Europe's pension funding strategy
It is often said that funded pensions are the only way forward for Europe but, with stock markets headed south for the third year in a row, this belief is being sorely tested in Europe. This is especially true of countries, such as France and Germany, where the tradition has yet to be properly adopted.
While France is still struggling with reform, hopes were high earlier this year for the ‘Riester Rente’ or pension reforms implemented by Germany’s government at the beginning of the year. A bonanza of up to e40bn for the financial services industry was forecast by some commentators as Germans started to invest for their retirement.
However, with very unimpressive markets and an extremely complicated and – some would argue – typically German, set of regulations, it is no surprise that the expected rush has failed to materialise. Apparently, only 6% of the 35m Germans entitled to take out a private pension product have done so. Only 1.9m policies have been sold.
Even if, as the German government believes, the take-up rate doubles over the next six months we will be many years away from believing that Germans really will be able to fund their retirement properly.
Whether the result would have been significantly different if markets had been positive is anyone’s guess. What does look clear, however, is that further changes to the law will have to be made before serious reform can be expected to take place. But at least Germany is trying.
France, however looks more problematic. President Jacques Chirac seems determined to press ahead with tax cuts worth 2% of GDP, the centrepiece of his election manifesto, together with additional spending on security. These plans will require a balanced budget being put off until 2007. The problem, however, is not France’s current debt burden. It is the fact that it has probably the highest structural deficits in the EU. One of the country’s heaviest liabilities is the cost of pensions for a very large part of its workforce, especially for a huge civil service, now provided on a pay-as- you-go basis. If it does nothing soon France will break its EU promise to balance its budget.
One of the many fears of Britain’s euro-sceptics is that countries like the UK and the Netherlands, each with their own arrangements nearly fully funded, will have to help pick up the tab for France’s unfunded liabilities. It is difficult to see that this actually could happen, but the new French government is hardly helping to reassure the market. The longer France puts off change the more expensive it becomes. Eventually, it will reach a point where the level of taxation required to sustain the system becomes unaffordable and, French politicians will no doubt argue, unfair. We have already seen proposals to provide equalisation of tax rates throughout Europe!
I am not sure there is anything that would encourage properly funded pension provision throughout Europe, unless governments start it. We need either compulsion or some real incentives that will encourage individuals to save for their retirement in individual or group plans. This means offering generous subsidies or tax benefits. Ironically, we actually need compulsion or better subsidies in countries like the UK as well as the obvious ones of Germany and France. The problem in the UK is that what have been actuarially reasonable saving rates are starting to reduce at the very time they should be increasing.
I really believe that what we need now in the UK and Germany is legislation to force companies to have to offer and pay into occupational schemes for employees. For their part, employees will have to accept such corporate arrangements or make alternative and equivalent personal arrangements. Just requiring companies to have to offer occupational schemes to employees is not sufficient.
Representatives of two of Germany’s (and therefore Europe’s) leading financial services companies, Deutsche Asset Management and Allianz Fund Management, have recently emphasised this point. Even the chairman of the UK’s National Association of Pension Funds has apparently privately accepted this view. Politicians also seem to accept it. They just want a way to introduce compulsion without it being perceived as additional taxation.
Employees need to get used to the idea of saving for retirement and employers need to get used to providing good funded pensions. In both cases, very soon!
In the UK pension contributions have traditionally been invested mostly in equities. Over the past two and half years this has hurt. Asset allocation is now changing, with much more money moving into bonds and other asset classes. I really hope the current market situation is just a rather prolonged stockmarket blip and does not deter companies and their workforces from saving for retirement. With all of us living so much longer these days, well- funded pension funds have never been so needed. How long we do we have to wait before governments get the message?