statute of limitations does not run if payment of the increase amount is dependent on an express adjustment decision.

8. conclusion
It is worth taking the adjustment review of current pension benefits seriously and critically questioning the company’s previous practice of reviewing, documenting and communicating the decision to the beneficiaries in favor of a balanced and legally secure adjustment decision.
We will be happy to advise you individually and show you suggestions for finding a suitable solution for your company that is sustainable, legally secure and well justifiable in terms of personnel policy.

We will be happy to advise you individually and show you suggestions for finding a suitable solution for your company that is sustainable, legally secure and well justifiable in terms of personnel policy.

Contact at KPMG LAW: Christine Hansen (specialist in employment law, focus on company pension schemes)