PensionReforms' summary and comments

The German pension system started more than 120 years ago and the 'Bismarckian System' became the model for many.  However, Chancellor Bismarck would not now recognise much of his original model.  It became one of the most generous state pension schemes in the world.  With growth (both in the economy and population) improvements were easy to promise but the problems those improvements created seemed almost impossible to resolve.

Germans receive nearly all their retirement pensions from the state and the costs - about 12% of GDP before the baby boomers start retiring - looked set to about double.  The social security contribution rate was 19.5% of employees' gross covered income in 2003 and, pre-reforms was set to increase to reach 40% by 2035.

Something had to give but progress has been both glacial and erratic.

"The reform process began in 1992 and reached its peak in the 2001 and 2004 reforms.  The 1992 reform started a time table along which the worst incentives to retire early were abolished.  The 2001 reform converted the exemplary monolithic Bismarckian public insurance system into a complex multipillar system.  Finally, the 2004 reform converted the pay-as-you-go pillar into a quasi notional defined contribution (NDC) system.  This paper delivers an assessment [of] how far these reform steps will solve the German pension problems."

The defining characteristic of the Bismarckian systems was their specific aim of allowing workers to continue something like their pre-retirement standard of living once they stopped working.  The other main Beveridgian model (based on the UK's original arrangement) delivers only a base pension.  Although, on the face, the Bismarckian system was not re-distributive, what the Germans have discovered is that it is does just that between, rather than within generations.  However, the ageing population coupled with the fall in the population replacement rate (now only 1.3 children per woman) fundamentally undermines that inter-generational bargain.

German's system started as 'fully funded'; changed to fully invested in government bonds between the two World Wars before becoming fully PAYG in the mid 1960s.  Benefits improved in a number of ways - a 70% replacement income after 45 years' contributions (for a worker on the national average wage); unreduced early retirement pensions for those with a 'long service life'; generous disability pensions and low mandatory retirement ages for women and the unemployed all added to liabilities.

The 1992 changes started the pull-back.  Indexation of pensions changed from gross to net wages.  Early retirement benefits were reduced and mandatory retirement ages increased but these will not be fully in place until 2017.

The next change happened in 2001 (the "Riester Reform") with the introduction of a multi- pillar arrangement with a "small but growing pre-funded pillar.  The new system will be fully phased in by about 2050, but its main implications will be felt from 2011 onwards.  The main insight was that no pension reform will succeed in keeping contribution rates "bearable" unless it entails a substantive pre-funded component."  The objective here was apparently to offer workers an incentive to save privately to replace the cuts in the state pension.  Though subsidised (either directly or by tax deductibility through a complex double-calculation under an EET framework), these private pensions (not lump sums) were not mandatory. The direct subsidy was an attempt to correct part of the naturally regressive aspect of tax breaks for retirement saving.  However, it can do that on only the contributions.  The rest of the tax environment for the savings is just as regressive.

That structure lasted unchanged for just two years - the 2003 proposals from the "Rürup Commission" became law in 2004.  "Most significantly, it transformed the pay-as-you-go pillar into a notional defined contribution (NDC) look-alike by introducing a sustainability factor into the benefit indexation formula and recommended an increase in the normal retirement age [from 65 to 67]."

The new arrangements will 'stabilise' the combined retirement pension only if workers contribute 4% of pay to the private Tiers 2 or 3 (depending on the out-turns of a number of factors in both the public and private components of the system).  Total contributions by workers (both state and private) are expected to exceed 27% of pay.  That sounds to PensionReforms like an unsustainable amount.

PensionReforms disagrees with the paper's contention that pre-funding constrains pension costs.  In fact, the opposite is more likely unless we are talking about only the PAYG, state-provided component.  It seems that Germany has yet to discover that the cost of any pension (public or private; funded or PAYG) is the benefits that are actually paid - it doesn't much matter how the pension is financed.  Shifting public pension liabilities to the private sector merely changes the payer not the liability - that stays with the economy as a whole.

What was an all-embracing, almost wholly state-provided pension has, over the last 15 years, become a complex mélange that ordinary citizens will find difficult to understand.  In PensionReforms' view, changes to the German system have been installed before some quite fundamental questions have been answered.  In fact, they may not even have been asked.  What workers will make of their entitlements before making their private saving decisions is anyone's guess.  That understanding is a crucial foundation of any successful pension system.

PensionReforms suggests that future, further reforms are inevitable.  101