Pension buyouts as a strategic option for banks and insurers: an interview with VEDRA Pensions

Together with a solution provider, zeb has recently prepared a study providing an overview of the topic of outsourcing pension obligations. This study describes various options for dealing with pension obligations and derives impact analyses for typical banks and insurers. A key focus of the study is the so-called pension buyout as a key strategic option to ultimately transfer pension liabilities to a specialized provider.

A pension buyout is the (complete) transfer of pension obligations from a companyโ€™s balance sheet to a so-called pensioner company. The pension buyout is not only the most comprehensive and thus the most consistent approach to outsourcing pension obligations, but it is also particularly widespread in Anglo-Saxon economies and is gaining increasing popularity in Germany. The method used, known as a โ€œRentnergesellschaftโ€ (pensioner company), has a long history of success as an internal structuring instrument in German companies, providing the corresponding degree of legal certainty.

In this article, we discuss selected aspects and questions with two representatives of VEDRA Pensions GmbH[1], Siegbert Weissbrodt (SW) and Dr.ย Nicolas Blanchard (NB).

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?

Siegbert Weissbrodt
Siegbert Weissbrodt is a member of the advisory board and has 27ย years of experience in human resources, organization and restructuring. Before joining VEDRA Pensions, he was Head of Human Resources at the Deka Group in Frankfurt, Head of Human Resources at Nord/LB and trustee for the bankโ€™s UK pension plans.

SW: In practice, companies have many options for funding pension commitments. These include recognition in the companyโ€™s own balance sheet, reinsurance, contractual trust agreements (CTAs), โ€œUnterstรผtzungskassenโ€ (benefit funds), pension funds and โ€œRentnergesellschaftenโ€ (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?

Dr. Nicolas Blanchard
Dr. Nicolas Blanchard is also a member of the advisory board and has more than 25ย years of experience in the financial services industry at senior management level. Previously, he was a member of the Management Board of Hamburg Commercial Bank, after working as a personally liable partner at and as Managing Director of UniCredit Group. He is also a member of the advisory board of several companies in the financial services sector and SMEs.

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 โ€œnet 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.

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 โ€œUmwandlungsgesetzโ€ (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 3โ€“4ย months.

Mr. Weissbrodt, Mr. Blanchard, thank you very much for the interview!

[1] About VEDRA Pensions:ย VEDRA Pensions originated from the first takeover of pension plans from the former AEG Telefunken Nachrichtentechnik in 2016. Since then, VEDRA Pensions has established itself as a pioneer in the German market with innovative and pragmatic solutions.

VEDRA Pensions works with carefully selected experts to achieve the best possible results for its clients and beneficiaries.

Feel free to contact us!

Dr. Dirk Hollรคnder / author BankingHub

Dr. Dirk Hollรคnder

Senior Partner Office Frankfurt

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