Ageing population forces a rethink

By Ralph Atkins, date 23.10.2000 – Financial Times


In a country whose system dates from the 19th century and the days of Chancellor Bismarck, the proposal changes are radical

After years of debate, Germany’s pension sector may – finally – be on the brink of the biggest changes since the 1950s. The center-left government of Gerhard Schroder, the chancellor, is proposing amendments to the state pension system, which could open up the may for millions of ordinary Germans to start private pension schemes. With the opposition Christian Democrats indicating they may not block the changes, there is a real chance of the proposal becoming low.

            Change has been forced by the dramatic ageing of the population. Today there is one pensioner for every three workers. By 2030 there will be two. Under such condition the current pay-as-you-go state system – by which contributions from today’s workers are used to pay today’s pensioners – will not longer be sustainable.

            Already, the federal government subsidies is contributing more than DM 100bn annually to top up the state system. Previous attempts to curb the escalating costs have been make-shift. As part of his budget consolidation measures, Hans Eihel, finance minister, lifted for this year the link between wages and pension levels.

            But the pension reform in the pipeline would go much further. For the first time, the government has officially acknowledged that the pay-as-you-go system will no longer be sufficient for today’s younger workers. Instead they should start making private provision. The bill, says Walter Riester, labour minister, “is not a repair job – it is an innovation”.

            Under Mr. Riester’s plan younger workers would start saving 0.5 per cent of gross wages in authorized occupational or private insurance and pension funds from next year, rising to 4 per cent in 2008. That would be in addition to their contributions to the state pension system, currently 19.3 per cent of gross wages, split equally between employees and employers.

            Private pension for old-age would be voluntary. But the government is planning significant financial incentives, eventually worth DM20bn a year. In return future pension levels would be cut back, although the government has given an assurance that they would not fall below 64 per cent of average net wages until at least 2030.

            By putting a cap on the escalating cost of the pension system, the government hopes it can keep contributions to the state scheme wages until at least 2030. That should help keep Germany’s non-wage labour cost under control.

            Few doubt that the government’s plan radical for Germany: the current system dates from the 19th century and the days of the chancellor Otto von Bismarck: Germany have a strong emotional attachment to the pay-as-you-go principle which has proved long-lasting and provided ‘solidarity between the generations”. But the reform plan has nevertheless met a critical reaction.

            Trade unions have complained about the threat to the state pension level and that fact that additional burdens are being piled on to employees, rather then the employers.

            For its part, The German employers association (BDA) argues Mr.Riester has not gone fare enough in cutting the level of contributions to the state system. Dieter Hundt, BDA president, says even the maximum 22 per cent rate promised by the government is “unacceptable from both an economic and social political perspective”.


Finance houses are disappointed at the modest scale and at many details of the reform


And anyway, he adds, there is a good chance the government’s projections are over-optimistic.

            Finance houses in Frankfurt are also disappointed at the modest scale of the reform. Deutsche bank estimates suggest that, if full advantage is taken of the incentives for private provision, some DM64bn would flow into the new funds in 2008.

            That is not inconsiderable sum, but falls well short of the amounts flowing into life insurance products in Germany or into private pensions in countries such as the US.

            Frankfurt also has problems with many of the details of the reform. Mr.Riester has decided that the types of pension funds qualifying for government support will have to meet two criteria: first they will have to guarantee a life-long pension; second, they must pay out at least as much as was paid in. the government says it wants the widest possible range of products to be made available but argues it has a social role to ensure security in old age. Financial services companies, it argues, will quickly develop products, which meet the rules.

            Indeed, the conditions may seem innocuous. But investment managers warn the consequences could be serious. Many investment funds would find it difficult to offer money-back guarantees. Ensuring the conditions are met for instance by combining investment fund-type products with insurance polices could lead to significantly lower rates of return. “It is like the state prescribing that motorists can only drive with the hand brake on,” says Manfred Laux, director of the German association of investment societies.

            Peter Koening at Morgan Stanley Dean Witter in Frankfurt, argues Mr. Riester’s proposal amount to, “a government-regulated substitution of a small part of the pay-as-you-go system with a very limited range of funded products”.

            Other issues have not yet been addressed by the government. These include the issue of taxation. There is a broad consensus that Germany should move to an internationally-compatible system of deferred taxation – by which pensions are taxed but not the contributions. Analyst argue that would give private and occupation pension a real boost. But it would be politically difficult; taxing pensioners is not a vote winning strategy. Mr. Schroder faces re-election in 2002. the existing pension reform measures already on the table will probably require considerable political energy to implement; anything more will have to wait.