By Dr. Johannes Fiala and Thomas Keppel
In the case of occupational pension schemes with deferred compensation, in the first contribution years the insurance company usually offsets the acquisition costs (e.g. brokerage commissions) against the premiums paid in. According to a recent ruling by the Munich Regional Labor Court (Landesarbeitsgericht – LAG), such agreements are void and must be reversed. This has considerable financial consequences for employers in particular – irrespective of whether or not employees have previously been made aware of the consequences of the acquisition cost offsetting. The authors explain in detail the reasons for this “drumbeat” in occupational pension provision, which could lead to the invalidity of millions of deferred compensation agreements. Finally, they give important practical advice on what consequences this will have for companies and how they can react to it (including limiting financial damage).
The case in practice: The decision of the LAG Munich of 15 March 2007 (4 Sa 1152/06) was based on the following facts: An employee had waived part of her salary for 35 months. 178 per month went to an inter-company pension fund, which took out a reinsurance policy. When the employee left after almost three years with the employer, a car dealership, she had thus converted a total of €6,230 in salary into a company pension. However, only €639 of this was available as an insurance (surrender) value. Almost 90% of the converted salary was missing. A typical case, as is conceivable in many employment relationships and is considered normal by the insurance industry.
The company pension scheme (bAV) can only be implemented in Germany via the following implementation channels (cf. in detail Plenker, BC 4/2002, p. 77 ff.): – direct or pension commitment (§ 1b para. 1 Company Pension Act – BetrAVG), – direct insurance (§ 1b para. 2 BetrAVG), – pension fund (§ 1b para. 3 BetrAVG), – pension fund (§ 1b para. 3 BetrAVG), – support fund (§ 1b para. 4 BetrAVG). Since 2002, employees have been able (in accordance with § 1a of the German Occupational Pensions Act (BetrAVG)) to request their employer to convert their remuneration within certain limits. The case in practice: The decision of the Munich Higher Labor Court (LAG) of March 15, 2007 (4 Sa 1152/06) was based on the following facts: An employee had waived part of her salary for 35 months. 178 per month went to an inter-company pension fund, which took out a reinsurance policy. When the employee left after almost three years with the employer, a car dealership, she had thus converted a total of €6,230 in salary into a company pension. However, only €639 of this was available as an insurance (surrender) value. Almost 90% of the converted salary was missing. A typical case, as is conceivable in many employment relationships and is considered normal by the insurance industry. The Company is entitled to demand the conversion of shares for the purpose of building up or supplementing a company pension plan. If the employer offers implementation via a pension fund or a Pensionskasse for this purpose, this is done there. Otherwise, employees are entitled to have the employer take out a direct insurance policy: – The policyholder is the employer, – the beneficiary is the employee, who has salary components passed on as contributions via his employer. So far, zillmerised tariffs have been used for about 90% of all occupational pension contracts.
What does “zillmerization” mean? Zillmerization is an insurance mathematical method developed by the mathematician August Zillmer (1831 to 1893) to offset the acquisition costs of life and health insurance policies. The acquisition costs are taken into account in the present value of the insurance benefits. As a result, the zillmerised actuarial reserve is negative at the start of the contract. Because the surrender value is based on the accumulated actuarial reserve, there is no surrender value and no premium-free sum insured in the initial phase (possibly several years). In the event of premature termination of the contract, there is even the risk of total loss of the premiums paid up to that point in the worst case.
Conversion of remuneration agreements that provide for zillmerized tariffs are invalid, as the LAG Munich determined in its decision of March 2007. The employer therefore owes the employee the difference between the surrender value and the sum of the premiums paid in – irrespective of any breach of the duty to advise and inform. The Düsseldorf Higher Regional Court (OLG) even declared in its judgment of 6 March 1992 (17 U 201/91) that employers are in a fiduciary-like position vis-à-vis their employees in the context of deferred compensation. Justification: By waiving cash wages, the employee transfers a corresponding countervalue to the assets of the employer, who is supposed to manage these for the benefit of the employee. In contrast, the Karlsruhe Higher Regional Court ruled in its judgment of 18 January 2007 (12 U 185/06) that deferred compensation does not constitute a fiduciary legal transaction. The Occupational Pensions Act distinguishes between – deferred compensation (Section 1(2)(3) and Section 1b(5) of the Occupational Pensions Act) on the one hand and – the employee’s own contribution (Section 1(2)(4) of the Occupational Pensions Act) on the other. An entitlement to dispose of assets economically attributable to the employees would not be created by the deferred compensation agreement. This merely replaced the claim under the law of obligations for payment of remuneration to the employee with another claim for payment of premiums to the product provider (insurance undertaking). If the deferred compensation is not assumed to be a fiduciary legal transaction, this excludes at most a conceivable criminal liability of the employer in this context in the case of “withholding and embezzlement of remuneration” (pursuant to § 266a StGB). Even if the Federal Financial Supervisory Authority (BaFin) has not objected to zillmerised tariffs in principle, they are inadmissible in the context of deferred compensation, as the decision of the LAG Munich shows. The Court of First Instance gives several reasons for this. Not “equal in value” The inadmissibility of corresponding agreements follows from the requirement of equal value applicable to the conversion of remuneration (Section 1 (2) no. 3 BetrAVG): According to this, future remuneration claims are to be converted into an expectancy of pension benefits of equal value. The term “equal value” is to be understood in the sense of an economically comparable pension expectancy. Employees must therefore always be entitled to the total amount of contributions paid in – at any time during the contribution payment phase. This inevitably results in the invalidity of deferred compensation agreements with zillmerized tariffs. Even a provable reference to the differentiated equality of value between the conversion amount and the pension claim does not release the employer from its liability, as the LAG Munich has now clarified in its decision. Therefore, it does not depend on the proof of such a notification by the employer (however, this was still the case at the Stuttgart Labor Court in a highly regarded ruling of January 17, 2005, 19 Ca 3152/04). Equality of value, as a statutory requirement, is generally not capable of consent.
Practical advice: – It does not matter which implementation channel (direct insurance, support fund, pension fund, pension fund) was chosen: According to the deferred compensation agreement, the employer does not only owe the mere forwarding of the converted salary components to the occupational pension product provider. Rather, with a view to his liability, even if a third party (e.g. a provident fund) is involved, he has to provide for a liability insurance in accordance with § 1 para. 1 sentence 2, para. 2 No. 3 BetrAVG, the employer is responsible for ensuring that the value of converted remuneration entitlements and the pension entitlement thus established is also equal. This is not the case, however, with zillmerised (reinsurance) contracts, as no entitlement is achieved here that would be economically comparable in the long term with the salary components contributed by the employee. – Due to the comparable interest situation, the same probably also applies to the so-called “caf�teria model”, i.e. the contribution of money to an occupational pension scheme under waiver of a higher salary. – The principle of equality of value cannot be circumvented as a higher-ranking federal law even by a generally binding collective agreement.
Unreasonable disadvantage If Zillmerisation is permitted by clauses in deferred compensation agreements, this also means an unreasonable disadvantage for the employee (in the opinion of the LAG Munich) contrary to good faith (within the meaning of § 307, Subsection 1, Sentence 1, BGB). Contractual provisions based on forms are unreasonable if the so-called user of the clause abusively seeks to assert his own interests at the expense of his contractual partner without also taking the latter’s interests sufficiently into account and granting him appropriate compensation. In this context, the special features applicable under labor law, in particular the provisions of the German Company Pensions Act (Betriebsrentengesetz), must be observed (pursuant to Section 310 (4) sentence 2 of the German Civil Code (Bürgerliches Gesetzbuch – BGB)). The contractual provisions must therefore be measured against the principle of equal value and the employer’s strict liability for default (Section 1(1) sentence 3, Section 1a(4) sentence 2 of the BetrAVG). If, therefore, the actuarial reserve that has been saved with converted salary components is impaired by a zillmerisation provision, this constitutes an unreasonable disadvantage and the corresponding clause is invalid. Restriction of portability According to the aforementioned ruling of the LAG Munich, an offsetting of acquisition costs in five years, as provided for in the draft of the new Insurance Contract Act (VVG) and which does not represent zillmerisation in the true sense, is also contrary to the flexibility and portability of the occupational pension scheme demanded by the legislator (§ 4 of the Occupational Pensions Act (BetrAVG)) and is therefore impermissible. The transfer options and entitlements (pursuant to Section 4 of the German Occupational Pensions Act (BetrAVG)) are intended to enable employees to concentrate the vested pension entitlements that they have acquired throughout their entire employment biography (with various employers) in a single pension account. Since the value of the entitlement to be transferred in the event of a change of employer in the case of zillmerisation – depending on the duration of the previous contribution payment – often tends towards zero or, in extreme cases, no surrender value could even be formed, the objective of portability pursued with the transfer regulations in Section 4 of the German Occupational Pensions Act would come to nothing if zillmerised tariffs were permissible. Furthermore (according to the LAG Munich), tariffs with a minimum surrender value in the context of deferred compensation constitute a violation of the principles of the recent case law of the Federal Court of Justice (ruling of 12 October 2005, IV ZR 162/03) on (minimum) surrender values for life insurance contracts, which was confirmed by the Federal Constitutional Court. Accordingly, the following must be ensured in the case of early termination of life insurance contracts with zillmerised tariffs: The calculated acquisition costs must be in reasonable proportion to the benefits provided by the insurance undertaking with regard to – the shortened term and – the objective of capital accumulation pursued by the policyholder. Accordingly, the surrender value must not be disproportionately low, which is why the BGH set a lower limit (= 50% of the unzillmerised actuarial reserve, which corresponds to about 45% of the premiums paid in). The points of view underlying these decisions of the Federal Court of Justice must apply all the more in the case of (purely) employee-financed occupational pension schemes, where the choice of the implementation method and the product provider (insurance company) is made solely by the employer. Objections of the insurance industry The German Insurance Association (GDV) objects to the aforementioned ruling of the Munich Higher Labor Court, among other things: – With zillmerised tariffs one achieves higher maturity benefits. – If the employee is sufficiently informed, a private autonomous voluntary (individual) agreement exists, which is why there is no unreasonable disadvantage. – In the more recent case law cited by the court, the Federal Court of Justice (BGH) had established the fundamental admissibility of Zillmerung. – In addition, according to the draft of a new Insurance Contract Act (VVG), an offsetting of acquisition costs would be permissible at least within five years. However, these arguments put forward by the insurance industry against the decision of the Munich Higher Labor Court are not convincing. The statutory requirement of equal value cannot be circumvented with an allegedly higher maturity benefit in the case of zillmerised tariffs. Given the fact that employees work for an employer for less than five years on average, the required portability and flexibility of occupational pensions is in any case not achieved. Even an express reference to Zillmerung does not make an individual agreement out of a general business condition. A statutory commandment cannot be overridden by it. The ideas underlying the rulings of the Federal Court of Justice (BGH) (of 12 October 2005), namely the proportionality of the acquisition costs and the objective of capital formation, speak against the admissibility of Zillmerisation in the case of employee-financed occupational pension schemes, as stated by the Munich Higher Labor Court. In the event of premature termination of employment, the accumulation of assets is precisely thwarted by zillmerised tariffs. The basic admissibility of zillmer-like methods of settlement under the draft reform of the VVG (zillmerisation in the actual sense is no longer to be permitted), e.g. over a period of five years, is irrelevant because the principle of equality of value is to be observed as the overriding special law in the case of deferred compensation.
Practical advice: Even if GDV takes the opposite view, the Federal Labor Court is unlikely to change the ruling of the Munich Higher Labor Court (LAG) – the defendant employer has appealed against this ruling (Case No. 3 AZR 376/07). This assessment is also supported by the fact that the decision of the Munich Higher Labor Court is based on the views of Dr. Gerhard Reinecke, the presiding judge at the Federal Labor Court who is responsible for occupational pension issues.
Consequences for the employer There is a risk that the deferred compensation agreement with the employee and the contracts with the insurers or product providers will be rescinded. Added to this are losses from additional burdens in taxes and social security contributions. Late payment penalties (0.5% or 1.0% per month) may be imposed for late payment of taxes. Under certain circumstances, a voluntary declaration may have to be made in order to obtain immunity from prosecution. In addition to additional costs for tax advisors or payroll offices, the employer also has to pay taxes because he can no longer deduct the employee’s social security contribution from his wages after three months.
Effects on the initial case (p. 206): – First, an amount (100%) was (ineffectively) converted into a bAV. The tax saving (up to and including 2008) was around 20% for the employer. Since after almost three years only 10% of the premiums paid in are now available as a surrender value, he must pay the difference of almost 90% in arrears and charge it to the employee as wages. – In addition, the employer must pay about 40% in social security contributions (social security at 90%). Thus, a burden of about 125% of the contributions made by the employee is borne by him.
Where have the contribution payments gone? The product provider calculates the zillmerised acquisition costs up to the statutory maximum rate of 4% of the sum of the premiums to be paid over the entire contract term from the insurance premiums contributed by the employee and passed on by the employer (Section 4 (1) Sentence 2 of the Actuarial Reserve Ordinance).
Reaction options for employers The ruling of the LAG Munich, which has met with widespread interest, now raises the question for many employers: How should they react to this decision? Anyone who waits risks even greater damage: The hope for a different decision by the Federal Labour Court (appeal proceedings, ref. no. 3 AZR 376/07) does not seem to be justified in view of the above reasons. Even hoping that the affected employees will not sue does not provide employers with the security they want and need. In any case, it is advisable to have the existing occupational pension scheme reviewed by lawyers and actuaries and not to conclude any new contracts with further employees until then. However, the following is problematic in this respect: The employee can insist on a contract on the basis of his entitlement in accordance with § 1a BetrAVG. With regard to possible claims for damages by employees, appropriate provisions should be made in the balance sheets. When buying companies, prospective buyers should take a close look at the existing occupational pension scheme and ask about associated risks on the balance sheets. However, the hasty conclusion of new products is not advisable. At the very least, you should have them legally and actuarially reviewed beforehand. Employers should also bear this in mind: In this context, they could possibly be entitled to recourse against intermediaries or insurers or other product providers due to incorrect information or incorrect advice. In many cases, employers were not even informed at all by the intermediaries when taking out the occupational pension. Rather, they only addressed the employees and then simply forwarded the contracts to the personnel departments of the companies, where they were then concluded due to a lack of information about the risks and disadvantages that this might entail. In particular, a failure to explain the undefined legal concept of “equal value” constitutes a breach of the intermediary’s legal duties. A claim against the respective insurer or product provider could already follow from the fact that the (insurance) contract with the latter is also invalid. The invalidity of the deferred compensation agreement affects the latter because it is a contract bundle with reciprocal reference. Employers have at least three years to assert such claims in court. It should not wait until employers, for their part, have recourse through their employees. Incidentally, due to the LAG ruling, many product providers (insurers) now offer to indemnify the employer against claims of its employees in the event that the deferred compensation agreement is null and void. Where appropriate, such a provision should also be sought in respect of existing contracts.
In addition, there are often so-called overbilling acquisition costs, ongoing costs and risk premiums. Under certain circumstances, cancellation deductions may even be due in the event of premature termination of the contract. As a rule, no information is provided on this risk associated with zillmerised tariffs in employee-financed occupational pension schemes. ❒
The authors Dr. Johannes Fiala, lawyer, MBA Financial Services, Master of Business Administration (Univ. of Wales), Master of Mediation (Univ.), banker (IHK), lecturer in civil law and insurance law (Univ. of Cooperative Education), and Dipl.-Jur. Univ. Thomas Keppel, lawyer, Munich (e-mail: firstname.lastname@example.org, Internet: www.fiala.de).
Published in ‘Bilanzbuchhalter und Controller’ (BC), issue 7/2007, Betriebliche Altersversorgung: Pflicht des Arbeitgebers zum Verlustausgleich bei Entgeltumwandlung, pages 206 to 209, with the kind permission of the BC editorial office, Verlag C. H. Beck oHG, Munichwww.bc-online.de.
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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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