Attempts to ensure the sustainability of Germany’s pension system have been underway for years, say Klaus Stiefermann and Cornelia Schmid
There is an American proverb that says: ‘Even if you’re on the right track, you’ll get run over if you just sit there’. In terms of social politics this means that the end of one reform leads immediately to the start of the next. The process of the reform of the German pension system is a good example of this.
Against the background of increasing life expectancy and a low birth rate, the minimum age for a standard statutory pension in Germany is to be gradually increased from 65 to 67 between 2012 and 2029. According to the Pension Insurance Retirement Age Adjustment Act, the Rentenversicherungs-Altersgrenzenanpassungsgesetz, from 2007 the new statutory retirement age of 67 applies to those born after 1963. A phased increase will be introduced for those born between 1947 and 1963 from 2012, with the target age being reached by 2029. An exception was made for members of the statutory pension insurance scheme who have completed at least 45 years of compulsory contributions, the exceptionally long-service pension, who are entitled to an full old-age pension from the age of 65.
The attempt to prolong working lives is one part of the pension reform process. Since 2001 several reforms have been undertaken to insure the financial sustainability of the pension system. The Riester Reform of 2001 offered incentives for occupational and private pension provision. In particular, from 2002 it gave employees the right to contribute up to 4% of the upper income limit for social security (currently €2,544 per annum) to an occupational pension scheme via deferred compensation (Entgeltumwandlung). The contribution was to be free of taxes and social contributions for a limited period and was due to expire at the end of 2008. In addition, the 2001 law also introduced the voluntary Riester-Rente, with state subsidies or tax incentives to encourage the building up of a supplementary funded pension in the second or third pillar.
The subsequent Rürup reform of 2004 introduced further changes. One was the reform of pension taxation leading to significant cuts in the future level of net pensions. Another was the modification of the statutory pension adjustment rule, the so-called sustainability factor, which takes into account the trend in the ratio of pensioners to contributors. As a result, pensioners share part of the extra burden resulting from greater life expectancy and the impact of birth rate and employment trends on the funding of statutory pension insurance.
The new statutory pension paradigm was a contribution rate of less than 22% and net replacement rate before tax of more than 43%. The experts behind the reform were proud of having created a ‘self-stabilising’ pension system, that is to say a rational mechanism that adapts the pension system automatically to changes in the economic and demographic environment.
However, earlier this year, with the 2009 general election looming, the governing grand coalition of the conservative CDU/CSU and social democrat SPD agreed to depart from the statutory pension adjustment rule and raise the pensions by 1.1% on 1 July.
Some 65% of all salaried employees in Germany were entitled to occupational pensions at the end of 2006 compared with just 52% half in 2001, according to the latest study by the research firm TNS Infratest Sozialforschung (1). It found that only 56% of salaried private sector employees have entitlements, although this compared with 38% five years earlier.
Of Germany’s five types of pension provision, the most dynamic were seen to be the six-year-old Pensionsfonds, although up from a very low level, support funds and the traditional Pensionskassen. Pension promises financed via book-reserves constituted by far the most important vehicle for financing occupational pension, although external funding through contractual trust arrangements (CTAs) have become increasingly popular among large corporations.
However, SMEs - the German Mittelstand - have found it easier to assign pension liabilities to Pensionsfonds. Indeed, in recent years many Pensionsfonds have developed new products to enable the transfer of existing pension entitlements from internal employer schemes and since late 2005 companies have been making use of an option to take on pension commitments with lower liquidity implications for the employer.
Despite the positive trend, the study suggested that growth slowed in 2006. The main reason was the threatened ending of the exemption from social security contributions of pension contributions at the end of 2008, meaning a 20% cost increase for deferred compensation in 2009 for both employees and employers. However, after long and difficult discussions, legislation was passed at the end of 2007 providing for limited exemption beyond 2008. As a result, contributions remain free of taxes and social contributions. Employers retain a cost-effective way of offering occupational pensions and employees retain a crucial incentive to save.
Meanwhile, the political debate has moved on from occupational pensions per se. The new focus is on differing approaches to capital sharing for employees. The SPD is in favour of the creation of a ‘Germany fund’ supra-company saving model. By contrast the CDU/CSU tends towards ‘company alliances for social capital partnerships’ at an individual company level and advocates a plurality of capital-sharing models.
Both right and left would like to improve the incentives for capital sharing. Their different proposals allow for preferential tax and social security treatment to promote capital sharing for employees. One result of the plans coming to fruition would be a fall in the number of employees joining deferred compensation plans because of the greater attractive incentives for capital sharing.
However, acquiring a direct stake in a company is not unproblematic and some trade unions argue that it involves a double risk for employees. They suggest that their pay and their investment would be dependent on one and the same company and that in the event of its bankruptcy, participating employees would lose both their job and their investment. Thanks to the transparency requirements, many companies also have reservations about direct capital sharing for employees. The problems are complex, in particular in an unincorporated firm, the most common type in Germany.
Nevertheless, against a background of a decreasing statutory pension level, would not capital sharing for employees be an attractive option? Unlike all capital-sharing models, occupational pension schemes offer lifelong reliable pensions for employees. Employees should start with deferred compensation and legislators should be cautious with attractive incentives for capital-sharing models. Money can be spent only once. Perhaps it is not such a serious problem that only 4% of firms in Germany offer their employees a capital-sharing facility.
The 2007 amendment to the Insurance Supervision Act (VAG) allowed pension funds without insurance-like guarantees to underfund their obligations by up to 10% and distribute additional employer contributions over a period of up to 10 years. Until 2007 Pensionsfonds could only fall to 5% below full funding and were required to be restored to full funding immediately.
It had already become easier for Pensionsfonds and Pensionskassen to engage in foreign business as a result of a 2006 amendment to the VAG. The new rules enabled companies that employed staff in several EU member states to offer all their employees occupational old-age pension products that are permitted abroad via Pensionsfonds and Pensionskassen in Germany. Previously when engaging in the provision of cross-border services, they had only been able to offer occupational pension products approved in Germany.
The more flexible funding level, a recovery period of 10 years and a bigger range of products all gave pension funds more flexibility. What remains to be seen is whether the changes are sufficient to ensure the vehicles’ competitiveness with those from other EU countries.
The Solvency II project will redefine the regulatory solvency requirements for insurers in Europe. Pension funds, or insitutions for occupational retirement provision (IORPs) in EU jargon, are concerned because article 17 of the IORP directive on regulatory own funds refers to the life assurance directive. According to Article 319 of the draft Solvency II directive, the life assurance directive will be repealed and references to “this directive” shall be construed as references to the Solvency II directive.
There are many good arguments not to impose the new solvency framework on IORPs, at least in the proposed form. In contrast to insurers, for example, many IORPs do not underwrite the liabilities themselves. Solvency II does not recognise the ability of a sponsor or the social partners to raise contribution rates as an alternative to solvency capital.
In addition, IORPs are generally not-for-profit institutions, which ensures that plan members are protected by organisations whose activities are not dominated by the financial interests of shareholders. Moreover, the IORP directive already contains stringent and modern regulations that secure the future retirement income of European citizens. IORPs must at all times have sufficient assets to fulfil their pension commitments. Besides the funding requirements - which are referred to as the pillar I requirements in Solvency II - the IORP directive also contains regulations that safeguard sound administrative procedures, adequate internal control mechanisms, professional qualities of governing bodies (pillar II requirements) and transparency towards plan members (pillar III requirements).
According to the text of the latest CEIOPS study: “Solvency II … is not an appropriate course to pursue. Such action could lead to excessive costs and thus bear risk of threatening the continued provision of DB schemes” and “heavy funding requirements may impose inappropriate large up-front payments”.
So far, the question whether or which parts of the Solvency II framework should be applied to IORPs - in Germany Pensionkassen and Pensionsfonds - is still open on the European level. Therefore, it is difficult to understand the new German regulations for improving risk management in section 64a VAG. Therefore, the first elements of Solvency II became already reality for Pensionkassen through the 2007 amendments to the Insurance Supervision Act. Are German lawmakers, as they are so often, hurrying ahead?
1) K Kortmann, Situation und Entwicklung der betrieblichen Altersversorgung in der Privatwirtschaft und im öffentlichen Dienst 2001 - 2006, study commissioned by the federal ministry of labour and social security from TNS Infratest Sozialforschung, Munich (2007)
2) Survey on Technical Provisions and Security Mechanisms in the European Occupational Pensions Sector from http://www.ceiops.eu/media/docman/public_files/publications/submissionstotheec/ReportonFundSecMech.pdf
Klaus Stiefermann is managing director of the German Occupational Pensions Association (aba) and Cornelia Schmid is aba’s EU affairs specialist