Germany: Significant Changes Of The Law On Occupational Pensions In Germany – Mobility-Directive Enters Into Force On May 20, 2014

Keywords: occupational pensions, Mobility-Directive, European Parliament, pension rights, German Pensions Act,

Today, on May 20, 2014, the Directive 2014/50 of the European Parliament and of the Council on minimum requirements for enhancing worker mobility between Member States by improving the acquisition and preservation of supplementary pension rights, shortly referred to as the Mobility-Directive, enters into force. Once transposed, this Directive will cause significant, cost-relevant changes to the law on occupational pensions in Germany. Employers operating pension plans in Germany are well advised to acquaint themselves with the content of the directive and to analyze its consequences for the existing plans and define possibly necessary actions.

Content of the Directive New Rules on Vesting

Under the current law, pension rights become vested in Germany upon the end of an employment relationship if an employee leaves his employer at age 25 or later and the pension promise has been given at least five years before the end of the employment relationship (Sec. 1a of the German Pensions Act). For pension rights resulting from promises given before 2001, the relevant numbers are age 35 and 10 years since the pension promise. Art. 4 of the Directive does now oblige the Member States to ensure that pension rights shall vest after a period that, under no circumstances, exceeds three years and that the minimum age for vesting is not higher than 21.

Further, any vested pension rights resulting from a defined benefit promise are static under German law. Pursuant to Sec. 2 para. 5 of the German Pensions Act, any developments after the employee's exit, e.g., any dynamic or amendments of the underlying plan, do not affect the vested pension right. The nominal value of the pension right remains unchanged; as a consequence the pension right's relative value diminishes because of inflation.

Pursuant to Art. 5 of the Directive, Member States shall adopt measures necessary to ensure that the vested pension rights or their values are treated in line with the value of the rights of the active beneficiaries or the development of pension benefits currently in payment. The Directive prohibits the German concept of static vested pension rights. It remains to be seen how the German legislator will address this issue. It might adopt a rule reflecting the already existing principles for the adjustment of benefits in payment, or introduce an automatic increase in line with capital market developments.

Additional Information Duties

Under Sec. 4a of the German Pensions Act, employers or external pension providers have to inform beneficiaries about the benefits that they are likely to receive and about the so called transfer value (Übertragungswert) if the beneficiary has a justified interest in such information. According to Article 6 of the Directive, these information rights will be broadened; e.g., surviving beneficiaries shall have these information rights as well.

The most important aspect of these new rules is likely to be the requirement of "clear" information. It is to be expected that the courts will interpret the "clear" requirements in the same way in which they interpret the requirement to use "clear" language in general terms and conditions under Sec. 307 para. 1 of the German Civil Code. This is a very strict test and any ambiguity from a third-party perspective in the language used is likely to lead to the "clear" requirement not being met. Consequentially, the hurdles posed by the clarity requirement are likely to be high and demanding.

Further Reduction of Employer's Rights to Pay Off Annuity Rights

The current law in Germany very strongly reduces an employer's right to prematurely pay off an employee's pension right. Under the Mobility-Directive any paying off of vested pension rights will require the employee's informed consent. The practical possibility to unilaterally pay off minimum pension rights, which is possible in Germany today, will therefore no longer be allowed. This is likely to increase administrative burdens for employers.

Scope

The Directive stipulates that it only applies to cross-border employee transfers. However, the German Ministry for Labor and Social Matters has already announced that they will transpose the Directive also for inner German scenarios in order to avoid an unjustified different treatment of these scenarios. According to information available to us, this will definitely apply to the reduction of the vesting period from five to three years, the obligation to ensure dynamic vested rights and the reduction of the minimum age to 21.

The Directive further stipulates that its content shall apply only to periods of employment falling after its transposition. The German legislator could, however, go beyond this minimum requirement when transposing the Directive and stipulate, e.g., that the new rules also apply to periods of employment as of 2014. However, this is not to be expected in our eyes. The Directive does not apply to any pension plan that was closed for new entries on 20 May 2014.

Practical Consequences

According to our knowledge, the Ministry of Labor and Social Matters plans to publish a first bill of a transposition law in fall 2014. However, it is generally expected that the new rules will not be effectively transposed into German law before 2017. The German legislator must have transposed the Directive by May 21, 2018.

Therefore, employers offering occupational pension plans in Germany still have some time to acquaint themselves with the consequences of the transposition of the Directive and to prepare suitable reactions. The economic consequences, especially the consequences of the obligation to introduce a dynamic to vested pension rights and the reduced criteria for vesting, will lead to significant additional cost, especially for those employers operating dynamic defined benefit plans.

Maintaining occupational pensions as an attractive component of a total compensation package and as a strong measure to retain top talent while at the same time ensuring cost control and proper risk management will require creative solutions. In many cases the amendment of DB plans into German DC-like plan structures may be the solution. Those plan structures are especially referred to in Article 5 of the Directive fair solutions, if they provide for certain dynamic elements (e.g., the return of investment derived from the plan is used to adjust the value of the vested pension rights).

Originally published May 20, 2014

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