Review of pension benefits in accordance with Sec. 16 BetrAVG
Impulses from recent case law
According to Sec. 16 BetrAVG, employers must every three years review the need for adjustments to current benefits from pension commitments. In our DPE Client Alert, we discuss current impulses from the jurisdiction of the German Federal Labour Court for the practical implementation of such review.
1. Introduction: The Scope of applicability of Sec. 16 BetrAVG
Pursuant to Sec. 16 (1) of the German Company Pension Scheme Act (BetrAVG), employers must at least every three years undertake a review of the current benefits from their company pension commitments (BAV commitments) for the need of adjustments and - if they execute the adjustment in the form of a lump sum adjustment pursuant to Sec. 16 (3) BetrAVG - decide on such adjustment at their equitable discretion. The review covers BAV commitments with retirement pension and survivor benefits. The review also covers vested entitlements of eligible former employees if the employer ensures the equivalence required for the pension members vis-à-vis active employees by means of the adjustment review pursuant to Sec. 16 BetrAVG (Sec. 2 a (2) sentence 2 no. 2 lit. c) BetrAVG).
The employer must carry out the adjustment review every three years. The bundling of all examination dates occurring in the company to a uniform annual date (e.g. 1 July) or a uniform three-year date (e.g. 1 July of every third calendar year) is permissible.
2 Starting point of the adjustment review
The adjustment review is based on a weighing of the pension beneficiary’s interest in an equivalence of the pension benefits with the employer’s interest to carry out an adjustment only in case it has sufficient economic capacity.
The pension beneficiary's interest in the equivalence of the pension benefits results from the inflation-related devaluation of the pension benefits during the adjustment period. Pursuant to the law, the relevant parameters for the protection against devaluation by means of adjustment consist in (1) the development of the consumer price index and (2) the increase in the real wages of comparable employees in the employer's company during the reference period of the adjustment review (Sec 16 Para. 2 BetrAVG).
The concept of the employer’s economic capacity requires that the employer is able to fund the adjustment from its earnings and the increase of its enterprise’s valuation rather than the company’s substance. The adjustment of the pension benefits must not adversely affect the preservation or competitiveness of the employer’s enterprise or the number of jobs in the company.
The adjustment review is subject to review by the competent labour court. If the labour court comes to the conclusion that the employer has made only inadequate adjustments, the labour court can replace the inadequate adjustment decision with its own assessment.
3) Individual Assessment of economic performance: Appropriate return on equity
The Federal Labour Court (BAG) has provided additional guidance with respect to the criteria to be applied when determining an employer’s economic capacity. The employer is subject to the obligation to adjust (only) if the employer achieves an appropriate return on equity from its operating business. The return on equity is calculated by dividing the earnings power by the equity base, in each case in accordance with the accounting provisions of the German Commercial Code (HGB).
The applicable earnings power is assessed on the basis of the operating result (EBIT). For the adjustment review, the EBIT must be adjusted for extraordinary income and losses (Sec. 277 (4) HGB). Furthermore, the investments to be expected on the adjustment date must be deducted from the EBIT.
The equity base is to be deduced from the equity position pursuant to the German HGB based balance sheet (Sec. 266 (3) A. HGB). For the adjustment review, the equity base must be modified by reducing the equity by already justified pension obligations not (yet) recognised in the balance sheet and by accounting for increased depreciation. The equity base is determined on the basis of the average equity of the financial year of the adjustment reporting date.
The benchmark for the appropriate return on equity is the current yield on public bonds, which for comparison purposes must be increased by a risk premium of 2%. The appropriate return on equity is subject to a dynamic analysis. The decisive factor is whether there are signs of a positive development in the reference period, which suggests that the economic situation in the three years following the adjustment date will be sufficient to fund the adjustment.
If the company has gone through an equity-consuming crisis, the employer does not have to make a - complete - adjustment even if the return on equity develops positively. The employer may firstly use the income to compensate for the reduction in the equity base caused by the losses. This is particularly the case if and where the company's equity capital has not yet reached the sum of subscribed capital (Section 272 (1) HGB) and additional capital reserves (Section 272 (2) HGB).
4. Current Impulse from case law: Dynamic Assessment
In its judgement of 22 January 2019 (3 AZR 616/17), the BAG has further specified the parameters for a dynamic analysis of the development of the return on equity. In the case decided by the BAG, the employer had consistently achieved a positive result in the adjustment period (years 2011 to 2013), but was able to achieve a return on equity that exceeded the yield on public bonds plus the 2% risk premium only in the financial year 2012.
The BAG clarifies that the appropriate return on equity must be calculated separately for each financial year and that a below-average development in individual financial years cannot be offset by an average over the three-year adjustment period. Since the result also declined steadily during the adjustment period, the BAG recognized that the employer could assume that its economic situation would not stabilize as of the adjustment date (1 January 2014) due to the volatile economic development.
The BAG points out that a prudent overall assessment, taking into account all parameters relevant to the review, must be carried out for the specific adjustment review.
5. Summary: Need for Examination of each Individual Case
In view of the complexity of the underlying requirements, adjustment reviews may entail considerable economic risks for employers; especially if, despite positive operating results, employer's only carry out a partial adjustment during the adjustment period with regard to the other parameters for economic performance or where employer’s refrain from making an adjustment and pension beneficiaries then file an action against the results of the adjustment review, based on the allegation that the adjustment is inadequate.
At the same time, the additional guidance given by case law, in particular decisions of the BAG offer lines of argumentation for needs-based and legally secure results.
Feel free to contact us with any questions you may have regarding implementation.