Credit risks due to company pension schemes

Liability risks and over-indebtedness of borrowers due to lack of equal value of deferred compensation and undervaluation of other pension obligations.
I. Introduction
w “No future can make up for what you fail to do in the present.” (Albert Schweitzer, Protestant theologian, musician, philosopher and physician 1875-1965)
This simple formula marks the beginning of the bank clerk’s training in the credit department. But the pitfall is in the detail, especially in the balance sheet analysis in the case of corporate credit with numerous regulations such as KonTraG, Basel II, etc. In connection with the company pension scheme, the credit risks of the entrepreneur and the company are often not tangible at first glance. The task is therefore to determine what questions the banker in the credit department needs to ask in order to facilitate an assessment of the risk potential.
II. Employer liability in the case of deferred compensation – requirement of equal value
To put it delicately, the claim under insurance law (of the employer as policyholder in the case of direct insurance) clearly lags behind the claim under labour law (of the employee vis-à-vis the company). This can be applied by analogy to almost any implementation method for deferred compensation. With effect from 01.01.2002, the Company Pensions Act stipulates that the employer must invest the money of its employees “in equal value” within the framework of a company pension scheme, in particular in the case of salary conversion (requirement of equal value). The legislator did not provide a definition for this. Courts found, however, that the employer “participates as a disinterested fiduciary” in the process. At the beginning of 2006, a judge of the Federal Labour Court literally dropped a bombshell. He postulated that a violation of the requirement of equal value leads to the (partial) invalidity of the deferred compensation. From a practical point of view, the issue is the acquisition costs which, in the case of direct insurance and other ways of implementing occupational pension schemes, are charged “through the back door”, as it were, to occupational pension contracts for the benefit of intermediaries and insurers. The acquisition costs (including brokerage commissions) may amount to more than 10% of the agreed sum insured or more than 6% of the scheduled premium sum agreed until the start of the annuity: These costs are then usually charged to the insurance contract immediately in the first few years. Here is an example: A 30-year-old office temp saves €100 each for 18 months, i.e. €1,800, as part of a deferred compensation scheme. The money goes into a life insurance policy. When the employee leaves the company after 18 months, the employer gives her the insurance contract, in which she has a surrender value of about 30 € at her disposal. The so-called zillmerisation of the acquisition costs alone has already consumed 4% of the premium sum up to age 65 (35 years times € 1,200 = € 42,000), i.e. € 1,680. As a rule of thumb from practice, in the first few years it is a matter of “missing amounts” in the four-digit range per employee – in the retirement age of the employees it is mainly a matter of five-digit amounts due to the additional interest disadvantages – in the example case with 5.5% interest up to age 65 alone as a result of zillmerisation already just under € 11,000. Effectively, this results in reductions in later pensions of 20% and more, and occasionally also significantly higher losses for the employee (see Fig.1). The employer’s liability due to the lack of equal value of the deferred compensation often becomes apparent when the employee leaves the company – or only at the start of the pension, as soon as the employee learns of the actual value of his or her pension plan. More serious is the liability, initially hidden, which is not recognized until the annuity begins and has increased to a multiple of the original amount through interest and compound interest.
III. hidden over-indebtedness through deferred compensation
1. calculation of hidden over-indebtedness
The exact amount of the employer’s or deficiency liability must be calculated in each individual case by an actuary or actuaries, because this can lead to a previously unrecognized over-indebtedness of the company. Here is an example: An industrial company paid € 1.2 million into a provident fund (U-Kasse) for its 1,000 or so employees over a period of three years as part of deferred compensation. After three years, € 3.6 million had been paid in – the current value of the assets in the U-Kasse was only € 0.6 million. The actuary was able to calculate the total loss after an assumed average term of 25 years as a liability potential of just under € 8 million. Roughly speaking, the employer owes the employee the amounts not effectively converted as damages, plus annual interest and compound interest.
2. legal obligation: risk management
Such findings lead to further questions for management, such as the question of legal risk management. The tax advisor must provide information on how he treated the “partially ineffective deferred compensation” for tax purposes – or whether, for example, an “affiliated” company collected the brokerage commission. The cautious banker will not consider recourse claims against insurers, intermediaries and advisors, as these would regularly have to be sued for first. There are also said to be more than just individual cases in which the management made a profit from the commissions under the table and had this financed by the converted remuneration of the employees. usually exists for the employer since 2002 according to § 91 para. 2 AktG the obligation for risk management – the gaps in the company pension scheme and the sometimes considerable employer liability cannot be left out here. This also applies accordingly to every medium-sized GmbH via § 43 GmbHG. Transparency within the employer’s company is intended to prevent insolvency risks and increasing liability risks.
3. hidden over-indebtedness due to management pension plan
Pension commitments and provision via a U-Kasse are popular methods of providing for managing partners (GGF). The yardstick for determining whether the available assets are sufficient from an economic point of view can be the offer of a life annuity by an insurer. Practice shows that often only a fraction of this is actually available as cover funds. A look at the balance sheet is also deceptive in the pension commitment model, because only the so-called tax provision value according to § 6 a EStG can be found there: The capital required at the start of the pension is discounted at 6% to the pension expectancy cash value and the trend from lengthening life expectancy is largely disregarded. The tax law thus assumes that existing capital investments will earn interest at 6% and that life expectancy will hardly be extended any further. In the commercial balance sheet and even more so in an over-indebtedness balance sheet, however, only half or even less of the discount rate can be applied, depending on the situation on the capital markets, as a matter of commercial prudence. The provisions would therefore have to be valued significantly higher in the commercial balance sheet – in view of the size of some items in the liabilities, this alone can often consume the entire equity capital. In order to determine the exact amount of the real economic obligations, a legal analysis of the specific commitment formulations in the employment contracts and a subsequent actuarial valuation are required. In principle, this also applies to models that are not even shown in today’s balance sheet because it is assumed that the obligations are fully covered by other product providers. In the case of such models for off-balance-sheet outsourcing of pension provision, they often claim that this would even allow the employer’s liability for the occupational pension provision to be completely outsourced. However, this is not the reality – the employer is still liable and cannot legally avoid liability by transferring the pension scheme to a product provider. No product provider will legally enter into any liability of the employer – e.g. due to the lack of equal value of the deferred compensation.
(BankPraktiker 5/2007, 285)
Courtesy ofwww.bankpraktiker.de.

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About the author

Dr. Johannes Fiala
PhD, 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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