31.03.2020 | KPMG Law Insights

Company pension plans – Effects of the Corona crisis on pension obligations

Effects of the Corona crisis on pension obligations

The outbreak of the coronavirus has led to sharp falls in financial markets worldwide. The leading stock indices in the USA and Europe plummeted by more than 30%. There were also significant price falls on the bond markets. Employers must register short-time work. Economists expect a global recession. In this Client Alert, we would like to explain the main implications that the global Corona crisis may have for pension obligations under company pension plans, and also point out possible ways of reducing pension burdens under labor law.

1. significant influences on the occupational pension system
The world of work and business is significantly affected by the Corona crisis. This also applies to the companies’ pension obligations. Currently, this mainly relates to the decrease in the scope of obligations resulting from the increase in the actuarial interest rate. On the other hand, the slump in the stock markets is causing existing plan assets to shrink. How lasting these current effects will be ultimately depends on the temporal scope of the current shutdown. What long-term effects the Corona crisis will have on occupational pension schemes can only be speculated at present.

2. actuarial interest rate
The most significant factor influencing the gross pension obligation is the discount rate. According to the requirements of IAS 19, this is to be determined on the basis of yields on high-quality corporate bonds whose maturity and currency match the pension obligations. Yields on these fixed-rate corporate bonds have risen by around 70 basis points as a result of the Corona crisis. This was due to the price declines on the bond markets. Investors probably currently fear higher default risks even for good-quality corporate bonds. This rise in interest rates will lead to a significant decrease in pension obligations. Depending on the age structure of the pension beneficiaries, the decrease in the extent of the obligation can be up to 20%. However, it remains to be seen whether the interest rate increases will be sustainable. As in the times of the financial crisis, the ECB is trying with all its might to keep interest rates low and is once again expanding its bond-buying program.
Another threat to the actuarial interest rate comes from the rating agencies. If they also come to the conclusion that the default risks of companies previously rated good quality have increased due to the economic impact of the Corona outbreak, there could be downgrades in the corporate ratings. This is likely to lead to declines in interest rates under IAS19, as the returns of the graded companies can then no longer be used to determine interest rates. It therefore remains to be feared that the interest-related relief for corporate balance sheets is likely to be rather short-term. Yields on AA-rated bonds are currently extremely volatile and as of March 23, 2020, they have already fallen again somewhat. It remains to be seen how yields will change over the coming weeks. Under HGB, the discount rate is determined over a 10-year period. Short-term turbulence has only a marginal impact here.

3. plan assets
The declines on the global stock markets are also likely to have hit the numerous assets that have been segregated to fund the bAV. In the past, for example, numerous companies have begun transferring assets to a contractual trust arrangement (CTA) and using them to cover and fund pension obligations. CTAs currently manage assets worth almost EUR 300 billion for DAX 30 companies alone. These plan assets are recognized at fair value under both HGB and IAS19. Thus, even temporary volatilities are reflected in companies’ balance sheets. Whereas IFRS only requires these fluctuations to be recognized directly in equity, HGB even requires them to be recognized in the income statement. The extent to which plan assets are reduced also depends on the assets of which the plan is composed and the respective equity ratio.

4. mortality table
Due to the spread of the coronavirus, deaths are unfortunately to be expected. However, the mortality tables used to date should continue to be applied unchanged in the measurement of pension obligations. Extensive source material was collected to derive the mortality tables with the aim of reflecting long-term trends in mortality development in the mortality tables. Short-term, temporary events should have no influence on this.

5. contributions to insolvency insurance
The Pensionssicherungsverein (PSVaG) is the body responsible for statutory insolvency insurance for occupational pension schemes in Germany. In the event of a company’s insolvency, it takes over the provision of benefits for the beneficiaries protected by the insolvency proceedings. To finance it, the PSVaG sets a contribution rate each year. This contribution rate reflects the claims expenditure, i.e. the insolvencies of the respective calendar year. If there are increased bankruptcies due to the economic impact of the coronavirus, this could lead to an increase in the contribution rate for 2020. Currently, the contribution rate for 2019 is 3.1 per mille. In 2009, i.e. during the financial crisis, it amounted to 14.2 per thousand.

6. obligation of the companies to pay
Occupational pension plans are often no longer implemented directly by the employer by way of a direct commitment, but indirectly by (external) pension providers (direct insurance companies, pension funds, support funds and pension funds). Nevertheless, the employer is always liable within the scope of the statutory subsidiary liability. Some providers were already in financial distress before the Corona crisis due to the prolonged period of low interest rates. For example, the first reinsured provident funds were no longer able to finance regular pension adjustments in accordance with Section 16 of the German Company Pension Act (BetrAVG) from current surpluses. The situation was similar for some pension funds, some of which were no longer able to maintain high interest rate guarantees in their tariffs and even had to cut benefits.
If the funding situation of the pension providers were to deteriorate again in the long term as a result of the slump on the financial markets, further employer obligations to make contributions could become more likely and there is a risk of charges for additional contributions or additional contribution payments to the provider or the recognition of additional provisions in the company’s balance sheet if benefit differences have to be paid directly in the future.

7. labor law structuring means
Although it is essential for companies to maintain their liquidity in this crisis and, in particular, to reduce fixed costs such as personnel expenses, employer-funded pension contributions must (continue to) be made in accordance with the pension commitment, irrespective of the Corona crisis and any short-time working. In each individual case, it must be examined whether and to what extent the payment of short-time allowance affects the amount of the contribution. In the event of a deterioration in the economic situation, a modification of the commitment may be justified in accordance with the principles of labor law regarding the protection of legitimate expectations and the proportionality of the intervention.
In the context of employee-financed pension provision by means of deferred compensation, the employee can generally reduce or suspend his or her contributions if he or she adjusts the deferred compensation agreement accordingly and observes any existing deadlines. In this case, the employer’s mandatory or voluntary subsidies are also reduced or suspended. However, premium waivers or reductions also reduce benefits. In order to maintain the pension level as far as possible, a partial payment or a possible deferral of the contributions can be considered after agreement with the pension provider.

8. conclusion
It is difficult to predict today how lasting the effects of the Corona crisis on occupational pension schemes will be, and it will probably depend to a large extent on how long the pandemic and shutdown last. Hectic actionism is not advisable; especially in the area of companies’ longest-lived obligations – pension obligations – further developments should be monitored and a cost-saving concept tailored to the specific pension system should be developed. If the risk-bearing capacity of the occupational pension system has not been examined for some time, the current situation is a reason to do so.
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