Germany is in an unenviable situation. Its people are over-reliant on a state pension system that is no longer financially viable, and the Riester reform, designed to develop a third pillar pension system, and boost the unpopular second pillar pension system, has not been as successful as expected. If the government fails to persuade employers and employees of the importance of additional provision, however, Germany’s economy could well find itself at crisis point.
The demographic challenges facing Germany run deeper than those of its European counterparts. In 2000, the German government spent around 10.3% of GDP on pensions, and this cost is expected to rise by at least another 5% of GDP by 2040 – well above the average for all developed countries.
The root of Germany’s problems lies in its almost exclusive pay-as-you-go model, introduced in the aftermath of World War II. It is among the world’s most generous, where a full-career worker earning average wages can retire with a benefit that replaces 70% of pay. Total private pension assets amounted to just 15% of GDP in 2000, compared to 81% in the UK, 110% in the Netherlands, 23% in Italy and 128% in Switzerland.
Combined second and third pillar pension provision account for only 15% of total pension income, compared to 35% in the UK, 50% in the Netherlands and 58% in Switzerland.
Recognising the problem, former Labour minister, Walter Riester, introduced a pension reform in the spring of 2001, reducing state benefits and introducing new private pension options to make up for the loss experienced by retirees. For the second pillar, in addition to the book reserve system, support funds, direct insurance and pensionskassen, the Riester reform authorised a fifth type of pension provision – Pensionsfonds, which allows much greater investment freedom.
The government firmly believed this would be an end to its problems, but take-up has been disappointing. Only 9% of the population are thought to be contributing to the personal product, and only 52% of employees are estimated as having access to a company scheme.
The fundamental problem with the Riester reform is pointed out by the Centre for Strategic and International Studies (CSIS) which blames the German government’s failure to acknowledge the magnitude of the long-term cost problem. “In presenting the reform to the public, the government used a new definition of average wages that allowed it to say that the replacement rate would only fall from 70% to 67% over the next 30 years. With the government trying to downplay the impact of reform on promised benefit levels, the public’s lukewarm reaction to the new private pension options is understandable. Why should people save more if they are going to get practically everything they are promised anyway?”
Others have criticised the government of having been too optimistic with regards to fiscal projections about the economy. “It is exactly those most in need of Riester-Rente, who cannot afford them,” says Achim Tiffe, head of the Hamburg-based Institute for Financial Services’ pensions department. “On one hand Riester-Rente are interesting for the lower income earners, yet it is exactly those people who do not have the means to take them up.” In a survey conducted 50% of Germans said they would want to take up a private pension product, but among other problems, it would depend on an improvement in their financial situation. “Product suppliers and the government ought to be looking at this situation, because otherwise those at income levels where pensioner poverty is a concern will not be able to find adequate provision in retirement,” he stresses.
Complexity is another criticism frequently voiced of the personal pensions products. According to the Deutsche Gesellschaftent für Hauswirtschaft, around 80% of application forms are incorrectly completed.
Ulla Schmidt, labour minister, has now conceded that ways of simplifying the personal pension plans will have to be looked into, despite Chancellor Schroeder’s insistence last year that no changes would be made. Schmidt, however, does not hold the government solely to blame. “When individuals look to buying a car, they spend time comparing cars, testing them out, looking at financial aspects, such as petrol consumption, insurance. They should be spending the same amount of time and effort when choosing a pension.” Bert Ruerup, head of the welfare reform commission, has admitted that the only way to increase take-up may be to make the Rieste-Rente private pensions products compulsory if the situation is unchanged in two years time.
Complexity is also a criticism of the second pillar. Establishing a company scheme takes too much time, and involves too much paperwork. ABA, the association for occupational schemes in Germany, is desperately trying to convince employers that it need not be so.
“There are five different ways a company can offer pension provision in Germany. We must encourage companies to be more positive in this area,” says Boy-Juergen Andresen, chairman of ABA. While agreeing that the legal framework is complicated, Andresen points out that, with such a variety of options available to employers, there are possible solutions – something for everyone. As Peter Scherkamp, head of finance strategy at Siemens says: “We must not forget that we are talking of company pensions schemes, and companies should be looking at which of the plans is most appropriate for them.”
ABA is confident, however, that more companies will establish company pension schemes, and points to the recent success of Robert Bosch’s Pensionsfond, and the Chemie pensionsfond, administered by HVB (see page 47). Says Klaus Stiefermann, secretary at ABA: “We are on the right tracks now, but we need to speed up.”
Adamant that further changes to the occupational pension regulations must be avoided in fear of further confusion and complexity, ABA is hoping for a few minor ‘tweakings’ which will encourage companies to set up schemes. One tweaking being a change in contribution levels for pensionsfonds. Pensionsfonds presently have to contribute 100% in order to meet money back guarantees. But argues Andresen: “There is no need for such a high contribution level, given the guarantees in place from the companies themselves, and the government.” He believes such a high contribution is only discouraging the establishment of pensionsfonds, of which there are now around 15. ABA is asking the government to reduce this level to just 20%, and Andresen is optimistic that the government will.
Even if Germany does manage to make a funded system work, it may not be enough to save the economy, however. Going forward, an essential strategy for ageing Germany will be globalisation, says CSIS. The ageing of developed countries, which will in turn slow economic growth, will also slow rates of returns to financial assets. When the baby boomers retire in the 2020s and begin cashing in their portfolios, the value of private pension savings would erode just as public systems are becoming affordable.
In pay-as-you-go systems, returns are limited to the rate of growth in worker payroll – slowing Germany’s economy further. In funded systems, however, workers can continue to invest in faster growing economies around the world. According to the Mannheim Research Institute for the Economics of Ageing, Germany could offset the demographic impact on financial rates of return by shifting assets to countries that are ageing less or later. However, even if Germany does succeed in its transition towards funded pensions, the problems are not over, says CSIS. According to Dresdner Bank, only 7% of German pension fund assets are invested internationally, including in other EU countries. This compares to 29% for Dutch funds and 25% for UK funds. Germany will have to adopt a strategy which requires relaxing quantitative investment restrictions and embracing the ‘prudent man principle’ more extensively if it is to tackle the issue, says CSIS.