Does the low interest rate require the formation of provisions for pension obligations via pension funds and reinsured support funds?
By Stefan Bäumler (Deal Advisory, Pensions | KPMG AG Wirtschaftsprüfungsgesellschaft)
Direct insurance, pension funds and reinsured support funds are frequently used to implement company pension plans. Your advantage: As a rule, neither the local (HGB) nor the international (IFRS) balance sheet shows provisions for pension obligations. But is this approach still justifiable and correct against the backdrop of the ongoing low-interest phase?
Local balance sheet (HGB)
The German Commercial Code distinguishes between direct and indirect pension commitments. In the case of indirect pension commitments, the pension obligation is not fulfilled by the employer directly, but with the involvement of an external third party. This also applies in particular to the insurance-based implementation channels of direct insurance and the pension fund as well as the provident fund. Due to the general option to recognize liabilities in Article 28 para. 1 sentence 2 EGHGB, a provision need not be recognized for an indirect obligation in any case. An indirect obligation still exists even if the pension plan’s assets are no longer sufficient to cover the pension obligations. Even if the employer has to assume liability within the scope of its subsidiary liability, for example following the specific failure of payments by the pension fund to the beneficiaries, the obligation initially remains indirect. It is not mandatory to recognize a balance sheet item in accordance with the provisions of the German Commercial Code until the pension provider changes its rules with the employer and permanently reduces its benefits or permanently ceases to provide benefits. Only in this case does a direct obligation arise for the employer.
International Balance Sheet (IFRS)
The situation is different under international accounting standards. IFRS distinguishes between defined contribution plans and defined benefit plans, irrespective of the implementation method. Plans in which the employer pays fixed contributions to a separate entity and has no legal or constructive obligation to pay amounts in excess of this are classified as defined contribution plans. All other plans are categorized as defined benefit plans. While no balance sheet disclosure is required for defined contribution plans, a net liability resulting from the difference between the pension obligation and plan assets must be disclosed in the balance sheet for defined benefit plans.
All German supply arrangements to date have included (minimum) performance guarantees. Due to the subsidiary liability, the employer is liable if the promised (minimum) benefits cannot be paid by the external provider due to its financial situation. Before the low-interest phase manifested itself, there were no signs that external providers might run into such difficulties. As a result, it was common practice not to show provisions in the company balance sheets for pension plans structured via competitor pension funds or reinsured provident funds.
Against the background of the persistently low level of interest rates, however, the question arises as to whether this subsidiary liability is really still of a theoretical nature. For example, in the case of reinsured provident funds, the regular pension adjustment to which employees are entitled under Section 16 of the German Company Pension Act (BetrAVG) is often not guaranteed by the reinsurance policy. In the past, the surplus participation was generally sufficient to cover the pension adjustments due. However, the extent to which sufficient surpluses can still be generated in the future in the face of continuing low interest rates needs to be examined. The situation is similar for some pension funds, some of which have included high interest rate guarantees in their (older) tariffs. Initial benefit cuts have already taken place at individual providers. For example, pension funds no longer granted pension adjustments or permanently waived the provision of disability benefits.
If it can no longer be classified as highly unlikely that the pension plan in question will lead to payment obligations on the part of the employer that exceed the payment of contributions, the plan is to be regarded as defined benefit in the future. In principle, a change in accounting treatment from defined contribution to defined benefit can be made through equity without affecting profit or loss.
The rationale for this approach is that in the past, the employer’s claim – e.g., the employer’s liability – was not covered. The probability of utilization for pension adjustments not guaranteed by the reinsurance policy – was classified as highly unlikely (cf. IDW RS HFA 50 module IAS 19 – M1), but the probability of utilization must now be reassessed taking into account the current situation. This resets one of the actuarial assumptions made. Losses arising from such remeasurement are recognized as actuarial losses in other comprehensive income (OCI) without affecting profit or loss.
Conclusion: As long as the pension fund or the reinsured support fund cannot in principle avoid the fulfillment of the benefits, a provision for these indirectly implemented pension plans need not be shown under HGB in any case. This applies in particular if the employer has the option of preventing a reduction in the benefits paid by the pension fund by paying additional contributions. Under IFRS, there are considerations as to how an accounting changeover of such plans from defined contribution to defined benefit can take place, but it is not clear when such a changeover is to take place. In principle, the probability of the employer making a claim must always be assessed in the specific individual case. Another interesting question is whether benefit cuts that have already been implemented will make further cuts in the future more likely or, on the contrary, less likely.
