20.Provisions for Pensions and Other Post-employment Benefits

Provisions for pensions and other post-employment benefits were recognized for defined benefit obligations. The expenses for defined contribution obligations are shown in note 9 “Personnel Expenses and Employee Numbers.” The net defined benefit liability for post-employment benefit plans was accounted for as follows:

The expenses for defined benefit plans and for other post-employment benefits included the components described as follows:

In fiscal 2019, a total of €439 million (previous year: €198 million) in effects of remeasurements of the net defined benefit liability was also recognized in other comprehensive income. Of this amount, €427 million (previous year: €220 million) relate to pension obligations and €12 million (previous year: minus €22 million) to other post-employment benefit obligations.

The changes in the net defined benefit liability for post-employment benefit plans were as follows:

The benefit obligations pertained mainly to Germany (84%; previous year: 80%) and the United States (12%; previous year: 15%). In Germany, current employees accounted for about 63% (previous year: 62%) of entitlements under defined benefit plans, retirees or their surviving dependents for about 29% (previous year: 31%), and former employees with vested pension rights for about 8% (previous year: 7%). In the United States, current employees accounted for about 40% (previous year: 36%) of entitlements under defined benefit plans, retirees or their surviving dependents for about 53% (previous year: 60%), and former employees with vested pension rights for about 7% (previous year: 4%).

The actual income from assets of defined benefit plans for pensions or other post-employment benefits amounted to €353 million (previous year: expense of €72 million) and €0 million (previous year: €0 million), respectively.

The following table shows the defined benefit obligations for pensions and other post-employment benefits along with the funded status of the funded obligations:

Pension entitlements and other post-employment benefit obligations

The Covestro Group provides retirement benefits for most of its employees, either directly or by contributing to privately or publicly administered funds. The way these benefits are provided varies according to the legal, tax and economic conditions of each country, the benefits generally being based on employee compensation and years of service. The obligations relate both to existing retirees’ pensions and to pension entitlements of future retirees.

Funded pension plans exist for employees in various countries. In principle, an individual investment strategy is determined for each of the Covestro Group’s defined benefit pension plans taking into account the risk structure of the obligations (especially demographics, the current funded status, the structure of the expected future cash flows, interest sensitivity, biometric risks, etc.), the regulatory environment and the existing level of risk tolerance or risk capacity. A strategic target investment portfolio is then developed in line with the plan’s risk structure, taking capital market factors into consideration. Further determinants are risk diversification, portfolio efficiency and the need for both a country-specific and a global risk/return profile centered on ensuring the payment of all future benefits. In principle, as the capital investment strategy for each pension plan is developed individually in light of the plan-specific conditions listed above, the investment strategies for different pension plans may vary considerably. The investment strategies are generally aligned less toward maximizing absolute returns and more toward the reasonable assurance of financing pension commitments over the long term. For plan assets, stress scenarios are simulated and other risk analyses (such as value at risk) are undertaken with the aid of risk management systems.

Bayer-Pensionskasse VVaG, Leverkusen (Germany), (Bayer-Pensionskasse), is by far the most significant of the pension plans for Covestro. It has been closed to new members since January 1, 2005. This legally independent fund is regarded as a life insurance company and is therefore subject to the German Insurance Supervision Act. The benefit obligations covered by Bayer-Pensionskasse comprise retirement, surviving dependents’ and disability pensions. It is financed with contributions by the active members and by their employers. The company contribution is a certain percentage of the employee contribution. This percentage is the same for all participating employers and is set by agreement between the plan’s executive committee and supervisory board, acting on a proposal from the responsible actuary. It takes into account the differences between the actuarial estimates and the actual values for the factors used to determine liabilities and contributions. Bayer AG may adjust the company contribution in agreement with the plan’s executive committee and supervisory board, acting on a proposal from the responsible actuary. The plan’s liability is governed by Section 1, Paragraph 1, Sentence 3 of the German Law on the Improvement of Occupational Pensions (BetrAVG). This means that if the pension plan exercises its right under the articles of association to reduce benefits, each participating employer has to make up the resulting difference. Covestro is not liable for the obligations of other participating employers, even if they cease to participate in the plan.

Pension entitlements for people hired in Germany on or after January 1, 2005, are granted via Rheinische Pensionskasse VVaG, Leverkusen (Germany), (Rheinische Pensionskasse). Future pension payments from this plan are based among other things on contributions and the return on plan assets; a guaranteed interest rate applies.

The Bayer-Pensionskasse and Rheinische Pensionskasse pension obligations are classified as multi-employer plans as defined by IAS 19 (Employee Benefits). A defining characteristic of multi-employer plans is that assets from various employers not under common control are pooled at plan level and used to collectively grant pension benefits to employees. Allocation mechanisms that would permit an exact distribution of the plan assets managed by the pension plan to individual employers often do not exist, as in the case of Bayer-Pensionskasse and Rheinische Pensionskasse. Covestro therefore applies an estimation method that is adequately suited to this purpose to calculate its proportional share of the assets of the pension plans.

Another important pension provision vehicle is Metzler Trust e.V., Frankfurt am Main (Germany), (Metzler Trust). This vehicle covers further retirement provision arrangements for German employees of the Covestro Group, such as the conversion of salary entitlements into pension entitlements, pension obligations and components of other direct commitments.

The defined benefit pension plans in the U.S. have been frozen for some years, and no significant new entitlements can be earned under these plans. The assets of all the United States pension plans are held by a master trust for reasons of efficiency. The applicable regulatory framework is based on the Employee Retirement Income Security Act (ERISA). In particular, these stipulate a statutory 80% minimum funding requirement to avoid benefit restrictions. The actuarial risks, such as investment risk, interest rate risk and longevity risk, remain with the company.

The investment strategy for German direct commitments revised in fiscal 2017 was further implemented in fiscal 2019. The changes in the investment strategy were subsequently carried out by third-party asset managers. Environmental social governance (ESG) criteria were given consideration for around 47% of the investment volume.

The risk management concept aligned with the benefit obligations (asset-liability matching) was revised for the U.S. defined benefit pension plan again in fiscal 2019. First, the actuarial obligations were analyzed and updated. Then statistical methods were applied to this information to determine an investment strategy that would ensure a suitable risk-return profile. The factors considered here included expected returns for the various asset classes and anticipated balance sheet volatility. In addition, certain benefit obligations and plan assets were transferred to an insurance company in order to further reduce actuarial risks for Covestro.

The other post-employment benefit obligations outside Germany are mainly related to retirees’ health care benefit payments in the United States.

The fair value of the plan assets to fund pensions and other post-employment benefit obligations was as follows:

No properties leased by Group companies were included in the fair value of the domestic plan assets. Likewise there were no Covestro shares or bonds held through funds. The other plan assets comprise mortgage loans granted, other receivables and qualified insurance policies.

Risks

The risks from defined benefit plans arise partly from the defined benefit obligations and partly from the investment in plan assets. The risks lie in the possibility that higher direct pension payments will have to be made to the beneficiaries and/or that additional contributions will have to be made to plan assets in order to meet current and future pension obligations.

Demographic/biometric risks

Since a large proportion of the defined benefit obligations comprises lifelong pensions or surviving dependents’ pensions, longer claim periods or earlier claims may result in higher benefit obligations, higher benefit expense and/or higher pension payments than previously anticipated.

Investment risks

If the actual return on plan assets were below the return anticipated on the basis of the discount rate, the net defined benefit liability would increase, assuming there were no changes in other parameters. This could happen as a result of a drop in share prices, increases in market rates of interest, default of individual debtors or the purchase of low-risk but low-interest bonds, for example.

Interest rate risks

Declining capital market interest rates, especially for high-quality corporate bonds, would increase the defined benefit obligation. This effect would be at least proportionately offset by the ensuing increase in the market values of the debt instruments held in plan assets.

Measurement parameters and their sensitivities

The bond portfolio consists exclusively of high-quality corporate bonds with a rating of at least AA or AAA. The portfolio does not include any government-guaranteed or secured bonds. The following weighted parameters were used to measure the pension obligations as of December 31 and the expense for pensions and other post-employment benefits in the respective reporting year.

In Germany, the Heubeck 2018 G mortality tables were used, in the United States the adjusted RP-2014 Healthy Mortality Tables. The parameters for measuring the benefit expense are the same as those used to measure the benefit obligations in the most recent annual financial statements.

The parameter sensitivities were computed by expert actuaries based on a detailed evaluation similar to that performed to determine the net defined benefit liability. Altering individual parameters by 0.5 percentage points (mortality by 10% per beneficiary) while leaving the other parameters unchanged would have impacted pension and other post-employment benefit obligations as of the end of fiscal 2019 as follows:

Provisions are also set up for the obligations, mainly of the U.S. subsidiary, to provide post-employment benefits in the form of health care cost payments to retirees. The valuation of health care costs was based on the assumption that they will increase at a rate of 7% (previous year: 6%), which should gradually decline to 5% (previous year: 5%) by 2023. The following table shows the impact on other post-employment benefit obligations and total benefit expense of a one percentage point change in the assumed cost increase rates:

Employer contributions made or expected

The following payments or transfers correspond to the employer contributions made or expected to be made to funded benefit plans:

Pensions and other post-employment benefits payable in the future from funded and unfunded plans are estimated as follows:

The weighted average term of the pension obligations is 22.8 years (previous year: 21.6 years) in Germany and 12.2 years (previous year: 11.4 years) in other countries. The weighted average term of the obligations for other post-employment benefits in other countries is 12.4 years (previous year: 11.9 years).