1. Reforming an Unsustainable Public Pension System: The German Case
Reforming an Unsustainable Public Pension System:
The German Case
Anette Reil-Held
Mannheim Research Institute for the Economics of Aging (mea), University of Mannheim, Germany
BPI Asset Management Conference on Pensions,
Lisbon, 18 March 2005

2. Outline: 0. The German Pension System 1. Problems and Challenges:
- Ballooning dependency ratio of monolithic PAYG systems
- Two dimensions of demographics change
- Weak economic growth
2. Causes and Cures:
- Growth: Stabilize contribution rates, foster prefunding
- Babyboom/bust: Subtle shift between 1st and 2nd/3rd pillar
- Longevity: Shift of retirement age

3. History of the German Pension System
1880s: Bismarck installs funded system (ret.age=70)
1957: Adenauer converts to pay-as-you-go (ret.age=65)
1965: Indexation to gross wages
1972: Introducton of „flexible“ retirement age (effectively age 60) without actuarial adjustment
1992: Indexation to net wages, % actuarial adjustments (starting from 2001!)
1999: Indexation to life expectancy (revoked in 2000)
2001: Riester Reform: Introduction of multipillar system
2003: Rürup Commission: Ret.age slowly increasing to 67, Indexation to system dependency ratio (NDC)
2004: Reform law to establish sustainability factor

4. Main Features of the German Pension System
Obligatory, designed to maintain the standard of living in retirement: ubiquitious!
Pensions are roughly proportional to labour earnings over the whole working life („point system“)
Only few redistributive properties: „pension insurance“
Financed by contributions (19.5% of gross wages) and state subsidy (one third of pension expenditures)

5. Outline: 1. Problems and Challenges: 0. The German Pension System
- Ballooning dependency ratio of monolithic PAYG systems
- Two dimensions of demographics change
- Weak economic growth
2. Causes and Cures:
- Growth: Stabilize contribution rates, foster prefunding
- Babyboom/bust: Subtle shift between 1st and 2nd/3rd pillar
- Longevity: Shift of retirement age

6. ….and Old Age Dependency.
15-64/65+
Italy
GER
Portugal DK

7. Ballooning System Dependency
Pensioners Employees
[75%]
[125%]
90%
50%

8. Demographic Change: 1. Baby Boom/Bust Transition
1997
2025
2050
2100

9. Demographic Change: 2. Increasing Life Expectancy
Additional Benefits = Additional Financial Burden 7
female 4
male

10. Weak Economic Growth
GDP growth rate:
GDP per capital level:

11. Keep public systems, foster private savings
0. The German Pension System
1. Problems and Challenges
-- Ballooning system dependency of monolithic PAYG systems
-- Two dimensions of demographic change
-- Weak economic growth
2. Causes and cures:
Keep public systems, foster private savings
1. Growth: Stabilize contribution rates
2. Babyboom/bust: Partial transition to more funding
3. Longevity: Shift of retirement age

12. Increasing taxes/contributions is no solution in the large EU countries:
International Labour Costs per hour in Euro

13. 1. Growth: Stabilize Contribution Rate
2010
2020
2030
 Need Benefit Cuts!

14. 2. Babyboom/bust: DB->NDC (demography indexed PAYG), Prefunding
1997
2025
2050
2100
Solution: Partial funding
(pillars 2 and 3)

15. Index to System Dependency
Pensioners Employees
[75%]
[125%]
90%
50%

16. 2. Babyboom/bust: Demography-indexed PAYG and Funding
General idea of system with “sustainability factor”:
Budget equation of a PAYG system:
cont_rate  wage  NWORK = repl_rate  wage  NPENS
Hold cont_rate = repl_rate  NPENS/NWORK = constant!
 repl_rate has to be proportional to NWORK/NPENS
System dependency ratio

17. 2. Babyboom/bust: Demography-indexed PAYG and funding
Annual Pension Increase
Change in earnings, net of contributions
(aggregate, lagged)
Change in system dependency ratio
(„sustainability factor“)
The German pension indexation formula

18. Babyboom/bust: Fill gap with private pensions
Funded pillars 2 and/or 3 at a 4% saving rate (return = 4% / 6%)
48%
PAYG pillar 1 reduced by sustainability factor

19. …if there were only sufficient time: Room for Prefunding

20. How to fill the gap, the 2nd pillar
2nd pillar: Promotion of occupational pensions
Traditionally played a minor role in Germany
=> Introduction of additional subsidies were introduced with the „Riester reform“:
general right to convert part of the salary into contributions to pension plans for each worker
pension funds are now eligible for subsidies/tax relief
==>successful: broader coverage ( : +14%)

21. How to fill the gap, the 3rd pillar
Successful?
Don‘t know yet ...
50%

22. 3. Longevity: Increase Retirement Age (Can‘t do all by savings ...)
Very unpopular
 late start (2011), slow phase-in (1 month p.a. until 2035)
Current high unemployment
 cause and effect?
 have a regular check of labor market situation
 put pressure on employers
Worn-out argument
 see ; since then four (healthier) life years more, until 2035 another three years
Effective vs. statutory retirement age; expectational effects
actuarial adjustments are absolutely necessary
Increase earliest retirement age

23. Four essential reform steps (GER):
Where do we stand?
The most pressing pension problems have not been resolved in *any* of the four large continental EU countries:
- Neither dimension of demographic change fully addressed
 Ballooning contribution rates
 Weak economic growth
Four essential reform steps (GER):
x. Growth: Raising contribution rates is not an option
1. Babyboom/bust: Change PAYG systems from DB to DC 
2. Fill gap with private savings (natural limits): tbd
3. Longevity: Shift of early and normal entitlement ages: tbd