Company pension scheme – Pensions Update | Issue 2/2015

A review of our bAV roadshow this year

Low interest rates: Challenges and opportunities for occupational pension systems

Interest rates have already been at a historically low level for several years. Despite short-term recoveries, the financial industry expects this low-interest phase to continue for a long time. In some cases, even negative interest rates are forecast for the medium term. Does this mean the end of the company pension scheme?

The low level of interest rates determines the discount rates to be used in the measurement of pension obligations under IFRS as well as under German GAAP. While this discount rate under IFRS directly reflects the current interest rate level, the discount rate under German GAAP reacts only with a time lag and in a weakened form – namely because it is calculated as an average of the market interest rates of the last seven years.

However, this averaging also means that the interest rate under HGB will fall over the next few years – and this even if the current interest rate level remains stable or rises. Even an extension of the averaging period currently under discussion (see the article on current legislation on page 17) will not fundamentally change this future development, but merely reduce the rate of decline.
The associated increase in pension obligations to be reported on the balance sheet places a considerable burden on companies – after all, they result in a declining equity ratio and, associated with this, a poorer credit rating as well as a lower dividend payout. In the worst case, even economically sound companies can become over-indebted.

So should companies say goodbye to company pensions?

At first glance, the current interest rate scenario may suggest this conclusion. Against the backdrop of demographic developments and the already emerging shortage of (qualified) workers, however, such a step should be carefully considered. The current political and social discussion of old-age pensions and rising old-age poverty underscores the importance of occupational pensions for employees. It is therefore not surprising that the company pension plan is one of the fringe benefits most valued by employees. It is therefore an important compensation instrument for employer attractiveness. The answer to the low-interest phase should therefore not be to abolish occupational pensions, but to restructure or refinance them.

Against this background, companies are increasingly asking about possible “countermeasures”. Based on our practical experience in various projects, we have presented a number of approaches in this year’s bAV Roadshow as well as their labor law and tax framework conditions As a conclusion, we can state: There is no “silver bullet,” but there are a number of possible measures that can be combined in a sensible way based on the individual company’s circumstances.

Reorganization of corporate pension systems: Strategic and Economic Considerations

Finding and retaining talented young people is one of the biggest challenges facing companies. In addition, demographic change is intensifying competition for qualified specialists and managers. It is therefore essential for companies to differentiate themselves from their competitors – not only, but also in the design of their compensation packages. In recent years, company pensions have become increasingly important as a key component of compensation. Against the backdrop of current challenges such as the current low-interest phase, but also increasing life expectancy as well as current legislation and legislative projects, the question of a modern, financially viable and at the same time attractive company pension scheme (bAV) for employees arises.

More than 70 percent of companies finance their occupational pension plans jointly by the company (through employer contributions) and employees (through deferred compensation). More than 70 percent of companies finance their occupational pension plans jointly by the company (through employer contributions) and employees (through deferred compensation).

Due to their low-risk design for the employer and their neutral presentation in the commercial balance sheet, securities-linked pension commitments are becoming increasingly popular among companies. They are characterized by flexibility, high transparency and manageable risks for the employer. At the same time, they offer the chance of an attractive return by exploiting the global capital markets.

What is challenging, however, is the transition of an existing care plan into a modern system. Modern pension programs are often offered only for future periods of service while preserving vested rights from legacy systems, or even only for new employees. However, both approaches mean that several supply systems have to be managed in parallel over a very long period of time. Alternatively, the acquired entitlements can be transferred to the new program via a type of single premium. However, this approach is significantly more complex in terms of labor law and requires greater communication effort.

Falling interest rates and rising pension provisions – mitigation through “outsourcing” of pension obligations

The discount rate used to measure pension obligations under the German Commercial Code is falling – and, ceteris paribus, pension provisions are rising. However, it is also true that the drastic decline in market interest rates – unlike the
to the fair value principle of IFRS – the personnel provisions under commercial law only with a delay. This at least creates time to implement appropriate courses of action to manage the upcoming additional balance sheet expenses in a timely manner.

Provisions under commercial law with a remaining term of more than one year are to be recognized in accordance with Section 253 (1) of the German Commercial Code (HGB). 2 sentence 1 HGB are discounted at the average market interest rate of the past seven financial years corresponding to their remaining term. The discount rates are determined and published by the Deutsche Bundesbank in accordance with the German Regulation on the Discounting of Provisions (RückAbzinsV) (section 253 (2) sentence 4, 5 HGB).

By way of derogation from the above, in the case of pension obligations and comparable obligations due in the long term, in accordance with Sec. 253 (2) of the German Stock Corporation Act (AktG), the following may apply 2 sentence 2 HGB, a flat-rate “remaining term” (meaning duration) of 15 years is assumed. In accordance with the German Discount Rate Regulation (RückAbzinsV) and the announcement by the Deutsche Bundesbank, the discount rate at the end of 2014 was 4.53%. It is expected that, based on current market interest rates, the discount rate could fall to around 3.8% by the end of 2015 and even to around 2% by the end of 2019. This leads to considerable additional expenses for employers under commercial law.

One option for counteracting this development is to involve external pension providers such as provident funds and pension funds – often not quite correctly referred to as “outsourcing”. The aim of such a measure is to bring the future burdens from the interest rate meltdown under the umbrella of the liability recognition option for underfunding of indirect pension obligations (Article 28 (1) sentence 2 EGHGB). Put simply, this means that

• if all or part of the obligations are transferred, the pension provisions under commercial law are reversed in full or in part, as these will be subject to the option to carry them as liabilities in the future, and
• in the event of a subsequent increase in the total pension obligations due to falling interest rates, this additional amount is no longer recognized in the balance sheet, but only as a deficit in the notes to the financial statements.

This can significantly reduce the burden on the balance sheet. Such a transfer is not always trivial in terms of commercial accounting, as the principles of the prohibition of reversal (Sec. 249 (2) Sentence 2 HGB) and the continuity of recognition (Sec. 246 (3) HGB) must be observed. In addition, the labor law and tax framework conditions must be taken into account. And last but not least, such a transfer naturally entails an immediate outflow of liquidity.

Falling Interest Rates and Rising Pension Provisions – Tax Implications of Financing Measures or Changes in the Mode of Implementation

If the employer wishes to provide an existing direct commitment with an external capital cover, there are various possibilities – depending on whether the implementation method of the direct commitment is to be retained or changed, and to what extent a transfer of the economic risks from the commitment to a third party is to take place.

The pension fund and direct insurance schemes are not suitable for the transfer of prospective employees’ portfolios due to wage tax restrictions: In principle, only the annual wage tax allowance of 4% of the income threshold (currently approx. EUR 2,904) is available in the year of transfer. Any premium payments to the external pension provider (pension fund/insurance company) in excess of this amount would be fully subject to wage tax. The assumption of this wage tax burden by the employer by way of a net wage commitment will regularly fail due to the cost issue alone, while a burden on the employee with the corresponding wage tax (irrespective of the question of admissibility under labor law) is, in our experience, already “politically” unacceptable.

This essentially leaves the pension fund (Section 4e EStG) and the reinsured support fund (Section 4d EStG) as the (most far-reaching) means of passing on the economic risk when changing the implementation method of the company pension scheme. Both leave the transfer free of wage tax, although in the case of the pension fund this is subject to the condition that the payment amount exceeding the dissolved taxable pension provision (Section 6a EStG) may only be recognized as an operating expense by way of an off-balance sheet adjustment spread in installments over the following 10 years; the application required for this must be submitted to the responsible tax office before payment and is irrevocable (Section 4e (3) Sentence 1 EStG). In practice, however, a transfer to the reinsured provident fund will only be considered for existing pensioners for income tax reasons at the level of the employer – deductibility of the corresponding contributions as operating expenses of the sponsoring company – as the provident fund may acquire the corresponding policies for these pensioners in return for a one-off technical payment (cf. Section 4d (1) no. 1 lit. c) EStG).

If the direct commitment implementation method is to be retained, a spin-off of funding into a so-called CTA (Contractual Trust Arrangement) can generally be carried out without any tax implications. This tax neutrality should, however, in any case be guaranteed in advance by a corresponding binding information incl. a tax certificate. The tax office responsible must confirm that the employee’s salary tax has been paid. However, it should not go unmentioned at this point that such a transfer of assets to an independent legal entity under civil law does not result in the economic risks inherent in the promised pension benefits being passed on.

Alternatively, the economic risk arising from the pension commitments can actually be transferred to a third party – the debtor – by means of a debt assumption with internal settlement, who receives a compensation payment in return. From a tax perspective, the core element is that the debtor assumes at least in part the biometric risks arising from the pension commitments (longevity and invalidity) and the transferred funding (bearing the opportunities/risks of the future performance of the compensation payment received). In terms of income tax, this basically has the effect that the originally obligated employer must release the pension provision in accordance with Section 6a of the German Income Tax Act (EStG) for the collective that is covered by the debt assumption; to the extent that the compensation payment made exceeds this amount (which is likely to be the case on a regular basis), this can only be deducted as an operating expense spread over the following 15 years in installments. The prohibition on reversing accruals due to the absence of a legal obligation resulting from the German GAAP (GoB) does not apply as a result of the special legal arrangement (Section 4f of the German Income Tax Act (EStG)).

As of the first subsequent balance sheet date, the party assuming the liability must continue to carry forward the provision value existing with the original employer in accordance with section 6a of the German Income Tax Act (EStG). This results in a partial reversal of the pension provision and thus, ceteris paribus, income. However, it is possible to allocate 14/15 of this reversal amount to a revenue reserve, which is to be increased annually in subsequent periods by at least €1.5 million. 1/14 is to be reversed. However, there is no continuity requirement here, i.e. the claim can also be made in different high partial amounts (Section 5 (7) EStG).

Modification of occupational pension systems: Opportunities and risks under labor law

The labor law framework forms the external framework for the effort-optimizing modification of company pension systems and at the same time shapes their target image. The legislator and, above all, the Federal Labor Court (Bundesarbeitsgericht – BAG) have developed a differentiated system for the individual options for structuring employment law, which limits the employer’s autonomy in structuring the individual measures to varying degrees, but generally allows for overall solutions that are in line with the interests of the employer.

The labor law analysis of the status quo of the existing supply landscape forms the lynchpin of the effort-optimizing modification. The analysis serves to determine the existing benefit plans in a legally sound manner. It must also examine the effectiveness of previous modifications to benefit plans. If the respective benefit plans are governed by collective agreements – and here primarily by works agreements – the analysis must also extend to any accompanying materials to the agreements reached (such as protocol notes, separate agreements or other (e-mail) correspondence between the parties to the works agreement) in order to ensure a comprehensive (historical) regulatory understanding of the individual legal bases. For this purpose, it is usually essential to involve the employees responsible for the administration of the pension systems in the company in the analysis – this is particularly the case if the existing documentation is limited to the mere legal bases and therefore the interpretation understanding of the collective parties is not completely clear from the documentation. The analysis also forms the decision-making basis for the needs-based involvement of stakeholders (above all the affected employees, the relevant works councils and the relevant trade unions) in the modification of the pension systems. If the benefit plans are governed by works agreements, the employer must, among other things, identify the works council responsible for modifying the benefit systems (group works council, general works council or local works council) for this purpose. This also applies if the employer has issued the original benefit plan as an overall commitment and the works council is to be involved in the modification on the basis of its statutory co-determination rights (in this case, above all from Section 87 (1) No. 10 BetrVG).

In the conception of the modification that follows the analysis, two sets of questions must be kept strictly separate: First, starting from the legal basis for the pension system, it must be clarified which labor law instruments are available for the modification at all. Depending on this, the specific labor law design instruments for the modification can be determined in a second step, because the barriers to be observed for the individual design instruments are different.

Closure of pension plans for new entrants

The simplest way to modify a pension system to optimize expenses is to close it to new entrants. The closure does not require any factual justification. It is not subject to co-determination by the works council. If the pension commitment is based on an individual legal basis, the employer may deny the pension commitment to the new employee by simply not granting it. If the employer has made the pension commitment to a larger number of employees – in particular employees comparable with the new employee in terms of job-related function – it is advisable to clarify in the employment contract that the company pension benefits will not be granted. If the pension scheme is governed by a collective agreement (works agreement or collective bargaining agreement), the employer achieves closure for new entrants by ordinary termination of the collective agreement.

Clarification of scope for interpretation and clarifying closure of existing regulatory gaps

In general, no special objective justification is required for the clarification of scope for interpretation or the clarifying closure of regulatory gaps in the existing pension system. The purpose of these measures is to reduce the risk for the employer that, in any subsequent legal dispute regarding the pension benefits to be granted under the pension commitment, an employment tribunal will recognize the interpretation of the pension commitment that is (are) unfavorable to the employer as decisive. For reasons of legal certainty, the clarification should be made with the participation of the respective stakeholder, if possible, depending on the legal basis of the pension commitment. If the pension commitment is governed by a collective agreement, the employer should, if possible, set out the clarification in a supplementary agreement with the relevant works council or trade union.

Typical regulatory areas for such clarifications involve:

• Age for standard old-age pension benefits: Pension commitments made prior to the 2007 Pension Adjustment Act (legacy commitments) often still determine the age of 65 as the relevant age for standard company pension benefits. With the gradual increase in the age for first-time receipt of statutory retirement benefits to 67, employers generally have an interest in (continuing to) link company pension benefits to the statutory standard retirement age. In its ruling of May 15, 2012 (3 AZR 11/10), the Federal Labor Court (Bundesarbeitsgericht – BAG) clarified that the 65th year of life specified in old commitments can generally be interpreted in such a way that the employee benefiting from the pension can generally only claim benefits upon reaching the statutory standard retirement age. In the ruling, the BAG also recognized that the interpretation of the specific pension commitment may show that the employer wishes to grant the company pension benefits in any case – irrespective of the statutory standard retirement age – upon reaching the age of 65. A clarifying provision avoids such a risk of interpretation.
• Non-transparent valuation parameters for the calculation of pension benefits: These are typically found in the case of (final) salary-related pension commitments in that the pension commitment does not clearly specify which individual remuneration components are to be taken into account as the basis for calculating the specific pension benefits. This is the case, for example, if the pension commitment is generally based on the employee’s average salary in the last year of employment and the employer also grants non-cash benefits such as the private use of a company car. A clarifying provision – in the aforementioned example, for example, with an explicit restriction of the eligible remuneration components to the fixed monetary remuneration – avoids an interpretation risk to this effect.
• AGG-violating age limits for waiting periods: According to the case law of the BAG, age limits as a prerequisite for benefit entitlement violate the General Equal Treatment Act and are therefore invalid if they deny employees with an age of less than 50 years access to the pension plan (for the latest legal developments, see only the article in our Pensions Update 01/2014: https://kpmg-law.de/docs/Pensions_Update_01_2014.pdf#page=5). A modification of the age limit to AGG-compliant limits ensures the effective application of the age limit in the future.
• Reduction of early pension benefits: In accordance with Section 6 of the German Occupational Pensions Act (BetrAVG), beneficiary employees generally have a claim to early retirement benefits from the time at which they draw a statutory old-age pension as a full pension – even if the pension commitment does not contain any provision on such a claim to an early retirement pension. If there is no explicit provision in the pension commitment on the treatment or calculation of the early retirement pension benefit, the legal assessment must be based on the principles of supplementary contract interpretation. According to the case law of the Federal Labor Court (Bundesarbeitsgericht – BAG), in the event of early retirement, a company pension benefit can be reduced in two ways compared to the standard old-age pension despite the absence of a provision in the pension commitment, applying the regulatory principle contained in Section 2 of the German Occupational Pensions Act (BetrAVG) (cf. only ruling dated January 23, 2001, 3 AZR 164/00): The employer can reduce the pension amount by quoting the (fictitious) full pension according to the ratio of the actual length of service to the length of service that can be earned until the age limit specified in the pension commitment is reached and, in a second step, make a further deduction to take account of the fact that the employee claims the pension benefits earlier and for longer than was promised with the pension commitment. At the same time, the BAG ruled that a lack of provision for early reduction of pension benefits in an individual case could indicate the employer’s intention to provide early pension benefits in the amount of the standard old-age pension benefits (BAG ruling dated December 10, 2013, 3 AZR 726/11). This (interpretation) risk can be avoided by an explicit provision on the reduction of early pension benefits; for example, by a reference to the provisions of Section 2 of the German Occupational Pensions Act (BetrAVG) or with a flat deduction rate of 0.5% per calendar month of early claiming of pension benefits – recognized as permissible by the BAG (ruling dated March 8, 2011, 3 AZR 666/09).

Settlement of pension entitlements

The settlement of pension entitlements includes the debt-discharging granting of a one-time payment to the beneficiary employee. Claims of the beneficiary employee arising from the pension commitment expire with the severance payment. The effectiveness of the severance payment depends on the status of the employment relationship or the company pension relationship and on the amount of the present value of the pension entitlements: under the current legal situation, the employer can unilaterally terminate petty pension entitlements with a total entitlement amount of less than 1/100 of the monthly reference amount pursuant to Sec. § 18 of the German Social Code, Book IV (2015: EUR 27.65). A settlement of pension entitlements by virtue of a bilateral agreement is effective in an ongoing employment relationship if the settlement agreement was not concluded in a factual and temporal connection with the termination of the employment relationship. If the pension relationship is already in the benefit phase, the employer can settle the pension entitlements with the consent of the company pensioner if the first benefits from the pension relationship were drawn before January 1, 2005. The specific amount of the severance payments can be agreed autonomously by the employer and the employee or the company pensioner – within the limits of immorality.

The settlement of pension entitlements includes the debt-discharging granting of a one-time payment to the beneficiary employee. Claims of the beneficiary employee arising from the pension commitment expire with the severance payment. The effectiveness of the severance payment depends on the status of the employment relationship or the company pension relationship and on the amount of the present value of the pension entitlements: under the current legal situation, the employer can unilaterally terminate petty pension entitlements with a total entitlement amount of less than 1/100 of the monthly reference amount pursuant to Sec. § 18 of the German Social Code, Book IV (2015: EUR 27.65). A settlement of pension entitlements by virtue of a bilateral agreement is effective in an ongoing employment relationship if the settlement agreement was not concluded in a factual and temporal connection with the termination of the employment relationship. If the pension relationship is already in the benefit phase, the employer can settle the pension entitlements with the consent of the company pensioner if the first benefits from the pension relationship were drawn before January 1, 2005. The concrete amount of the severance payments can be agreed autonomously by the employer and the employee or the company pensioner – within the limits of immorality.

The BAG has recently made an exception to the scope of application of the statutory prohibition of severance payments for pension commitments to members of the executive board of a stock corporation (BAG ruling dated April 21, 2009, 3 AZR 285/07). According to the opinion of the BAG, the latter may conclude agreements with the company issuing the pension commitment which deviate from the prohibitions of Section 3 of the German Occupational Pensions Act (BetrAVG) and therefore, in particular, also agree on a settlement of pension entitlements in connection with the termination of the employment relationship. The BAG has not yet decided whether these legal principles are also applicable to the members of the executive bodies of other corporations (in particular managing directors of a GmbH). From a legal point of view, there are weighty reasons for such an application. (Capital) companies will weigh up the decision on any severance payments to such board members after an appropriate risk assessment.

Suspension of the adjustment of pension benefits

The expense-optimizing implementation of the adjustment of pension benefits in accordance with Section 16 of the German Occupational Pensions Act (BetrAVG) is aimed at using the labor law structuring option to avoid the implementation of the standard adjustment of occupational pension benefits in the amount of the respective development of the consumer price index. For this purpose, the employer may – if the respective requirements are met – choose one of the case groups of Section 16 para. 2 BetrAVG, which includes an effective flat-rate adjustment of pension benefits of 1% p.a. for direct commitments made after December 31, 1998.

Of greater practical significance in the context of the low-interest phase has become the partial or complete omission of pension adjustments due to the – lack of – economic performance of the employer. In this case, the (partial) suspension of the adjustment of pension benefits can achieve lasting expense-optimizing effects if the employer informs the company pensioner about the reasons for the (partial) suspension in accordance with the requirements of Section 16 para. 4 BetrAVG and, to this end, in particular points out to the occupational pensioner in the documentation of the notification the lack of economic capacity of the employer’s company to (partially) adjust in a manner that is comprehensible to the occupational pensioner (Section 16 (4) sentence 2 BetrAVG). The employer can obtain suitable documentation on economic performance from a substance preservation analysis, which we discussed in detail in our Pensions Update 2/2014 (https://kpmg-law.de/docs/Pensions_Update_02_2014.pdf#page=2).

Modification of the performance plan

The modification of the benefit plan aims to change the content of the parameters for the pension benefits. Their effectiveness is assessed according to the legal basis of the pension scheme and the economic situation of the employer at the time of the change:

The employer can generally only modify an individual contractual pension commitment by means of an individual contractual amendment agreement with the beneficiary employee. If the modification includes a reduction of the promised benefits, the partial waiver by the employee included in the reduction is subject to the requirements of the statutory prohibition of severance payments pursuant to Section 3 of the German Occupational Pensions Act (BetrAVG) according to the case law of the BAG. In this respect, performance-reducing change agreements can generally only be concluded during the current employment relationship. In addition to the amendment agreement, the unilateral options for amendment by means of a notice of termination or revocation of the pension commitment, which are theoretically possible, do not play a practical role, as the employer is generally unable to demonstrate the respective – extremely restrictive – requirements for both instruments. Likewise, the cost-optimizing modification of an individual contractual commitment on the basis of a collective agreement (in particular a collective agreement or a works agreement) is generally out of the question, as the collective agreement generally contains less favorable provisions than the individual contractual commitment – at least for individual performance parameters – and therefore takes a back seat to the individual contractual commitment due to the principle of favorability under collective law with regard to these less favorable provisions.

If, on the other hand, the individual contractual pension commitment contains an amendment reservation in favor of a works agreement, the employer can make the expense-optimizing modification as an alternative to concluding the amendment agreement by means of a works agreement to be concluded with the competent works council. A modification by means of a company-wide collective regulation is also possible in the case of individual pension commitments with a collective character. This relates to pension commitments based on an overall commitment, which are still frequently encountered, especially in long-standing pension systems. According to the case law of the Federal Labor Court (ruling dated September 16, 1986, GS 1/82), such individual pension commitments of a collective nature may be amended by a works agreement if the new arrangement is not less favorable overall for the employees concerned than the previous pension commitment when viewed collectively.

The effort-optimizing modification by means of a collective agreement must also comply with the general legal principles of the protection of legitimate expectations and proportionality. In order to concretize these legal principles, the BAG has developed a general equity test based on a three-stage proportionality test (“three-stage theory”, most recently for example in its judgment of September 2, 2014, 3 AZR 951/12), according to which the effectiveness of the modification is assessed as follows, depending on the structure of the pension commitment and the vested rights of the employee covered by the modification:

• Interference with vested insolvency-protected vested rights: Interference with these vested rights is only possible for compelling reasons. The BAG assesses these compelling reasons restrictively and only allows, among other things, an emergency situation of the employer close to insolvency or a disturbance of the basis of the business (here primarily as an unplanned overprovision of the employee).
• Interference with pro rata vested benefits: This vested benefit mainly relates to final-salary pension commitments where the pension benefits are based on the amount of remuneration last received by the employee in the employment relationship. Dynamics concerns the further development of the dynamic calculation parameters. An intervention in the dynamic (which then usually includes a capping of the salary development to the remuneration received by the employee at the time of modification) requires valid reasons. The intervention is effective if the continuation of the previous pension scheme would jeopardize the company’s continued existence in the long term. This is assumed to be the case if unchanged pension liabilities cannot be expected to be financed from the company’s earnings and there is also no sufficient increase in the company’s value available to offset them. The requirements are comparable to the conditions under which the employer may suspend the adjustment of pension benefits in accordance with Section 16 of the German Company Pensions Act (BetrAVG) in view of its (lack of) ability to pay. In practice, to justify the intervention at this level, the employer must present its economic development over a forecast period of at least three years.
• Intervention in incremental amounts that are solely dependent on (further) length of service: At this level, the vested rights relate solely to the increase in the value of the entitlements resulting from the employee’s continued service with the company. Interventions in these future and thus not yet earned service-dependent increases can already be made for factual-proportional reasons by reducing the rate of increase for the further years of service – if necessary until it is completely eliminated. The BAG understands any economically reasonable consideration of the employer as factually proportional reasons and assesses the effectiveness of the encroachment solely according to a general equity check. The BAG has already recognized a general harmonization interest of the employer or a general need for restructuring as an objectively proportional reason, without there having to be a serious threat to the employer’s company at the same time. In this respect, in order to justify the intervention at this level, the employer must explain the factual reasons for the modification of the benefit plan and plausibly explain the remediation options considered as an alternative to the intervention in the benefit parameters and their omission.

Conclusion:

The success of the specific effort-optimizing modification of the pension system depends on the legally effective application of the labor law framework conditions to be observed for the pension system. The framework conditions under labor law must therefore be taken into account at every stage of work on the intended modification of the supply systems in the sense of holistic project planning. At the same time, the labor law assessment is based on a strategic and economic decision by the employer on the future implementation of the pension systems in line with requirements – the labor law component establishes the legal rules and design instruments for the modification of the pension system, but does not replace the concrete (re)design idea.

And what else? – Further current labor law case law

The courts have also been active in other areas of occupational pension provision in recent months. Two rulings by the BAG on the Group-wide assessment of the modification of a pension commitment according to the three-step theory and on the dynamic interpretation of pension commitments with regard to the retirement age are worthy of particular mention. Also worth reporting is a ruling by the Frankfurt Higher Regional Court on the scope of pension equalization with regard to the benefits covered by the division. A ruling by the Cologne Higher Labor Court (LAG) on the permissible restriction of survivors’ benefits in a pension commitment concludes the case law report in this Pensions Update.

Pension commitments made prior to the 2007 Pension Adjustment Act often still stipulate age limits for initial pension payments that deviate from the current statutory retirement age (67) or the ages relevant for other – early – statutory pension benefits. Employers generally have an interest in (continuing to) link company pension benefits to the statutory standard retirement age. In its ruling of May 15, 2012 (3 AZR 11/10), the Federal Labor Court (Bundesarbeitsgericht – BAG) clarified that the relevant retirement age specified in old commitments can be interpreted in such a way – dynamically – that the employee benefiting from the pension can generally only claim the respective benefits upon reaching the respective statutory retirement age. This decision has subsequently met with criticism in the literature. Pro-employee literature in particular accused the BAG of overstretching the general legal principles for the interpretation of pension commitments in favor of the employer with this decision. In its ruling of January 13, 2015, the BAG had the opportunity to reconsider its legal opinion on the dynamic interpretation of age limits.

The subject matter of the legal dispute was a pension commitment made by the defendant employer to the plaintiff employee, who was born in 1959, on the basis of a pension plan already issued by the employer in 1959 by way of an overall commitment. Under the pension plan, retirement benefits were granted to retired male employees on reaching the age of 63 and to retired female employees on reaching the age of 60. The pension benefits were reduced by the pensions from the statutory pension insurance schemes, among other things. In 2010, the employer informed its employees that, due to the increase in the statutory age limits, persons born in 1952 or later would be able to claim their company pension at the earliest when they reached the age of 63. The receipt of a statutory old-age pension had always been a decisive prerequisite for the entitlement to the company pension. In her action filed following this information, the employee sought a declaration that she could receive pension benefits for the first time under the pension plan when she reached the age of 60.

The BAG dismissed the action. Confirming its case law from the judgment of May 15, 2012, it stated that, contrary to the wording of the pension commitment, the employee could not claim the company pension until she reached the age of 63. The defendant was not obliged to grant the plaintiff a retirement pension when she left the employment relationship after reaching the age of 60 if the plaintiff was not yet drawing a pension from the statutory pension insurance at that time. If a pension scheme provides for the offsetting of benefits from the statutory pension insurance, the age limit for the start of the company pension set out in the pension scheme is generally to be understood as dynamic, so that it is also shifted if the age limits in the statutory pension insurance are increased. A total pension is characterized by the fact that the employer does not promise the employee a specific pension benefit, but rather a pension level. In the case of an overall pension, the benefit is intended to ensure a certain level of provision together with the statutory pension and other occupational or other pension benefits and merely to supplement the basic security provided by the statutory pension insurance. In the case of a total pension commitment, it must therefore be assumed as a rule that the employer does not wish to pay the company pension until the employee simultaneously receives a pension from the statutory pension insurance.

Conclusion:

In its decision of January 13, 2015, the BAG confirmed its case law on the dynamic interpretation of age limits in old commitments. The decision concerned an overall pension system in which a discrepancy between the start of the company pension and the start of the statutory pension cannot be intended. However, it is to be expected that the BAG will also apply this case law to pension schemes that do not provide for the statutory pension to be offset.

Modification of a pension commitment according to the three-step theory and consideration of the economic situation of group companies (BAG ruling dated December 9, 2014, 3 AZR 323/13)

In order to be effective, modifications of pension commitments on the basis of collective agreements must satisfy the general legal principles of protecting the employee’s trust in the originally promised benefit content and of proportionality. The BAG has developed the three-step theory for the concrete formulation of these legal principles, according to which modifications with a (performance-reducing) intervention in – exclusively – service time-dependent increments as an intervention on the third step require objective-proportional reasons. The BAG recognizes any economically reasonable consideration of the employer as factual-proportional reasons and assesses the effectiveness of the interference according to a general equity check. In its decision of December 9, 2014, the BAG had the first opportunity to assess whether the employer modifying the pension commitment can also use group-related economic considerations as factually-proportional reasons.

The subject of the decision was a Group-wide savings program implemented by the EnBW Group in 2003 and 2004 which, among other things, provided for significant savings in personnel costs, including savings in the company pension scheme. The savings program was developed by the Group parent company – taking into account its economic situation at the time – and provided for a cascade-like distribution of the savings contributions to the individual Group companies. Also affected by the savings were pension commitments made by several Group companies on the basis of company agreements, under which the amount of pension benefits was determined by the employee’s final salary and the number of years of service. In order to achieve savings in the area of company pensions, the defendant Group company, of which the Group parent company is the sole shareholder, agreed a company agreement with the relevant works council which provided for the years of service eligible for pension benefits to be capped at the time the company agreement was concluded. The plaintiff employee sought a declaratory judgment that this cap was ineffective as an intervention at the third level in accordance with the three-level theory of the BAG. The requirement of the group parent company for the savings contributions used by the defendant group company as justification for the capping cannot be recognized as an objective-proportional reason within the meaning of the three-step theory of the BAG. The factually proportional reasons would have to exist directly with the employer granting the pension commitment. A group-wide consideration for the derivation of the factual-proportional reasons is inadmissible. The action was successful in the lower courts on this basis.

The BAG overturned the second-instance decision. It recognized the specifications of the Group parent company for the savings contributions in the Group-wide savings program as factually proportional reasons for capping the years of service. It is true that the assessment of the factual-proportional reasons is generally based on the economic development of the company that is the pension debtor. However, interdependencies within the Group may mean that, in exceptional cases, a uniform view of the Group is required and the employer may use economic difficulties within the Group as a reason to intervene in the unvested service-related increases. This is the case – as in the facts in dispute – if all shares in the employer owing the pension are held by the lead company of the group whose sole purpose is the management of a group of companies.

Conclusion:

The BAG clarifies that when assessing the economic situation of the employer in a group situation, the economic situation of the controlling company can also be taken into account in individual cases if the pension scheme is modified for economic reasons and the length of service-related increments not yet earned are affected. The decision deals exclusively with the admissibility of the group-wide consideration for the assessment of the effectiveness of an encroachment on the third step of the three-step theory of the BAG. In view of the very restrictive conditions for intervention at the other two levels of the three-level theory, the group-wide view is generally only likely to be considered for the third level.

The survivor benefit as the subject of the external pension equalization (OLG Frankfurt decision of 09.12.2014, 4 UF 244/12)

For the valuation of pension benefits promised in a pension benefit in an external pension equalization, many legal questions have not been clarified in practice even more than six years after the enactment of the Pension Equalization Act. In its decision of December 9, 2014, the Frankfurt Higher Regional Court had the opportunity to continue the legal development on the consideration of surviving dependents’ benefits as well as pension adjustments in the determination of value.

In this regard, the court ruled that in the case of a pension commitment with combined old-age, disability and death protection, the share of the pension attributable to the promised surviving dependents’ benefits is also subject to the equalization of values in the event of divorce.

With regard to the possible consideration of pension adjustments, the court recognized that adjustments to the pension amount in the benefit stage are not taken into account in the valuation of the equalization value of a company pension scheme that is decisive for the external division, unless they are fixed in accordance with Section 16 para. 3 No. 1 of the German Occupational Pensions Act (BetrAVG). Otherwise, performance increases cannot be reliably forecast at the time of the value adjustment. The pension beneficiary only has a right to a proper adjustment test under the commitment in conjunction with § 16 BetrAVG. § Section 16 of the German Occupational Pensions Act (BetrAVG) only entitles the beneficiary to a proper adjustment test.

Conclusion:

All promised pension benefits, including surviving dependents’ benefits, are to be settled. The compensation relates only to the committed value and does not include any subsequent company pension adjustments unless these have been explicitly agreed in the commitment.

No discriminatory exclusion from surviving dependents’ pensions LAG Cologne (judgment of April 24, 2015, 9 Sa 108/15)

According to the established case law of the BAG, employers have a wide scope for structuring the benefits specified in an employer-financed pension commitment. The employer of the pension commitment, which was the subject of the ruling by the Cologne Higher Labor Court (LAG) of April 24, 2015, had also made use of this leeway. The pension commitment specified the following conditions for surviving dependents’ benefits: “After your death, your current wife will receive a widow’s pension for life, provided that the marriage is not divorced in the meantime. […]. The plaintiff employee’s marriage was divorced after the pension commitment was granted, and the plaintiff employee entered into another marriage with his – 23 years younger – wife after the divorce. Upon receipt of this marriage, the plaintiff employee sought a declaration in his action that his wife from his second marriage could also claim survivor benefits under the pension commitment.

The Cologne Higher Labor Court dismissed the action. In its reasoning, the court stated that the employer is free to define the content of a self-financed pension plan and, in this respect, to limit the group of eligible third parties, including for survivors’ benefits, by means of additional qualifying features or special features excluding entitlement within the limits of the general legal framework (in particular the General Equal Treatment Act, AGG). The restriction of the group of surviving dependents to spouses who were married to the employee at the time the pension commitment was granted is in any case compatible with the general legal framework in relation to spouses from subsequent marriages of the beneficiary employee who are not entitled to claim.

Conclusion:

The decision of the Cologne Higher Labor Court (LAG Köln) clearly shows that the employer generally has a wide scope of regulation for the needs-based structuring of self-financed pension commitments.

Current developments in legislation I: Low interest rate phase – amendment of the HGB?

The steady decline in interest rates over the past few years is causing pension provisions to rise further – and is thus placing a considerable burden on companies. Against this backdrop, the Bundestag discussed balance sheet simplifications for companies in its session on June 18, 2015.

The discount rate used to measure pension obligations under German GAAP is currently calculated as the average of the market interest rates over the last seven years. Due to the current interest rate development, more and more years with high interest rates are falling out of the averaging period and are being replaced by years with low interest rates. As a result, the actuarial interest rate will fall steadily over the next few years, assuming that interest rates remain constant:

Depending on the number of employees and the pension plan, this development may almost double the pension obligations by the end of 2019 due to interest rate developments alone. Even an increase in the interest rate level cannot fundamentally influence this development – if the market interest rate rises to 3% by the end of 2015 and then remains at this level, the interest rate will still fall to 3.2% by December 31, 2019.

Due to the considerable burden this places on companies, on June 18, 2015, the German Bundestag discussed a change in the procedure for determining the discount rate under HGB as part of the final consultations on the Accounting Directive Implementation Act, BilRUG. The draft resolution provided for an extension of the average education period to twelve years. Assuming a constant interest rate level, this would result in an actuarial interest rate of 3.36% as of December 31, 2019.

The adopted resolution now calls on the legislature to consider an appropriate extension of the reference period for determining the average interest rate, “combining this with a profit distribution block if necessary.” It remains to be seen how such a profit distribution block will look in detail. The legal policy spokesperson of the CDU/CSU parliamentary group and the responsible rapporteur stated that an extension of the smoothing period to twelve years was under discussion and that the federal government would quickly examine a corresponding adjustment.

Current developments in legislation II: Tax law

In the area of tax law, the legislator has issued clarifying legal regulations on the scope of the (non-)recognition of contributions or allocations made by the employer on behalf of the employee to an external pension provider and on the determination of income in the case of partially overfunded provident funds in the legal form of a limited liability company.

Insofar as the employer makes ongoing contributions and payments on behalf of the employee to a pension fund, a pension fund or a life insurance company as part of an existing employment relationship, these are generally subject to taxation as income from employment (Section 19 (1) no. 3 EStG). In doing so, acc. § The tax exemption granted under Section 3 No. 63 of the German Income Tax Act (EStG) is limited in amount, but is “bought” at the price of full rather than pro rata taxation of the corresponding pension benefits at a later date. In principle, special payments by the employer to the aforementioned institutions are also regarded as income from employment, although the following special payments, among others, are excluded from this:

• Those for initial compliance with solvency regulations (§§ 53 c, 114 VAG), § 19 para. 1 No. 3 lit a) EStG or
• those for the restoration of adequate capital resources following unforeseeable losses or for financing the strengthening of the actuarial bases due to an unforeseeable and not merely temporary change in circumstances, § 19 para. 1 No. 3 lit b). EStG.

The above-mentioned provision in § 19 para. 1 No. 3 lit b) EStG, in particular with regard to the explicit clarification that the income tax exemption of such special payments is only granted if the said special payments do not result in a (subsequent) reduction of the current contribution, resp. a reduction in contributions is not the reason for the occurrence of these special payments. According to the explanatory memorandum, the legislator is thus taking account of the fact that the previous version of the law did not differentiate between the use of special payments made to meet solvency requirements. This would have enabled the employer to deduct taxable wages in the form of contributions to pension funds, pension funds or pension plans. Life insurance companies into tax-free payments.

Determination of income in the case of partially overfunded provident funds in the legal form of a limited liability company

As part of the ongoing legislative process to implement the protocol declaration on the Customs Code Adjustment Act, an amendment to the determination of income at the level of support funds in the legal form of a corporation (GmbH) is also planned. This proposed legislation can be seen as a reaction to the BFH ruling of December 22, 2010 published in the Federal Tax Gazette II 2014, p. 119, in which the Federal Fiscal Court found that contributions made by the sponsoring company to a provident fund operated as a corporation are operating income for the latter, and corresponding payments made by the provident fund to the beneficiaries within the framework of its statutory requirements are operating expenses. With this opinion, the Federal Fiscal Court has abandoned the general view that had applied until then, according to which benefits do not fall under any of the types of income pursuant to Sec. 2 (2) of the German Income Tax Act. 1 EStG (i.e. irrelevant for tax purposes), and benefits paid by the provident fund as use of funds in accordance with the articles of association. § Section 10 No. 1 of the German Corporation Tax Act (KStG) are irrelevant for tax purposes, has been clearly rejected for the support fund maintained as a corporation. Through the planned amendment of the wording of § 6 para. 5 sentence 2 KStG, the purpose is to ensure that the tax treatment follows the general view that has prevailed up to now, without having to differentiate according to the legal form of the relief fund. The regulation is to come into force for the first time from the 2016 assessment period.

In order to avoid excessive taxation of partially overfunded support funds in the legal form of a corporation, it is envisaged that, after deduction of the pension benefits in the relevant period, any remaining positive benefit amounts from the assessment periods 2005 to 2015 inclusive, to the extent that they are included in taxable income on a pro rata basis, may be determined separately upon application. From the 2016 assessment period, the taxable income is then to be reduced by the pension payments made in the fiscal year, limited to the remaining determined amount of the benefit (Sec. 6 (5a) KStG-E). In addition, the provisions of Sec. 3 No. 40 EStG and Sec. 8b KStG shall no longer apply (Sec. 3 No. 40 Sentence 5 EStG Draft, Sec. 8b (11) KStG Draft).

Current Legislative Developments III: The Draft Law on the Implementation of the EU Mobility Directive

On July 1, 2015, the German government passed the draft law for the implementation of the Mobility Directive, thus initiating the legislative process.

The draft law essentially builds on the draft bill (RefE) of the Federal Ministry of Labor and Social Affairs (BMAS) of April 16, 2015 (cf. see our report in Pensions Update 01/2015: http://www.kpmg-law.de/docs/Pensions_Update_Mai_2015.pdf). The draft legislation contains substantive changes compared with the RefE in the provisions of Section 2a of the German Occupational Pensions Act (BetrAVG) on calculating the partial entitlement of earned pension entitlements: Subsequent changes are generally not to be taken into account as long as the employee who has left the company is not disadvantaged with regard to the value of his vested pension entitlement compared with comparable employees in a (still) active employment relationship. It should still be possible to deny discrimination if the pension commitment does not contain any dynamic pension entitlements or if the employer adjusts the pension entitlements. The German government has revised the case catalog for the effective adjustment of pension entitlements (§ 2a para.2 Digit. 2 BetrAVG) was extended to include the annual adjustment of 1%. Unchanged is the effective adjustment of the entitlement already determined in the RefE in the same way as the adjustment of current benefits vis-à-vis pension recipients. According to the wording of the draft law, the employer may refrain from making the adjustment if it is not in a position to adjust current benefits in accordance with Section 16 of the BetrAVG due to its economic situation. The German government has also modified the requirements for the settlement of small entitlements in the event of a cross-border change of employer. The employer must now obtain the employee’s consent to the severance payment if the employee notifies the employer of his or her move abroad within three months of leaving the company. After the expiry of this three-month period, the employer may settle the small entitlement without the employee’s consent, even in the event of a cross-border change of employer. The bill was first forwarded to the Bundesrat. The parliamentary procedure in the Bundestag will be carried out after the summer break. The law is expected to be passed in the fall of this year.