Companies which opt for a supplementary pension via a branch 21 life insurance today run the risk of having to pay additional sums due to the constantly low interest rates. It is therefore worth making the effort to look at an alternative scenario. Companies can give themselves and their employees a financial boost with a well-considered approach via a branch 23 product.
Some 70% of Belgian employees build up a supplementary pension via their employer. Almost all these group insurances are branch 21 life insurances. These provide employees with a fixed yield and possible profit sharing, depending on the results achieved by the insurer.
On the other hand, with branch 23 group insurances the yield is dependent on one or more investment funds. In recent years the yield in branch 23 products with an even distribution of shares and bonds appeared to be higher than for branch 21 products (see table below where we list the yields of two branch 23 products). In concrete terms: anyone who has this type of pension plan benefits from higher yields. But branch 23 involves more risk: if the results of the investment fund fall short, it is not possible to rule out a negative yield.
The issue with branch 21 life insurance products has been known for several years. The interest rate on this type of savings product, and thus on the yield, has dipped considerably since 2000. This is as a result of the falling interest rates on long-term bonds and changes in solvency rules in which the opportunities of insurers to make differentiated investments have decreased.
At present, the guaranteed rate of interest is somewhere between 0.5% and 1%. At the same time the yield which the employer must guarantee to its employees has been legally set at a minimum of 1.75% since 2016. Is the insurer’s yield inadequate? In this case it is down to the employer to make up the difference from its own funds.
There was no apparent sense of urgency up to the end of 2012 in spite of the falling interest rates. Insurers made every effort to maintain the level of the yield in the expectation of a recovery in the market interest rate. But this positive trend did not arrive, which made the situation increasingly untenable. Insurance companies have therefore been adapting their interest rates to reality since 2013, and this appeared much less rosy. It was not long until employees and employers demonstrated a sense of urgency. At the end of 2015 an agreement was reached to safeguard the social nature of the supplementary pensions. One of the measures involved reducing the obligatory minimum yield guaranteed by the employer from 3.25% (and 3.75% for personal contributions) to 1.75%.
This solution ensured that a secure minimum yield was maintained which would remain affordable for the employer. But this still left two further problems unsolved.
Firstly, the interest rate dropped considerably between 2013 and 2017 while the legally guaranteed interest for the employer was still at 3.25% before 2016. The current yields for the contributions from those periods for branch 21 fall short with regard to the legally guaranteed minimum interest. At the end of the day the employer has to make up for this shortfall.
A second problem is the fact that it is doubtful whether the insurer will achieve a yield of 1.75% in a ‘constant low interest’ scenario. This can once again result in the employer having to pay a considerable additional amount. We also have to wait and see whether the insurers will put their guaranteed interest rates back up if the long-term interest rate climbs above 2%. There was recently an increase in the 10-year OLO rate, which went up to 1%.
At a time when there is a real possibility that employers will have to make an additional financial contribution to a branch 21 insurance product, consideration should also be given to another scenario for pension accrual. Branch 23 life insurance may present an alternative. Here the guaranteed yield is exchanged for the freedom to invest in shares or bonds which are of financial interest.
This choice must of course be well informed, and it is important to take two key factors into account:
- The interest rate within a branch 23 insurance can drop in the short term, leading to a drop in yield with the threat of you having to pay an additional amount as an employer. From a historical perspective, however, the yield on this type of insurance product is higher on average than the yield for the interest guarantees in branch 21.
- The necessary measures can be taken to smooth out the sharp edges on a branch 23 life insurance. The short-term risk is reduced considerably by incorporating adequate financial buffers with regard to the legal obligation of 1.75%, by not putting all financial assets into branch 23 immediately, by allowing the risk profile of the investment funds to drop proportionately as the date for payment becomes closer or by using a cash balance solution to ensure that leaner years are compensated for by better years.
Will supplementary pensions via a branch 21 product result in a financial blow for employers? This may well not be the case. However, by taking a look at alternatives in branch 23 life insurances today, employers can give themselves and their employees a financial boost.