Company pensions must be increased in line with inflation – mustn’t they?

What is the ‘adjustment review’ all about?

The starting point is Section 16(1) of the Act on the Improvement of Occupational Pension Schemes (BetrAVG):under this provision, employers must, in principle, review all current occupational pensions every three years and decide whether to increase them in line with inflation trends. The relevant adjustment date determines the extent of the adjustment. For example (simplified illustration), a cumulative inflation rate of around 16 per cent would be used as the basis for an occupational pension due for adjustment on 1 January 2024. In 2025, the figure would have been around 15 per cent, and in 2026 it would still have been over ten per cent.

By contrast, pension provisions generally assume only moderate inflation rates; in other words, the resulting costs are genuine additional costs that place an immediate and lasting strain on cash flow. Adjustment costs are not ‘one-off costs’. Once an adjustment has been made, it remains in place until the relevant pension beneficiaries (including their surviving dependants, where survivor’s benefits are provided for) have passed away, thereby increasing pension costs for many years to come.

Are all occupational pension schemes subject to this adjustment review?

No. What many companies are unaware of is that:

The law provides for a whole range of exceptions. In particular, most (modern) direct insurance and pension fund schemes, as well as many pension fund commitments, fall under these exemptions. Direct schemes and support fund schemes can also be structured in such a way that no inflation adjustment is required. There are further special provisions for (modern) deferred compensation schemes and certain types of pension commitments (defined contribution schemes with a minimum benefit).

However, this always depends on the specific pension scheme or commitment. It is therefore certainly advisable to have these reviewed to determine whether Section 16 of the BetrAVG applies at all. In most cases, the effort involved is very manageable.

If no exemption applies – does an adjustment then always have to be made?

By no means – and this, too, is something many companies are unaware of:

If the net wages of comparable active employees still working for the company have risen by less than the rate of inflation (which has been the case for many companies in recent years),the adjustment may be limited by this so-called ‘real-wage cap’.

Furthermore, the pension adjustment is always subject to the company’s financial capacity. This does not mean, however, that a company must have its ‘back against the wall’ in order to avoid having to make adjustments. On the contrary: 
Even companies that are fundamentally sound may, if necessary, invoke this provision if their current earnings situation does not exceed a certain threshold. This is calculated on the basis of the current yield on German government bonds plus a risk premium of 2 per cent per annum – meaning the threshold currently stands at around 5½ per cent.

Important: Depending on the company’s specific financial position, adjustments to the financial results may (or must) be made, for example if the company exceeds the threshold in a given year solely because substantial fixed assets were sold off in that particular year. Or if it is already quite clearly foreseeable that the economic situation will deteriorate significantly in the following year. Accordingly, the annual accounts and forecasts may need to be analysed very carefully. Such reviews can therefore be quite time-consuming – but are nonetheless worthwhile.

Practical experience from recent years

In recent years, we have supported a large number of companies with this issue. Time and again, this has confirmed how important it is to carry out a thorough review – but also to establish a sensible approach. At the same time, the perspective of occupational pensioners, as well as commercial and corporate-policy considerations, should not be underestimated and must be factored into the planning.

Furthermore, not every company is prepared to face the associated legal proceedings. Such proceedings entail costs that should be factored in. However, experience also shows that only a fraction of company pensioners are actually willing to pursue legal action against their former employer. Company pensioners are usually more interested in a swift, reasonable solution, and only very few are prepared to endure litigation lasting several years. This is, of course, all the more true once the company’s position has been confirmed by a court. Consequently, sensible compromises can often be reached in practice. It is important to note that, due to existing legal requirements, any agreements can only take the form of a so-called ‘settlement of facts’. We also observe that company pensioners are keeping pace with changing communication practices and, for example, networking and exchanging views in WhatsApp groups. This must, of course, be taken into account when conducting negotiations.

The approach that ultimately proves most effective therefore depends on a whole range of factors, such as:

• What are the actual, cumulative costs of a full adjustment, and what outcomes could realistically be achieved instead(taking all costs into account)?
• What are the legal prospects of successfully defending against such claims?
• Is the company prepared, if necessary, to take the matter to court?
• Accordingly, does a ‘tough’ defence against adjustment claims – if necessary, taking the case ‘all the way through the courts’ – make sense, or is a compromise strategy more effective?

Practical recommendations

In summary, we recommend that any company currently facing high adjustment costs have the legal position and possible courses of action carefully reviewed.