GERMANY - A study into civil servant pension funds for German provinces has found the ideal asset allocation is 22% equities, 47% bonds and 30% real estate.

In a Pension Research Council Working Paper, researchers from the council as well as Germany's Goethe University in Frankfurt calculated the optimal asset allocation for an assumed soon-to-be-created pension fund for the civil servants in the German province of Hesse.

Hesse is one of the provinces which has recently announced it will start to fund liabilities in of its civil servants' pensions. (See earlier IPE article: Lower Saxony to set up pension fund)

The research found a contribution rate worth 19% of salary "would be sufficient to cover future benefit accruals" once the pension reforms were implemented, raising the retirement age to 67 from the current 65 and capping pension payouts at a 71.75% replacement rate.

Under those conditions, researchers calculated the ideal mixture would be an allocation of 22% in equity index funds, 47% in government bond index funds and 30% in real estate index funds.

The authors noted they assumed "investments in index funds to prevent the state from systematically influencing asset prices".

This allocation will reduce expected pension costs by 25%, the paper concludes, while researchers argued holding 60% or more in equities as done by some US civil servant funds "is likely too aggressive".

On the other hand, investing in pure bond portfolios - as more or less done by the first German provinces to set up pension funds Rhineland-Palatine and Saxony - "provides stability, but can be quite expensive" as well as foregoing "the opportunity to improve the funds' financial situation by earning higher returns in equity markets".

"These results indicate that moving toward a funded pension system for German civil servants could be beneficial to both taxpayers as well as employees," the authors pointed out.

Membership of the civil servants pension fund would mean greater flexibility for individuals in their choice of job as their current pension provision restricts them to staying in the civil service.

In a new paper on the financial situation of German provinces, Moody's points out moving towards funded civil servants' pension was "generally a positive development."

Nevertheless, the rating agency cautioned "most pension funds have only been introduced recently or will be introduced in the near future; and the parallel funding of current pensions and the accumulation of reserves/payments for the pension funds could burden the budgets even further in the medium term, as budgetary relief will become only visible in the longer term".

Moody's concludes: "Nonetheless, these arrangements indicate that the parties involved are starting to deal with the issue."

The agency estimates pension payments could amount to 13.7% of total spending by 2030 against 8.7% in 2005 if no measures were taken.

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