The legal obligation to provide a minimum capital guarantee in defined contribution (DC) plans within Germany’s second pillar occupational pensions system provides money managers with a considerable challenge.
The challenge is to square the circle by providing an asset management solution to a problem that has traditionally been solved by an insurance contract. One company that has risen to meet this challenge is DEVK, a leading Cologne based insurer with a long history of providing insurance and pensions to transport workers including Deutsche Bahn employees.
In November, DEVK launched DEVK Pensionsfonds, using the new pensions vehicle created by the Riester pensions reform, to provide funding for DC and deferred compensation plans. The Pensionsfond has already attracted 6,500 members.
The DEVK Pensionsfonds has developed a pure asset management solution to the conundrum posed by the Beitragszusage mit Mindestleistung (contribution promise with minimum performance). It uses zero coupons to provide the guarantee of paid in capital. The duration of the coupons is the time between the beginning of contributions and point of retirement.
Hans Willi Siegberg, board member of the DEVK Pensionsfonds, explains: “Contributions to the plan are split into two parts – the contribution for the guarantee and the contribution for the investment. The guarantee contribution is used to buy zero coupons, which must have at least a AA rating. The part for investment is put in to equity funds, mostly in Euroland.”
Siegberg says DEVK Pensionsfonds took the asset management route to ensure pension fund members received the maximum returns from the markets. “We prefer this method to an insurance solution because it is more transparent and because it provides a better net yield,” he says.
Other innovations have come from asset managers, particularly foreign asset managers who must innovate to compete in fiercely protective home market. A solution developed by UBS Global Germany is the lifecycle approach to investment. This approach, which has been adopted by the motor manufacturer BMW and pharmaceuticals firm Altana, attempts to manage away the risk that there will be a shortfall in a plan’s funding.
Tim Blackwell, head of UBS Global Germany in Frankfurt explains: “The overall concept for the BMW pension plan is that the minimum guarantee requirement is modelled through a lifecycle concept. In a classical model you’d have coverage for the guarantee in the plan. However, what we do is look at the population of the employees in the corporation and according to the demographics of the employee base, we do asset and liability modelling with a Monte Carlo simulation in terms of how the asset allocation should be designed to meet the employer’s liability.” The asset allocation takes a conventional approach, so that allocation to equities reduces as the pension fund member nears retirement, to be replaced by fixed income and money market investments.
“Asset and liability modelling is very important upfront to assess the potential shortfall risk,” says Blackwell. “In essence what happens is that by allocation specific portions to the equities, bonds and money markets asset classes along the different age groups of the employees that can eliminate the need for the guarantee by the employer.”
Other asset managers have taken the lifecycle concept further. Invesco Germany, for example, has added a tactical asset allocation overlay, a process known as ‘dynamic hedging’. Christof Quiring, director of DC products at Invesco Germany, explains: “In our lifecycle fund concept we reduce the risk with the increasing age of the plan member. But on top of that we manage the risk budget dynamic. So in each age cohort we manage the equity quota according to our tactical asset allocation model – a kind of fund of funds concept depending on age. We have made a Monte Carlo simulation which reduces the risk of the employer dramatically.”
Quiring says advantages of dynamic hedging is that it continuously protects the insured level of capital by adjusting the portfolio. At the same time it allows the manager to change the asset allocation over the lifetime of the insurance. This has clear advantages, he says over a static, option-based insurance mechanism, where the portfolio remains unchanged over the lifetime of the insurance.
Invesco Germany recently sold the concept to Leica Microsystems in a three way business pitch with Allianz and Commerzbank. Leica were looking for the greater investment opportunities that the residual risk of a guarantee shortfall allows. “The lifecycle model limits their shortfall risk to a very low number. They have accepted the risk that we don’t meet the capital guarantee, but all our Monte Carlo simulations have shown that over a longer period of time there’s no risk to them. So they can give the full upside to their plan members.”
Companies that do not want any risk can opt for a guarantee fund called Global Protect. This fund is based on a Value at Risk (VaR) model with a tactical asset allocation overlay, and provides a guarantee that the shortfall will be almost zero.
“This is a very new and intelligent asset management product that enables us to avoid reinsurance premiums,” Quiring says. The principal attraction, however, is the upside: “Pension funds have full exposure to the bond and markets. They know exactly what the fund is doing, whereas with the insurance company pay the money over and they just have to trust that they will get the guarantee.”
Using lifecycle and guarantee funds within DC-oriented pension plan designs may be one way of spreading the DC message in Germany, says Quiring.

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