Europe's low interest rates a headache for corporate pensions

Historically low interest rates in the euro area are becoming an increasing headache for companies forced to set aside billions in extra cash to meet their pension obligations to employees.

The European Central Bank's ultra-easy monetary policy, with record low interest rates and unprecedented bond purchase programmes, has contributed greatly to the decline in yields on bond markets.

That is not good news for the in-house schemes that many companies offer employees to help top up their state pensions.

Like banks and insurers all across the eurozone, these corporate pension funds usually rely on adequate yields or interest rates to help increase and maximise their clients' investments.

But with interest rates in the euro area around the lowest they have ever been, pension funds are finding it difficult to meet those demands.

The corporate pension scheme is particularly well-established and popular in Germany. Around 17.8 million Germans had signed up to a corporate scheme at the end of 2013, or 60 percent of people in jobs required to pay social insurance contributions, according to data compiled by the Federal Labour Ministry.

Given the low yields, companies are having to dig deeper into their own financial reserves to fulfil their pension obligations.

German flag carrier Lufthansa, for example, set aside an additional 2.5 billion euros ($2.8 billion) in pension provisions for 2014 in order to meet the returns of six to seven percent it had guaranteed its employees. That burden was one of the factors that drove profits down to just 55 million euros last year.

Power giant E.ON set aside an additional 2.2 billion euros in pension provisions last year and carmaker Daimler an extra 2.9 billion euros.

According to a study by consultants Towers Watson, the companies that make up the blue-chip DAX 30 stock index saw their pension obligations jump by 25 percent to 372 billion euros last year.

"The ECB's policy of low interest rates is having a strong effect on the financing situation for corporate pension schemes in German companies," Towers Watson said.

British companies are facing similar problems, including several on London's FTSE 100 index of blue-chip stocks.

According to JLT, a pension and benefits consultancy, "a number of FTSE 100 companies will be forced to increase their cash contributions to their defined benefits pensions schemes in 2015".

JLT calculated that the total deficit in FTSE 100 pension schemes at the end of last year amounted to £80 billion (110 billion euros, $125 billion) wider than a year earlier.

- Dilemma -

This places companies in a dilemma between safeguarding their own financial reserves while still offering attractive pension packages to their workforce as demand for top-up schemes increases in the face of dwindling state pensions.

"Employees' expectations with regard to corporate pension schemes will continue to rise. Adequate pension provisions will play a key role for companies looking to hire and keep hold of skilled employees," said Thomas Jasper at Towers Watson.

"In order to remain attractive as an employer, companies need to offer attractive pension schemes while at the same time managing costs and risks," he said.

German airline Lufthansa, for one, is currently looking to re-think its retirement system for employees.

"The risks and costs of the existing pension system are jeopardising the airline's future sustainability," argued Lufthansa's personnel chief Bettina Volkens, insisting that pension provisions for all groups of employees needed to be reorganised.

But talks on the issue with unions are deadlocked.

Lufthansa's pilots, for example, have staged a series of walkouts over the past year in protest over management plans to scrap an arrangement under which pilots can retire at 55 and receive up to 60 percent of their pay until they reach the statutory retirement age of 65.

Nevertheless, despite the challenges many companies are facing with their corporate pension schemes, the government is looking at how such programmes can be extended even further to small and mid-sized companies.

With state pensions now averaging less than 800 euros per month, private sector employees are being encouraged to take every action to buy additional pension coverage.