A Chinese proverb says: ‘It’s not the load that breaks you down, it’s the way you carry it.’ It took the Germans quite a while to realise that this truism can be used for the old age crisis too.
The ageing of the population and negative incentive effects in the system of social security have induced a reform process that began in 1992 and is ongoing.
The main changes in the 1992 reform were to anchor benefits to net rather than to gross wages. This implicitly reduces benefits when taxes and social seurity contributions increase and reduce net relative to gross wages. But the final goal was still to stabilise the first pillar instead of shifting part of the burden towards second and third pillar.
At the end of the 1990s a typical pensioner obtained 85% of his income out of the first pillar, 5% came from occupational pensions and 10% was generated via private savings.

The Riester-reform – a step in the right direction
The so-called Riester-reform, named after Walter Riester, the former secretary of labour and social affairs, led in 2001 to an essential shift in paradigms. The load of creating retirement income has to be carried by a complex multi-pillar system instead of the monolithic Bismarckian public insurance system.
Today most workers receive virtually all of their retirement income from the public retirement insurance. Costs add up to almost 12% of GDP, more than two and a half times as much as the US social security system.
The 2001 pensions reform abandoned the long-cherished illusion that state pensions are secure and sufficient to guarantee an appropriate level of income in retirement for the majority of cases. The most important aspect of the reform, which came into effect on 1 January 2002, is a partial substitution of pay-as-you-go financed pensions by funded pensions.
The reform aimed to achieve three main objectives:
1. Sustainable contribution rates to limit further increases in non-wage labour costs and to achieve a fairer balance of intergenerational burdens;
2. Secure the long-term stability of pension levels by reducing the current level from 70% of average net earnings to around 67-68% by the year 2030;
3. Spread of supplementary private pension savings:
q Subsidised either by tax deferral and tax deduction or by direct subsidies to individual and occupational pension plans;
q Since 2002 every employee is entitled to claim deferred compensation plans;
q Occupational pensions became object of collective bargaining;
q One incentive for deferred compensation is to save social security contributions (20% for the employer and the employee) until 2008;
q Introduction of Pensionsfonds – pension investment funds with greater freedom in asset allocation;
q For deferred compensation the employer has to guarantee to repay during the pension-period at least all the contributions (defined contribution with a minimum guarantee).
As a result of the Riester-reform the number of occupational pensions increased (see Infobox 1). But it will take quite some time until we will see major effects regarding the assets of occupational pensions in general and the five different systems of creating occupational pensions.
The major impact came out of deferred compensation. Company sponsored plans did not grow that much. Aba criticised the government for not creating a more attractive legal framework for company sponsored plans.
Nevertheless reform was an important first step towards solving the demographic problems confronting the pension system. It did not stabilise the public pay as you go pillar for the next decades. This is why the so-called Rürup commission, named after its chairman, was established in November 2002 and presented the results of its work in the summer of 2003.
The report presented by the commission provided the political decision-makers with a realistic and practicable set of proposals for an enduring financial stabilisation of the social security systems in Germany.

The 2003 reform
Since some of the details were already published ahead of time they became the basis of the Pension Insurance Sustainability Act (Rentenversicherungsnachhaltigkeitsgesetz ), enacted on 11 March 2003. The most important medium- and long-term consolidation measures in the statutory pension insurance scheme are:
q Modifying the pension adjustment formula. The new formula will include a sustainability factor (Nachhaltigkeitsfaktor) that takes into account changing ratios of those paying contibutions to those drawing pensions. The sustainability factor recommended by the Rürup commission will be implemented in 2005. This measure will curb pension increases and thereby reduce gross pension levels in the long term, which will adjust the statutory pension insurance plan to the changed demographic conditions;
q Abolishing the crediting of years spent in college towards the pension accrual period;
q Raising the actual average age at which retirement pensions are claimed by eliminating incentives to take early retirement and improving training schemes and working conditions for older employees. Between 2006 and 2008, the federal government plans to raise the de facto retirement age from 60 to 63. The Rürup commission also recommended a phased increase in statutory retirement age to 67 (from the present age of 65) in the years between 2011 and 2035.
It became more and more obvious to employees that it is necessary to build up the individual second and third pillar. But the increasing unemployment rate, increasing costs of living, reduced wages and the lack of knowledge of the systems of second and third pillar were the main reasons why the change of the system did not speed up.

The 2004 reform
For those pensioners receiving occupational pensions in the form of an annuity 2004 started with a shock. The payment in January was almost 8% lower than the December cheque. Since January all pensioners who are members of the statutory health insurance for pensioners, that means the majority of all pensioners, have to pay the full compulsory contribution for the healthcare and long-term care insurance. So the contribution rates doubled from eight to 16%.
An ongoing political discussion started because the law that led to this situation does not have any provisional regulations or hardship regulation. The feeling of uncertainty grew not only amongst penioners but also amongst employees. Does deferred compensation make any sense in the long run? Pensioners do have to pay full contributions for their monthly check, and from 2009 on employees will no longer save part of their contributions for the national insurances if they attend deferred compensation plans. This has had a negative impact on the return of deferred compensation.
In 2009 employers will also no longer be able to save their part of contributions for national insurance if employees go for deferred compensation – legislation like this does not motivate people to attend deferred compensation plans. On the one hand the government calls to employees to join deferred compensation plans, and on the other they take away piecemeal some of the incentives to do so.

Pensions Directive
The implementation of the IORP is on its way. Many of the German rules are already in line with the directive’s requirements (ie, information rules), others are on its way (ie, investment rules). An open question is how will Germany manage the required monitoring process?
On 11 June 2004, the Alterseinkünftegesetz (see Infobox 3) was ratified. This law is a reaction to a federal constitutional court decision of 6 March 2002. In a far-reaching decision the court ruled that the unequal taxation of social security pensions and civil service pensions was incompatible with the principle of equal treatment. So a major change of tax law was necessary. The government decided to change the income tax law regarding all three pillars of the old age pension system so that the occupational pensions will fall upon the new law.
It will bring major changes for occupational pensions. How the second pillar systems, employers and employees will react is uncertain. Experts expect that an increasing number of employees will make use of direct insurance and German pension fund (Pensionskassen) under S40 b of the Income Tax Act, since this paragraph can be used only for contracts signed until 31 December 2004.
This type of occupational pension is of interest to employees with an actual individual tax rate that is higher than 20%, and with an expected tax rate as a pensioner that will be above 20%. Besides this, all the uncertainties regarding the legal framework
for the old age pension systems are slowing down the process
of building up second and third pillar.
The reform process is a never ending story, every few months new laws are enacted and even experts and those writing the drafts for the acts have problems to keep up with all the changes. And it seems that the government makes two steps forward and one step back.
However, employees realise that there is no alternative to strengthen second and third pillar protection. Equally, employers are starting to realise that they also will have to think about new ways of supporting occupational pensions, otherwise no employee will be able to afford early retirement in the future.
The cuts in the social security system will be too deep. A growing number of companies is perceiving that the demographic changes will lead to severe competition in hiring young talent. In the near future, a company without an attractive occupational pension system will no longer be an attractive employer. So over time the importance of the second pillar will increase. The unions will promote this topic and the occupational pensions industry will find systems that attract employees as well as employers.
It is up to the government to speed up this process. If all players work together, Germany will find a way to carry the burden of pensions without breaking down. But success comes before work only in the dictionary.
Klaus Stiefermann is managing director of Aba (Arbeitsgemeinschaft für betriebliche Altersversorgung) in Heidelberg

Infobox : Reister ‘a success’
The latest analysis of the research institute Infratest Sozialforschung, available at (http://www.bmgs.bund.de/download/broschueren
/F304.PDF), shows that the so-called Riester-reform was a success. The data proves that from January 2002 to March 2003 there was growth in second pillar pensions:
q the percentage of employees in the private sector with occupational pensions rose from 35 to 42%;
q the number of women with occupational pensions increased above average;
q the growth was especially high in former east Germany; and
q the boom was particularly high in medium-sized companies, 10-99 employees.

Infobox 3: Pensions tax changes in 2005
The Alterseinkünftegesetz – law that will change the taxation of old age provision - will bring major changes for the framework of occupational pensions in 2005. The most important measures:
q The general and long-term changeover to deferred taxation of statutory pensions (EET taxation);
q Changeover to deferred taxation of occupational pensions (limited EET taxation):
1. Taxation of occupational pensions (German pension funds (Pensionskasse), pension investment funds (Pensionsfonds), direct insurances (Direktversicherung) at present;
2. EET taxation up to 4% of the upper income limit for the statutory pension scheme, eg, E2,472 in 2004; S3 No.63 of the Income Tax Act: German pension fund, pension investment fund; no contributions to the social security, long-term care insurance, health insurance, unemployment insurance necessary;
3. Flat-rate taxation (20 %) up to E1,752 (S40b of the Income Tax Act): direct insurance, German pension fund, no contributions to the social security, long-term care insurance, health insurance, unemployment insurance necessary;
4. Riester incentives (subsidies and EET taxation; E525 in 2003; E50 in 2004; S10a of the Income Tax Act): direct insurance, German pension fund, pension investment fund; employer and employee will have to pay their share of the contributions to the social security, long-term care insurance, health insurance, unemployment insurance (adds up to 20% of each euro paid into the system for each of them);
5. Taxation of occupational pensions, pension investment funds, direct insurance in the future (only relevant for new promises of occupational pensions).
Including direct insurances in the tax assistance afforded by S3 No 63 of the Income Tax Act and abolishing the flat-rate wage tax in accordance with S40b of the Income Tax Act. Lifting the ceiling of S3 No 63 of the Income Tax Act by E1.800. On these E1,800 employer and employee will have to pay their share of the contributions to the social security, long-term care insurance, health insurance, unemployment insurance (adds up to 20% of E1,800 for each of them).
q Some simplifications for the Riester pensions concerning the subsidy procedure and the regulation, but more duties to supply information;
q Improvement of the portability of occupational pension rights (for German pension funds, pension investment funds, direct insurances);
q Abolition of tax incentives for endowment life assurances.

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