Germany’s pension market has been slow to embrace full risk transfer deals but a weakening economy and rising geopolitical instability are breathing life into the sector.
From a virtual standing start, buy-outs have increased in the past few years and the number of companies offering to absorb schemes has risen to about seven, with a handful more thought to be waiting in the wings as transactions multiply, said Hanne Borst, Head of Retirement at WTW Germany, the latest entrant to the market.
“De-risking is a hot topic in German corporate headquarters. In the past, the focus was on building up plan assets or outsourcing pension obligations. Now, buy-out solutions are increasingly coming to the fore,” she said.
“If you look in 10 years ahead, we think that perhaps 10% of the DB liabilities could be transferred – that’s about $60bn to $70bn.”
Total pension liabilities on German company books are estimated to total around €700bn.
The pension risk-transfer (PRT) market operates differently in Germany compared with the US and UK, and really just got going in the past few years. It was only in 2015 that the first deals became apparent following a Labour Court decision that paved the way for the creation of pension buyout companies.
DB schemes in Germany are principally managed through the Direktzusage model in which liabilities are held as book reserves by sponsoring companies. They make a direct promise to pay members their pension benefits from their own balance sheet rather than through a separate fund or trust.
While this adds to the long-term liabilities on a company’s books, there is no requirement for employers to make provisions for pension payments in advance; instead they are settled as each retiree leaves the workforce.
The pension scheme – risks and assets included – can be transferred from the balance books by spinning it off into an intermediate company, called a Rentnergesellschaft, which can then be sold to a pension risk vehicle that is usually a special fund or private equity firm.
The process, in essence, is a buy-out without the need for a buy-in that rarely includes insurance companies.
“A buy-out in Germany, in fact, does nothing else than replace the former employer, providing the pension promise is exactly one-to-one as originally contracted,” said WTW Germany Senior Director of Retirement Johannes Heiniz.
The emergence of companies that buy pension schemes in this way is partly the result of regulations in the country that limit the ability of insurers to offer more attractive pricing on bulk annuity purchases (BPAs), said Thomas Huth, Partner at Lurse, a German pension risk buyer and consultancy. As a result, BPAs account for a small part of the total pension de-risking market.
“For corporates the buy-out market appears to be more attractive than the bulk annuity market because insurance regulation limits the applicable discount rate to 1.0% for reinsurance contracts, compared to a market rate for pension buy-outs,” Huth said.
Despite the simplicity of the de-risking design, deals can still take as long as two years to complete. Slow progress is often the result of corporate caution over transacting deals of such high value and because many transacting companies are foreign owned; getting approval from head offices overseas takes longer than from a domestic headquarters.
“It’s big money and it’s decision-making within the company, and that’s always difficult,” said Huth.
Focused mostly on M&A and liquidation cases, a trickle of deals has turned into a stream that’s expected to grow at around 1%-1.5% each year.
Deals in the space have been relatively small, compared with the UK and US markets. The largest deal so far, a €300m transaction struck in 2022, came as part of the sale of airline group Lufthansa’s catering business. But deal sizes are expected to grow as the market matures.
“Within the next 12 to 24 months we will see a couple of mid-sized deals, around the €200m to €400m transactions,” Huth said.
Growth is expected to be driven by a number of factors. While higher interest rates and robust capital markets have made buy-out pricing more attractive to companies – effective funding ratios stand at 82% – the weakening German economy and the transformation processes of large industries is expected to have the greatest influence.
Declining profitability, rising inflation and geopolitical risk – especially since Russia’s invasion of Ukraine in 2022 and more recently amid threats of US tariff increases – have set German business on a prolonged bout of de-risking. Rising market risks increase balance-sheet volatility and impact firms’ profit and loss accounts. In such an environment, removing liabilities becomes attractive.
Further, business restructuring has become more widespread as the economy has weakened and M&As, business carve outs or liquidations tend to stimulate pension outsourcing.
Companies have traditionally had a number of avenues to reduce their pension risks. A common option has been the creation of Contractual Trust Arrangements (CTAs), which hold and manage scheme assets while enabling firms to retain the tax and accounting advantages of leaving their liabilities as book reserves.
Less commonly, schemes can be outsourced to Pensionfonds, which are similar in style to the UK buy-in and buy-out offerings of insurance companies, but often leave sponsoring companies with residual risks and financial obligations. Other firms have simply reduced risk by redesigning their plans.
Neither, however, offer a means of fully severing their ties to the scheme. Borst said this is good news for the buy-out market.
“This risk roadmap will continue, and I think the next logical step is that priority solutions will be pension buy-outs,” she said.
The forecast for the German PRT market is upbeat. Huth said that the infrastructure– lawyers, consultants and auditors with necessary expertise– is growing and that the managers of DB schemes are becoming more aware of the de-risking option.
This could be important as the pool of DB expertise dwindles. The steepening age profile of the country is being reflected in the back offices of pension administrators, with DB professionals retiring and few experienced staff able to replace them; new entrants are more likely to be schooled in DC pensions. This loss of talent could drive more companies to offload their schemes.
“The personnel that are administrating and counselling DB plans will leave within the next five to 10 years,” Huth said.
“Replacing them will be difficult and even if they are replaced it will be difficult to match their expertise. This is sooner or later going to be very critical for companies, and will drive outsourcing, but also pension buyouts.”
