It happens again and again that typical medium-sized GmbHs get into a crisis situation because a managing director suddenly becomes professionally incapacitated. Read where the causes and liability traps lie.
If the boss is absent due to health problems, it often becomes critical for the GmbH. This is not an isolated incident. 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?
Lack of reinsurance
The promise of pensions is a model to save taxes at the GmbH in the first place. That’s why it’s so popular. But already in the case of old-age pensions, i.e. pure old-age pensions, it is little known that the necessary financial resources have to be about twice as high as they are taxable. This means that the company has to set aside profits and pay tax on about half of them.
False 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 kicks in and a new insurance agent does some research. 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.
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 six percent per year net. For this, an investment or an insurance policy would have to generate a gross return of about ten percent per year. However, in the past and still today, the pension commitments were financed or reinsured with a German endowment life insurance policy. The realistic return on German life insurance policies is currently only around four percent per annum gross, i.e. around 2.4 percent net after tax (tax rate 40 percent of the GmbH). The missing financial means at retirement of the managing director must then be serviced by the GmbH from the GmbH’s own cash flow and this often for the next 20 years until the end of life.
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 to 30 percent 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 retirement pension. In other words, if only 70 to 80 percent of the savings portion flows into the reinsurance for the old-age pension, 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, the GmbH has covered the risk of occupational disability with an occupational disability pension from an insurer, which is the case in around 90 percent of all pension commitments on the market. Here, however, often begins another drama, which the insurance agent of course for business reasons usually does not mention. If the customer is healthy and the occupational disability pension is accepted by the insurer, then everything seems to be in order. Many old pension commitments were based on a benefit of the occupational disability pension 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 GmbH shareholder-managing director (GGF) if a clause for the payment of an occupational disability pension is included in the commitment, but the GmbH is not allowed to pay the pension to the GGF for the aforementioned reasons. Every GmbH should urgently review this clause 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.
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, in individual cases it may be “on balance” cheaper 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 prepared later by the tax advisor, as proof of loss. Some agents overlook this task as well, and fail to “fix” this liability trap.
Balance sheet bounce risk
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, however, invalidity cannot be established indisputably as a rule; 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. The box shows an example of such an argument. 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 fact that the following curiosity may occur in the end. In the event of disability, the employer (limited liability company) must pay the disability pension contributions 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. The GGF could also 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 generally be given to keeping disability or occupational disability pensions 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. Possible solutions The management consultant Andreas Bosl from Mittelstands Beratungs-Dienst (MBD) Pöcking sees a considerable need for advice in existing pension commitments and suggests the following solutions to the problem: It is better here to shift the coverage of occupational disability to the private sector, because then the GmbH and its GGF are not burdened. In addition, a pure risk insurance for occupational disability is often much cheaper and usually has even better insurance coverage, depending on the occupational disability rating of the insurance company. An existing occupational disability pension could also be limited to the so-called target/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 policy would have to be redesigned and the residual risk of disability would have to be covered by an inexpensive private occupational disability pension with a good insurer. Here 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 200,000 to 300,000 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, for example, 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.
Dr. Johannes Fiala Andreas M. Bosl
(Si-information 2/2007, 56)
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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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