A German state fund could help plug a future financing gap in the country’s pay-as-you-go public pension system and help safeguard its credit rating, according to researchers at credit rating agency Scope.

Germany is facing a large gap between contributors and beneficiaries in its state pension system as baby boomers retire. Scope has previously identified this as one of the major threats to Germany’s long-term credit rating in its view.

The rating agency carried out a scenario analysis for a state pension fund similar to funds proposed by Clemens Fuest, president of think-tank ifo, in December last year and economist Volker Brühl, managing director of the Centre for Financial Studies in Frankfurt. 

Brühl has proposed the creation of a sovereign wealth fund, to be financed from tax and, if necessary, “a moderate debt level”, to ensure sustainability of the state pension system.

Scope’s scenario analysis built on work carried out by the economist. It found that the state could pay out between €30,000 and €40,000 annually to people after the age of 67 from 2039 if contributions to the fund started now.

Under Scope’s assumptions the German government would pay around 1% of GDP per annum into the fund, partly coming from taxes and partly from new debt issued on the market.

The assumed expected net return on investments was 4% per annum on average. The researchers noted that a sample of 36 public pension funds in the OECD had shown average real returns of above 4% per annum, even after the financial crisis in 2008.

Bernhard Bartels, analyst at Scope and author of the report, noted: “Though a state pension fund is not designed to finance today’s pension needs, it could help to satisfy younger generations’ future claims, with current fears these generations will come away empty-handed at the same time as being obliged to finance their parents’ and grandparents’ pensions.”

Multiple credit rating benefits

For Scope, the increased security for future generations was one effect of the state fund that could help “further anchor Germany’s AAA sovereign credit ratings”. It reasoned that people who need to worry less about their retirement income spend more and thus help keep the economy running.

A state fund could help “lower future government liabilities” in the state pension system, and increased debt issuance “improves the country’s status as a benchmark issuer, thereby creating better liquidity for German bonds”.

In addition, an internationally diversified portfolio could mean that the fund’s investment income was anti-cyclical to developments in the German economy.

Apart from seeing the proposed fund as a means of topping up first-pillar retirement income for all citizens, Scope also said the fund could serve as a general savings vehicle for the German public.

Citizens could defer parts of their savings or private pension contributions to the fund instead of putting them in third pillar pension vehicles or second pillar top-ups.

For the payout phase the researchers indicated they would recommend a choice between lump-sum payments and retirement income.

“Thereby, the fund combines a beneficial public scheme with individual freedom on the size of optimal future pension levels with a guaranteed minimum,” wrote Bartels.

Scope’s report (in English) can be downloaded here. 

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