All systems go

Germany is known as the driving force behind the eurozone and a strong campaigner for spending cuts and better budgeting for the future. However, when it comes to pensions, the country could still make some improvements to increase people’s retirement savings.
Ten years ago the legislator introduced a right for employees to ask for deferred compensation, and a private pension product called Riester Rente was set up.

However, just one out of two Germans are eligible for occupational pensions, while there are currently 15 million Riester contracts, despite rough estimates of around 30 to 40 million people who would be eligible for contributing to Riester plans.

Fidelity Worldwide Investments Germany managing director Klaus Mössle explains: “Riester has been a certain success, but it is not an efficient way, also from the government point of view, which has to save money. What has not really taken off is the corporate pension area, but the regulatory framework is quite positive to do something in this area. It is in my view not yet fully appreciated by the companies.”

While the legislative framework is favourable for occupational pension saving, the second pillar is still under-developed in Germany. Currently about 5-8 per cent of pensioner income comes from corporate pensions, which is low compared to for instance the Netherlands, where occupational pension savings make up 29 per cent of the average retirement income.

Since the introduction of Riester Rente, the government has mainly been focusing on the private pension area, while the occupational pension has not been given much attention. Unjustly so though, as rising life expectancy will mean the pay as you go state pension system is unsustainable at its current level, while the private pension space can not fill this gap completely.

Partner at law firm Kliemt & Vollstädt Barbara Reinhard says that it is mainly low-income workers that are not saving enough. “It’s rather difficult to get the right ones to save. What the government tries to do is to say that if you’re going to do some extra savings, you will get some tax redundancies.”

Board member of the German Pension Fund Association VFPK and board member of the pension fund for the private banking sector BVV Helmut Aden adds: “We have the need for additional savings and we have the systems for these additional savings, but I think especially young people are still not doing enough for their old age pensions. There is a lot of talk about additional tax incentives here and additional incentives in terms of so-called Riester savings in the private pension system. But maybe we need a more mandatory approach.”

Large companies are driving the trend to increase workplace savings across the German population. For example, the private banking sector has a mandatory pension savings vehicle, which is managed by the BVV, while Fidelity in January introduced a new DC scheme with auto-enrolment and the possibility to opt out.

German Investment and Asset Management Association CEO Thomas Richter believes the share of occupational pensions is still underdeveloped. He adds: “The largest growth potential overall is to be seen in the small and medium sized enterprise area.”

However, pure DC plans like those found in the UK and the US do not exist in Germany, because under German law the employer always guarantees that nominal contributions will be protected.

In that sense the investment risk has not fully shifted to the employee, and Mössle explains that, to protect the nominal capital on a long-term basis, there are concepts which can achieve this with a very high degree of probability.

“What is possible under German legislation is to make a lump sum promise, so not to promise a pension, but to promise to pay out the capital in lump sum at retirement age, or to pay it out in 10 or 20 instalments. This takes away the longevity risk from the employer and it also takes away the inflation risk. If you put these elements together, you can design a plan which looks very similar to a UK DC plan.”

Despite the need for additional savings, the government is reluctant to put too much regulatory pressure on employers, as companies, government and trade unions are “rather nervous” that it would result in “too harsh legislation which would put off new companies to provide these company pension schemes”, Reinhard says.

But Aden points out that tax incentives work very well in Germany, and that some additional tax incentives may be the answer. “Opting out or mandatory systems may be the right approach. On the other hand, I think these days it’s not that easy to convince people to enter a saving system where interest rates are low and the timeline of investment is very long, until your old age pension. So the times are not that easy for funded systems at the moment.”

Solvency II – EU regulations

Apart from worries about low interest rates and people not saving enough, the German pensions industry has also been keeping a close eye on legislation coming from Europe.
Richter is positive about the IORP Directive and the White Paper on pensions and says: “I would really love to see more cross-border business in this area. But we should not raise our expectations too high, because all these pension systems have to blend in the local labour, social and tax legislation of various EU member states.”
However, while the EU might have limited powers to create a truly Europe-wide second pillar system, there is room for improvement in the area of the asset management solutions standing behind these vehicles.

When it comes to the controversial proposals for Solvency II style capital requirements for pension funds, Reinhard says that Germany does not need extra solvency requirements, as it has a pension security association that saw pension funds getting through the 2008-09 crisis quite well.

“By this association the insolvency risk of a company concerning its pension schemes is shared by all companies in Germany. And this gives you a very good base to handle these insolvencies. People therefore don’t feel that we need any more legislation,” she notes.
Calculations have estimated the additional costs of Solvency II style requirements for German pension funds to be around €40 billion and Helmut says it would increase the capital requirement of around 5 per cent now to 40 per cent post-Solvency II. “Where shall we get the money from? We can’t change the contracts, the only way to reduce capital requirements is to reduce the benefits and I don’t think this is what the legislator wants.”

He adds that it will also speed up the move from DB to DC systems. “The change from DB to DC is just a risk-shift from pension fund and employer to the employee.
This change is also driven by this solvency discussion and I don’t think that’s the right approach. If we want the employees to enter funded systems then we can’t shift the whole risk to them.”

Overall, corporations are driving change in the German pensions market, and any further innovations over the next few years in getting more people to save seem likely to come from the companies rather than the government.

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