On the outsourcing of pension obligations
The macroeconomic turnaround, along with the historic trend reversal in interest rates, has deeply impacted the German economy since 2022. The developments of the last two years have led to market upheaval and new volatilities. However, these changes also affect a part of the balance sheet that is important for many companies and should not be neglected: pension obligations.
Current interest rate and inflation trends have significantly increased the potential risks arising from pension obligations, with corresponding consequences for companiesโ balance sheets and cash flows. In particular, financial services companies, i.e. banks and insurers, are very much affected by these macroeconomic changes, be they positive or negative.
Moreover, the financial services sector has been undergoing fundamental disruptions for years. Changing customer behavior, the ever-increasing pressure to adapt resulting from the dual transformationย โ digitalization and decarbonizationย โ and increasing regulation are forcing many institutions to rethink their usual approaches and strategies. This situation warrants a detailed evaluation of how banks and insurers generally handle pension obligations.
Pension buyouts: effects and risks
What distinguishes pension buyouts from alternative approaches?
SW: In practice, companies have many options for funding pension commitments. These include recognition in the companyโs own balance sheet, reinsurance, contractual trust agreements (CTAs), โUnterstรผtzungskassenโ (benefit funds), pension funds and โRentnergesellschaftenโ (pensioner companies).
Only the latter option allows for a complete transfer of the risk and thus a complete derecognition from the balance sheet without any possibility of recourse.
Why have many companies currently opted for the CTA alternative?
NB: Banks and corporations want to outsource their pension obligations to shrink balance sheets and reduce financial risks. Contractual Trust Agreements (CTAs) do the job of shrinking the balance sheet, but ultimately the risks, especially inflation and biometric risks, remain with the company.
CTAs are very much in the public eye. Interestingly, however, the various risks and costs of this instrument are not widely discussed, especially among banks.
What risks and costs do you mean?
NB: Currently, banks must back CTA assets with a risk weighting of 0%. Many banks have therefore made investments through CTAs whose cash flows do not align with those of the pension obligations. This gives rise to further risks and costs on two levels in addition to the risks inherent in pension liabilities already listed above.
Firstly, the investment risks in a CTA must of course be assessed within the framework of Pillarย 2 of the Basel regulations. However, many banks have realized that they cannot adequately reflect these in their own existing risk models. This results in significant costs and additional complexity, which in a โnet viewโ can outweigh the advantages of a CTA.
Secondly, it cannot be ruled out that the supervisory authority will withdraw the RWA zero weighting in the foreseeable future. This is not unlikely, if only because insurers have to back 100% of the risks from the CTAs with capital.
What economic effects can be expected on the balance sheet and income statement if there is a complete buyout?
NB: In principle, the effects on ROE and capital ratios naturally vary from bank to bank. Together with zeb, however, we have developed a simple analysis grid to assess the significance of the topic.
We currently assume that the topic could be of considerable importance for more than 80ย savings banks and more than 70ย cooperative banks and could make a relevant contribution to increasing ROE and capital ratios.
Apart from purely economic considerations, what other factors need to be taken into account?
SW: Economic considerations are only one aspect in this context. The “human” component must always be taken into account. In my opinion, the issue of “emotions” will have more of an impact on the discussion than the pure question of maximizing the ROE. How will the transaction be communicated? Do pensioners feel included? What kind of relationship does the bank want to maintain with pensioners?
At the same time, there are specific situations where a pension buyout offers additional benefits. These include strategic realignments, the need to hedge against equity volatility, or a high level of risk aversion on the part of the institution.
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Feasibility and implementation
What information is needed to assess feasibility?
SW: An initial assessment requires the pension reports and ideally the projected pension payments. For a more detailed due diligence, it is also necessary to include the biometric data of the beneficiaries and the individual pension regulations to make a sound risk assessment.
How complicated is the implementation of a transaction?
NB: Such a transaction is not all that complicated, as it essentially consists of three components:
- First, the pension liability is spun off into a pensioner company in accordance with the โUmwandlungsgesetzโ (German Transformation Act), with an endowment that follows established case law.
- Second, the pensioner company is sold to a service provider, such as VEDRA Pensions, which will operate the company.
- Third, the pension assets of the pensioner company are usually transferred to a trust, ensuring that these assets are earmarked for a specific purpose. Such a pension buyout can usually be completed within 3โ4ย months.
Mr. Weissbrodt, Mr. Blanchard, thank you very much for the interview!
