Currently, the typical medium-sized GmbH (limited liability company) finds itself more and more often in a crisis situation because a managing director suddenly becomes incapacitated for work. An isolated incident? No, because insolvency administrators observe that the occupational disability of the managing director has become an increasing reason for insolvency. But what are the causes and liability traps? What should be considered?
Risk of lack of reinsurance
The pension commitment is a model for first of all saving taxes at the GmbH. That’s why it’s so popular. But already in the case of old-age pensions, i.e. pure old-age pensions, little is known about the fact that the necessary financial resources have to be about twice as high as they are tax deductible. This means that the company has to set aside profits and then pay tax on about half of them.
Risk of incorrect broker information
It is not uncommon for the agent to tell the client that there is no possibility of insurance for certain pre-existing conditions. Later, disability occurs, and a new insurance agent investigates. In the case of various companies, it then emerges from their archives that the customer would in fact have been insurable after all. As a result, the former agent must now pay the disability pension.
Risk of the provision values
Furthermore, the provisions for a pension commitment are calculated on the basis of the so-called Heubeck mortality tables with an interest rate of currently 6.0 % p.a. net. For this to happen, however, an investment or an insurance policy would have to generate a gross return of around 10.0% p.a.. However, in the past and still today, the pension commitments were financed or reinsured with a German endowment life insurance policy, but the realistic return on German life insurance policies is currently only approx. 4.0 % p.a. gross, i.e. approx. 2.40 % net after taxes (tax rate 40 % of the GmbH). The GmbH then has to cover the lack of funds when the managing director retires from the GmbH’s own cash flow – and often for the next 20 years until the end of his life.
Risk of lack of insurance solution
In addition, a typical medium-sized GmbH cannot afford it financially if a managing director becomes disabled. His occupational disability leads to financial obligations that lead straight to insolvency. Business economists speak of “incongruent reinsurance” if the managing director is promised an occupational disability pension in his pension commitment but there is no special reinsurance for this risk. Then in the case of damage the middle class GmbH must carry the financial expenditure alone.
Risk in the insurance solution
In the past, however, an occupational disability pension was often included in the pension commitment, as this is an original field of business of the insurance companies. Good insurance premiums can also be earned in the process, often accounting for nearly 20-30% of the total premium for the insurance policy.
This risk premium built into the overall contract has the disadvantage that there are insufficient funds available in old age for the savings portion of the insurance, which is needed to finance the old-age pension. In other words, if only 70-80% of savings flow into the reinsurance for the old-age pension, then the capital required to finance the pension is usually not available at the start of the pension. This is a vicious circle, because if the company cannot be financed, the tax office can possibly point to hidden profit distribution, which in turn can lead to insolvency. In the best case, however, the GmbH has covered the risk of occupational disability with an occupational disability pension from an insurer, which is the case in approximately 90% of all pension commitments on the market.
However, this is often where another drama begins, which the insurance agent usually doesn’t mention for business reasons. If the customer is healthy and the occupational disability pension is accepted by the insurer, then everything seems to be in order. However, many old pension commitments were based on an occupational disability pension benefit in relation to the statutory pension insurance, which used to be correct as long as there was still an occupational disability pension from the legislator. However, this was dropped in the course of the changeover to the so-called reduced earning capacity pension and therefore there is no longer an occupational disability pension from the legislator.
It is fatal for the GmbH and the GGF if there is a clause for the payment of an occupational disability pension in the commitment, but the GmbH is not allowed to pay the pension to the GGF – for the above-mentioned reasons. Every GmbH should urgently have this clause checked in the interest of its GGF and have it redrafted accordingly by an expert. In any case, it would be important to adjust the occupational disability pension to the current insurance conditions of the respective insurance company. This means that the GmbH is only obliged to pay a pension in the event of occupational disability if the insurance company also pays on the basis of the conditions, otherwise there is the threat of insolvency again.
Tax risk of a design in the company
Not infrequently, a comparative calculation for tax optimisation of the burden is also missing. Two design errors are typical here, namely first of all that in the model calculation for the determination of needs it was simply overlooked that such pensions must also be taxed. The manager will then consider whether the model calculation was seriously flawed and he can claim the missing annuity to pay the tax from the insurance intermediary. In addition, it may be cheaper in individual cases “on balance” to cover occupational disability privately via a pure risk insurance, i.e. not via a pension commitment in the company. With nice regularity, such comparative calculations are only prepared later by the tax advisor as proof of loss. Some intermediaries also overlook this task and fail to “repair” this liability trap.
The problem of disability pensions in the context of a company pension commitment
However, the highest tax risk is likely to be the balance sheet risk in the case of premature disability benefits for the managing director. A relatively high disability pension as part of a pension commitment of a GmbH to the managing director is problematic in principle. In the event of disability, the GmbH is exposed to high risks, which are then generally to be covered by a reinsurance policy.
Unfortunately, as a rule, invalidity cannot be established indisputably; moreover, it is linked to a large number of conditions. In the case of the disability pensions under discussion, the insurer very often does not initially recognise the obligation to pay benefits, which then often has to be enforced through lengthy disputes and also litigation. Recent rulings on this contentious issue of occupational disability show that it is virtually impossible for a self-employed person (especially also controlling GmbH shareholder-managing directors – GGF for short) to receive such a pension. A decision of 18 February 2005 by the Hamm Higher Regional Court, which has only just become known, dismisses the action brought by a restaurant owner against his occupational disability insurer (Ref.: 20 U 174/04).
Reason: A self-employed person is only then incapable of working if there are no areas of activity open to him in his business in which he can still work to the conditional extent with his health impairment. The judges stated that a self-employed person was obliged to reorganise his business if necessary in the event of a health impairment.
In plain language: If a business has fields of activity which are still reasonable for the owner in terms of health, or if a reasonable reorganisation of the business would open up corresponding possibilities of activity, the court is convinced that this rules out a conditional occupational disability. Any reorganisation would have to take into account, where appropriate, redundancies and the recruitment of other staff. Conclusion: According to the judges, the owner of a restaurant who is no longer able to lift and carry heavy loads or to walk and stand for long periods of time has a wide range of employment possibilities, e.g. a supervisory position.
Furthermore, the difficulty arises that the conditions of the reinsurer and those of the pension commitment are difficult to reconcile. The theoretically possible reference in the pension commitment to the conditions of the insurer is problematic from a tax point of view because an independent definition of benefits is required here. Moreover, even this does not necessarily protect against the following curiosity occurring in the end: In the event of disability, the employer (GmbH) must pay the disability pension under the contract between it and its GGF, whereas the insurer may successfully defend itself against this. In this case, the GGF would insist on his benefits with the consequence that the GmbH would have to provide a considerable amount of capital as cover for the disability pension. However, the GGF could possibly waive its claims. However, this could be interpreted as unusual for him for tax purposes, with the consequence that the tax office would define a hidden equity contribution subject to wage tax for him in the amount of the cash value of the disability pension. For these reasons, consideration should in principle be given to the invalidity or
Keeping disability annuities out of a company pension commitment. This applies in particular if the GmbH is managed by several participating managing directors (or also authorised signatories), so that the remaining partner in each case has to deal with this problem. The management consultant A. Bosl of MBD Mittelstands-Beratungs-Dienst, Pöcking, sees a considerable need for advice here in existing pension commitments and proposes the following solutions to the problem:
In this case, it is better to shift the coverage of occupational disability to the private sphere, because then the GmbH and its GGF are not burdened. In addition, a pure risk insurance for occupational disability is often much cheaper and also usually has better insurance cover – depending on the BU rating of the insurance company. An existing occupational disability pension could also be limited to the so-called debit/partial value of the provisions. This has the advantage that the GmbH pays an occupational disability pension to the GGF in the event of a claim, but only on the significantly lower provision values at the time of the occupational disability. The balance sheet risk is then completely eliminated and the GmbH can usually cope with these pension payments without any problems.
However, the pension commitment and reinsurance would have to be redesigned and the residual risk of disability would have to be newly covered by an inexpensive private occupational disability pension with a good insurer. However, it should be checked in advance to what extent the new insurer covers the occupational disability risk on the basis of the existing health conditions. Only then should the existing contract be reduced or restructured. A worthwhile story, if one considers that under circumstances alone by the balance jump risk often 200000 to 300000 euro reserves must be booked profit-reducing by the tax adviser into the balance, which can mean inevitably an insolvency for the GmbH.
A sensible alternative for executives or managing directors is also a Keyman policy against e.g. 36 serious illnesses (cancer, heart attack etc.) which provides an immediate high capital sum and can be claimed as a tax-reducing business expense. This policy often makes more sense, as the sums due immediately provide the GmbH with an immediate high level of liquidity. This can be used, for example, to hire a new business partner or to pay off high credit obligations from the company. Disputes in court are usually avoided, because a heart attack is a heart attack, and the illnesses clearly defined in the contract therefore automatically lead to the insurer’s obligation to pay benefits.
by Dr. Johannes Fiala and Andreas Bosl
by courtesy of
www.median-verlag.de (published in Hörakustik 4/2007, page 76)
www.comepetence-site.de (published in competence-site.de, 01.2007)
www.channelpartner.de (published Jan 17, 2007)
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About the author
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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