Adjustment of occupational pension benefits according to sec. 16 Pension Schemes Act (BetrAVG) in the inflation environment and the economic situation of the company

Prerequisites for an adjustment obligation

Pursuant to sec. 16 para. 1 BetrAVG, the employer has to consider an adjustment of current occupational pension benefits every three years and decide on this at its reasonable discretion. In particular, the interests of the beneficiary and the economic situation of the employer need to be taken into account. Such an adjustment obligation does not exist (only) if (i) the employer increases the current benefits by at least 1% per year for pension commitments made after 31 December 1998; (ii) the occupational pension is implemented through a direct insurance or a pension fund (Pensionskasse) and from the beginning of the pension all surplus shares (Überschussbeteiligung) accruing to the pension portfolio are used to increase the current benefits provided; or (iii) a defined contribution plan with minimum benefits has been granted.

If it is evident that the pension has lost purchasing power since the individual commencement date of the pension, the "concerns of the pension recipient" are affected and pension recipients are generally entitled to a respective adjustment of their pension benefits to the loss of purchasing power that has occurred.

Adjustment options

In order to determine a loss of purchasing power, the employer has different standards at its disposal: The employer can either refer (i) to the development of the consumer price index (CPI) or (ii) to the development of the net wages of comparable groups of employees in the company. In principle, the employer may decide at each review meeting (anew) which standard to use.

In practice, the majority of employers made use of the development of the CPI up to now. However, as the reference period is calculated from the individual pension start date to the respective adjustment date, this may lead to significant increases for pension payments that have recently started. For example, the CPI increased by 11.1% from June 2019 to June 2022. A monthly occupational pension benefit of EUR 100.00, which was first paid in June 2019, would then have to be increased to EUR 111.10 from June 2022.

In contrast, the net wages of employees generally did not increase by a comparable amount in the past three years. For example, the average annual pay grew by only 7.99% from 2019 to 2022; in the collective bargaining sector of the metal and electrical industry, wages increased only 4.68% from 2019 to 2022.

Adjustment according to the net wage method - sensible alternative?

As liquidity in many companies is under severe strain, particularly due to the COVID-19 pandemic, the semiconductor shortage, the war in Ukraine and the associated raw material difficulties and rising energy costs, a significant pension adjustment may further increase the risk of economic bottlenecks for companies.

Therefore, it may well make sense to examine whether the pension adjustment in conformity with the net wage development leads to lower costs than an adjustment according to the CPI. Another positive (side) effect may be the increase in employee satisfaction, since when using the CPI as adjustment factor, pension payments usually increase significantly more than the salaries of active employees when the inflation rate is high.

However, it should be noted that according to sec. 16 para. 2 no. 2 BetrAVG it is necessary that the respective net wage development is determined on the basis of "comparable groups of employees in the company", which may cause difficulties in practice. In many cases, a comparable group of employees in the company no longer exists or it can no longer be determined to which group of employees a pensioner previously belonged. It is also conceivable that after a restructuring, the necessary historical income data is no longer available. Therefore, the choice will primarily depend on a case-by-case consideration of the savings potential and the additional administrative effort associated with a legally correct and partly complex determination of the comparable employee groups.

However,  adjustments by the net wage development are usually not favorable if it concerns pension payments that have already been running for a long time. For example, the CPI has increased by about 70.63% from 1992 to 2022 while net wages have increased by 97.52% in the same period. In particular, the development of collectively agreed wages has regularly significantly exceeded the increase in the CPI in the past.

When may an adjustment be omitted?

Although an employer may be in principle obliged to adjust, he may be allowed to omit or refuse the adjustment if it conflicts with the employer's economic situation. This is the case if the additional burden of the adjustment cannot be financed by the expected earnings. According to case law, the burden caused by the cost-of-living adjustment need to be determined and estimated due to their effects on the further development of the enterprise.

In order to be able to assess whether the additional burden of the adjustment may be financed in the future by expected earnings, a forecast decision is required. As a basis for this, the previous development over a longer, representative period of at least three years has to be evaluated. First, the foreseeable investment needs of the business must be taken into account as of the adaptation date, e.g. currently in particular with regard to the pressure to adapt due to climate changes and digitalisation.

Second, the appropriate return on equity has to be taken into account in favour of the company. If the company cannot show such a return, it generally has to be assumed that the additional burden of adaptation cannot be financed by expected earnings. According to the case law of the FOPH , the appropriate return on equity (for operating companies) consists of a basic interest rate and a risk premium, whereby the basic interest rate corresponds to the current yield of public bonds (Bundesanleihe ) and the risk premium corresponds to a uniform 2% for all companies. Thus, if the return on equity is not at least two percentage points above the current yield of public bonds, an adjustment may be omitted. Whether this is the case is determined based on the company's annual financial statements prepared in accordance with commercial law. It should be noted, however, that according to case law, necessary business corrections need to be made, e.g. with regard to fictitious profits or excessive depreciation.

However, in the still prevailing low interest rate environment, this standard often does not representatively indicate the capitalisation of the company required to make the adjustment. Even in cases where equity capital was used to overcome economic difficulties, the return on equity alone is not informative. The economic situation will therefore usually only be discernible from the overall picture of the criteria recognised by case law and from their interaction. For example, a decline in turnover with rising profits can indicate a good economic situation, whereas a loss can only indicate a poor economic situation. Frequently, the economic situation of the enterprise therefore has to be examined based on several or even all of the relevant criteria.

In group structures the difficult question arises whether the criteria are limited to the individual group company or whether there is a "pierce of the corporate veil" within the group towards the controlling company. In principle, the separation for legal persons of the corporate law also applies in to the law of occupational pension. Therefore, such “pierce-the-corporate-veil liability”  are only accepted under certain conditions. Jurisprudence demands a "close economic link" between the group and the controlling company, at least a control and/or profit transfer agreement (Beherrschungs- und Gewinnabführungsvertrag). However, according to recent case law of the Federal Labour Court (BAG) and the Federal High Court of Justice (BGH), it is becoming apparent that additional conditions are required. For example, a calculation based on the economic situation of the controlling company should (only) be possible if the risk situation for the pension recipients created by the control agreement has materialised.

Conclusion

It may be worthwhile for companies to change the adjustment standard for occupational pension benefits in the current adaptation cycle, as an adjustment according to the net wage development may offer opportunities for cost savings due to the current inflation rate, especially for short-term pensions. Employers should consider making a comparative calculation and determining the existing savings potential. In doing so, however, this savings potential should be weighed up against the increase in administrative effort, which the determination of comparable employee groups may entail.
If companies have identified an adjustment obligation - based on CPI or net wage development - a pension adjustment may nevertheless be omitted if the economic situation of the company is at stake. When deciding on a suspension of the adjustment, it should in any case be taken into account that the requirements for proving an economic situation are complex and extensive according to the case law of the Federal Labour Court. The assessment of the economic situation should therefore be examined in detail in order to avoid claims by pension beneficiaries.