by Diplom-Kaufmann (Univ.) Edmund J. Ranosch, financial analyst (Wöllstadt) (eranosch@web.de) and Johannes Fiala, lawyer (Munich), M.B.A. (Univ.Wales), (www.fiala.de)
Pension commitment for widows and orphans: A design error that is still being made today by smaller and larger insurers is the incorrect pledging of the pension commitment to widows and orphans at the GGF. This is caused by standard forms which cannot provide for a separate pledge to potential widowers, widows and orphans.
These separate pledges are particularly important in the event of inheritance. The GGF’s lien on the reinsurance usually also falls within the estate. But if the lien (over the estate) does not go to the widow or orphan, it dies. Indeed, a lien can never legally exist without the actual claim (from the pledge). If the GGF files for divorce, the spousal right of inheritance without a will is over. If the testator appoints someone else as heir, the latter receives a legally ineffective lien ? However, widows and orphans are left unsecured for this, as they lack the lien as security.
occupational pension commitment without sufficient reinsurance: One of the tasks of a pension commitment audit is to identify any gaps in coverage. It is surprising how often the commitment includes, in particular, disability and widow’s benefits ? but there is no suitable reinsurance. This then exposes the pledging GmbH to an unnecessary insolvency risk. The occupational pension consultant Bosl (Pöcking, Starnberger See) describes this with the words “If the case of occupational disability occurs, but the reinsurance only consists of an accident insurance, the company is unfortunately broke in the case of an emergency”.
bAV reinsurance necessary: In order to discuss the economic dimension with the GGF, here are a few basic considerations on the effects for widows and orphans in the commitment for the GGF.
Due to the content of the pension commitment with the obligation to pay widow’s pensions and possibly orphan’s pensions, the balance sheet situation is exacerbated particularly drastically if the death of the actual pension recipient occurs unexpectedly. The company must pay the widow’s pension and at the same time have a not inconsiderable capital sum available to settle the widow’s pension payments. Of course, it might be possible to pay the widow’s pension, which is usually around 60%, from the current earnings of the continuing company, if it were not for the mandatory accounting requirement, which completely changes the picture of the company balance sheet: Because of the pension event that has occurred, the provision must be increased to the widow’s pension cash value from now on. As a result, the obligations on the liabilities side of the company balance sheet suddenly rise sharply above the company assets of the GmbH and may lead to over-indebtedness with the associated legal consequences. The notorious ?balance sheet risk? hits the GmbH just in the situation, in which it can use this least.
An example may clarify the balance jump risk: A 45-year-old GF has a pension promise at a value of monthly 5,000 ? after many years of activity since short time. as of 1.11.2005. His wife, who is approx. 3 years younger, is to receive 60% of this as a widow’s pension, i.e. 3,000 ? monthly. The present value of the old-age pension obligation, which is slowly building up, will reach a value of approximately ? 798,000 in the 65th year of life of the GF. according to the Heubeck tables. In the event of the death of the GF in the same year, the possible early widow’s pension triggers an immediate increase in the previous provisions to the widow’s pension cash value of ? 542,633. which would shake up the company balance sheet considerably if the inflow of the lump-sum death benefit from a possible term life insurance policy did not balance this out at the same time on the asset side of the company balance sheet.
High death risk life insurances prevent ?balance sheet risk? and secure the means for the widow’s pension payments But not only for balance sheet reasons is the conclusion of a risk insurance extremely meaningful, but for liquidity reasons, in order to be able to settle the monthly widow’s pension payments for a long time (lifelong pensions for the widow ?) from the capital stock flowing to the GmbH. This immediately raises the question of which capital stock is sufficient for this ?
At the time of the commitment for the managing director, the Heubeck tables provide for a capital amount of ? 542,633 for this case if the managing director dies in 2005. From the capital amount flowing to the GmbH from the risk insurance, the widow’s pension of 3000 ? per month is to be fed and the remaining capital amount is always to be interest-bearing at 6 % p.a. in order to mitigate an even faster melting of the remaining capital through further (falling) interest inflows until this capital would be used up at the widow’s age of 74. Longer the capital lasts while maintaining the annual withdrawal of 36,000 ? Widow’s pension with 6% p.a. interest is not sufficient. Not only that the widow’s pension volume is designed from today’s view already for nearly eight years too little. An aggravation of the widow’s pension problem culminates in the constantly increasing life expectancy and the lower interest rates in the future than the 6 % p.a. calculated in the Heubeck tables, which aim in the same direction.
Life expectancy is rising steadily, for men and especially for women According to the latest evaluations of the Federal Statistical Office, the life expectancy of a 42-year-old woman is 82.54 years, which is more than 8 years higher than calculated in the Heubeck tables. It is more likely that life expectancy will continue to increase than decrease. Thus, the advised widow’s pension cash value according to Heubeck is neither sufficient with 6 % p.a. interest nor even less so with interest on the remaining capital at 4 % p.a., for example. interest and certainly not with interest on the remaining capital, e.g. at 4 % p.a.. If one calculates with 4 % p.a. interest and capital consumption until the age of 82.54, then already today approx. 699,000 ? be provided as capital stock in the example case. If the long-term interest rate even falls to 3 % p.a., approx. 800,000 ? are available for widow’s pension payments alone. Here, therefore, with the low-priced risk insurances in the company area (premiums as operating expenses), one should not spill the beans, but rather make do.
But this is only based on today’s life expectancy. This means that a lifelong widow’s pension cannot (yet) be guaranteed by the company.
On the interest of the capital in the company with 6 % p.a. internal interest after taxes can rarely be built on, if the driving force of the company has just left it. In many cases, the lump-sum death benefit in the company for widow’s pension payments is not separated and earns interest, but is gradually lost in the course of business. In this case, provision must be made in good time by means of a proper pledge to the surviving dependants.
Orphan’s pension payments For a more calculable period of time, the half-orphan’s or full orphan’s pension, which is usually payable until the end of the training at the most, is available with a further capital amount, by which the death benefit should be increased, so that the balance sheet risk, which is fatal for the GmbH, does not occur and the financial future of the company and especially of the family is comprehensively secured.
Legal and economic solutions The legal and economic possibilities via privileged hedges in residual Europe are not yet so well known, but have been subtly and profitably explored. Here, as an alternative to simple pledging, a trustee solution via a foreign country is an option. Spreading the reinsurance over various European product providers can also mean more potential returns and less risk.
Some tax advisors recommend that the widow’s and orphan’s risk be located outside the company ? the subsequent partial withdrawal up to the target partial value is a viable option, but only up to the limit of the tax-damaging waiver of the commitment.
Important for the intermediary Especially for the (real) insurance broker, with his constant duty to observe risks, there are thus numerous opportunities for a discussion with the customer, not least in order to point out (and document) the avoidable risks through the use of standard forms from the printers of some product providers.
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About the author
Dr. Johannes FialaPhD, MBA, MM
Dr. Johannes Fiala has been working for more than 25 years as a lawyer and attorney with his own law firm in Munich. He is intensively involved in real estate, financial law, tax and insurance law. The numerous stages of his professional career enable him to provide his clients with comprehensive advice and to act as a lawyer in the event of disputes.
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