Occupational pension provision: Zillmerisation in the case of deferred compensation inadmissible

Billion-dollar liability for employers, intermediaries and providers – employers successfully sued over company pension scheme. A few days before the oral proceedings (Case No. 3 AZR 376/07) before the Federal Labour Court (Bundesarbeitsgericht – BAG), the employer sued apparently recognised the hopelessness of its appeal.
The decision of the Munich Regional Labor Court (LAG) of March 15, 2007 (Case No. 4 Sa 1152/06) has now become legally binding after the employer withdrew its appeal.
He has been ordered to pay his former employee the wages that had gone into a company pension scheme (bAV) for around 3.5 years, but which was based on an ineffective deferred compensation agreement.

Liability for deferred compensation

Liability arose because the employer had offered its employee deferred compensation that was not “equal in value” as required by the Occupational Pension Act. About 90% of the contributions converted into or paid into the company pension scheme had “disappeared” when the employee left. These were the costs of intermediation (commissions) and contract set-up and management.

Seven legal grounds – one alone is sufficient: Zillmerisation leads to the invalidity of the occupational pension scheme

Agreements on deferred compensation which provide for zillmerised rates are simply invalid (cf. also presiding judge at the BAG Dr. Reinecke in: Der Betrieb, issue 10 of 10.03.2006, p. 555 ff, 562).

  1. infringement of the principle of equal value
    It is of no use to the employer if he (or “his intermediary”) had pointed out the lack of equality of value, because statutory requirements – such as the equality of value in sec. 1 para. 2 No. 3 of the German Company Pensions Act (BetrAVG) – cannot be waived.
  2. Violation of the duty of care under the employment contract (§ 611 in conjunction with § 241 (2) BGB)
    The employer violates these obligations if, by choosing a zillmerized contract, it initially allows the funds entrusted to it by its employees to be used exclusively to offset the acquisition costs of the insurance contract. Moreover, the question of criminal breach of trust may also arise here.
  3. Violation of the transparency requirement (§ 307 BGB)
    As already decided by the Federal Court of Justice, a clause in deferred compensation agreements allowing Zillmerisation is contrary to good faith and constitutes an unreasonable disadvantage, which results in its invalidity.
  4. Contradiction to the regulations on portability (§ 4 BetrAVG)
    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 (BetrAVG) would come to nothing if zillmerised tariffs were permissible. This also touches on the issue of free choice of occupation, as employees may in fact feel compelled not to change their occupation or employer in order to minimise the damage.
  5. Incompatibility with principles of recent case law of the federal courts
    According to rulings of the Federal Court of Justice (e.g. ruling of 12.10.2005, IV ZR 162/03), the absolute lower limit for private life insurance policies is “50% of the unzillmerised actuarial reserve”. The Federal Constitutional Court (decision of 15.02.2006, Ref. 1 BvR 1317/96) demands an appropriate distribution of costs because (private) life insurance customers must not be deprived of the opportunity to accumulate assets through zillmerisation. In employment law, the employer’s duty of care is added to this (see above).
  6. Restriction of legal flexibility (Section 1a (1) sentence 5 BetrAVG)
    The employee is entitled by law to determine anew each year whether and in what amount he or she wishes to convert his or her remuneration. It must be at least one hundred and sixtieth of the reference amount pursuant to Section 18 (1). 1 SGB IV (currently only 189 Euro per year). Gezillmermerte tariffs deprive this flexibility, since these assume a constant financing over often several decades.
  7. Incompatibility with the legislator’s objective: abuse of the systemThe legislator’s objective is to counteract old-age poverty and to close pension gaps. By participating in deferred compensation, the employee should ultimately not incur any risk. However, zillmerised contracts always involve a risk or certain loss for employees in the event of changes in the modalities of deferred compensation (contribution reduction or exemption from contributions). However, the fact that such models should then still receive tax incentives is not compatible with the objectives of occupational pension legislation. Zillmerisation in fact leads to a partial reintroduction of the “vesting” of the occupational pension, although the legislator has expressly provided for vesting here.
    The Federal Ministry of Labour and Social Affairs stated in an information brochure on deferred compensation of May 2002, among other things: “Contributions which employees invest in company pension schemes through deferred compensation cannot be forfeited. Every euro that is paid in either turns into an entitlement that is retained even if the company changes, or can be recovered later through severance pay …”
    Since it also states: “There are no acquisition commissions as in the case of a private pension insurance and no issue surcharge as in the case of the acquisition of investment units of an investment fund”, the prevention of the formation of a contract value in the first contribution years due to zillmerisation is excluded in the case of employee-financed occupational pension schemes.

Insurance companies know their liability

As a rule, providers of such “zillmerised contracts”, in which the costs of the contract for the entire (conceivable) term are regularly offset against the first savings instalments of the salary conversion, are insurance companies. Predominantly, agents or alleged business consultants sell such contracts for a commission – occasionally with an additional fee.

Stumbling block: incorrect advice and sales mediation

Some insurers are aware of their responsibility and have already set aside certain provisions in their balance sheets in recent years to cover employers’ claims. The sellers of such occupational pension contracts have regularly failed to point out to the employer that the legislator had expressly included employer liability in the absence of equal value in the law at the beginning of 2002.

Alternatives often cost the employer fees for independent advice

The employer would have had the option of contributing the salary, for which his employee also worked, to a company pension scheme without commissions or with the costs spread over the entire term of the contract. For example, there are pension schemes in which well over 90% of the contributions paid in are available as the “value” of the capital saved after just one year. Every employer and employee can check the value or surrender value annually and in advance, and compare it with the contributions paid in.

Support funds particularly affected

The lack of equal value occurs in almost all implementation methods of occupational pension provision (direct insurance, pension fund, etc.) – in the case of the relief fund this is apparently the rule due to additional administrative costs. In addition, some provident funds have already become insolvent – in which case the employer was additionally liable for the asset losses.
In addition, there is in principle no entitlement here with regard to transfer to a new employer.

Damage caused by insurance sales: Employer liability of over 50 billion euros

In such cases of ineffective deferred compensation, employers are regularly liable alone for the social security contributions to be paid in arrears – and then for both the employer’s and the employee’s share. This is then around 40% of the gross wage, plus interest from the respective payroll date in the amount of 0.5% per month. In addition, there is the compensation for damages, i.e. in effect the renewed payment of the converted wage plus interest.
Employers will want to recover this damage from insurance companies, management consultants and insurance brokers. Some employers perceive the misadvice of intermediaries as “financial fraud on a grand scale”. The auditors of the social security institutions visit the employer every four years and will do the math.

Old-age poverty or filling the pension gap: Others got the money!

Following the reduction in statutory old-age pensions, occupational pensions should serve to close pension gaps and counteract old-age poverty. In practice, however, the employees are left with nothing because the intermediaries – acting on behalf of the employer – have generally given incomplete advice. Conversion of remuneration reduces the entitlement to a statutory pension, sick pay and unemployment benefit. In old age, the employee must pay health insurance contributions and income tax on his occupational pension (usually alone). For the employee, this has rarely been a good deal later.

More in the account without deferred compensation

If an employee has his earned money paid out via the payroll, without deferred compensation, in order to invest it well at the bank for old-age provision, he would presumably have accumulated assets of around 70% by now with interest and compound interest. This money would then be available in old age – in contrast to the pension from deferred compensation – free of tax and social security contributions.

Insurance industry on the wrong track with its own creation of law

Some insurers believed that it was contrary to the contract for the employee to interrupt the payment of contributions (e.g. due to dismissal or parental leave). It is now often argued that there has been a new Insurance Contract Act since 2008 – but this does not regulate occupational pension provision in any way: The “mitigated” zillmerisation by distribution of acquisition costs still does not apply to occupational pensions by way of deferred compensation, because this has not been regulated in the Insurance Contract Act 2008, but is still in the Occupational Pensions Act with the employer liability.

Political response of the legislator since 2002 to the threat of old-age poverty

With the BetrAVG, the legislator is obviously deliberately making the employer liable. Leaving the establishment of occupational pension schemes to a mostly unqualified salesman who lives off commissions – mostly from a single insurer – is negligent. This would be just like an employer asking his cleaning lady to make payroll. The insurance industry has not yet realised that occupational pensions are a measure against the threat of old-age poverty among employees and not just another sales channel for unsuitable financial products. Insurance companies are of paramount importance to an economy, but not when they put masses of employers in a predicament of liability.
The sellers of occupational pension solutions are themselves not insured for the vast majority of incorrect advice: such “advisors” then lack an awareness of their responsibility.

Authors

Dr. Johannes Fiala, Lawyer (Munich), MBA Financial Services (Univ.), MM (Univ.), Certified Financial and Investment Advisor (A.F.A.), Banker, Graduate Mathematician Peter A. Schramm, Actuary DAV (Diethardt), Actuarial Expert and Thomas Keppel, Graduate Lawyer Univ., Lawyer (Law Firm Dr. Johannes Fiala)

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About the author

Dr. Johannes Fiala Dr. Johannes Fiala

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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