Germany's age old issue
Written by Pete Davy
Pete Davy asks what Germany is doing to address the challenges of its ageing population
Germany is a world leader in demographics. It hosts more organisations dedicated to addressing the challenges of an ageing population than probably anywhere else in the world. Unfortunately for its pensions system, however, it’s an issue that’s close to home.
The country’s national statistics office forecasts the country’s population will drop from 82 million today to 77 million by 2030 and as few as 65 million by 2060. Of those, a third will be at least 65 years old and one in seven 80 or over. Even by 2040, the Rentnerquotient, which expresses the relation between the number of retirees and the number of contributors in the German pension system, will have increased from 53 per cent to 73 per cent.
“That has huge implications for the labour market and social security systems,” says Dr. Martin Gasche, research director for old age security and social politics at the Mannheim Research Institute for the Economics of Aging.
Fortunately, of course, the problem has not gone unnoticed. Reforms at the start and end of last decade aimed to both strengthen occupa-tional schemes and make the state pension more sustainable. Most notably, the reforms agreed in 2007 raised the legal retirement age from 65 to 67, albeit slowly.
Each year from 2011 to 2022 the retirement age will increase by one month for new retirees. So from this year, workers will retire at 65 years and one month of age. From 2023 to 2029 it will rise by two month each year.
“This being Germany it’s not being done overnight,” observes Dr. Torsten Köpke, head of investment consulting in Germany for Aon Hewitt. However, it will have a significant impact.
So too will earlier reforms. In fact, look at the EU Commission’s studies of European pensions systems, and Germany is reducing its replacement ratio more rapidly than France, Italy, Hungary and a host of other countries, says Peter Doetsch, managing director of Mercer in Germany.
“It is probably still too high in comparison to our demographic problems but it is moving significantly in the right direction.”
In the private sector, meanwhile, since the Riester Reform introduced new tax-efficient supplementary pensions vehicles in 2001, about 12 million have been taken up and the proportion of private sector workers in occupational pension plans has increased from 38 per cent in 2001 to about 50 per cent today.
There remain, though, considerable challenges. The first is to ensure that progress continues. As Gasche says, “A lot of work has been done. Now it is important to execute the reforms decided.”
It’s by no means a certainty. Last summer the centre-left Social Democrats (SPD), who were part of the coalition Government that helped draw up the changes, nevertheless called for the planned increase in retirement age to be put on hold.
The 2008 reforms are also by no means the end of the story. Continued increases in life expectancy mean the statutory retirement age will need to be kept under review, says Dr. Hans-Peter Klös, head of education and labour market politics at the Cologne Institute for Economic Research, whose director caused a stir last year by responding to the SDP’s call for a postponement by suggesting retirement at 70 was all but inevitable in the long term.
“If we don’t update the legal retirement age regularly there are only two options: lowering the replacement ratio or/and by lifting contribution rate,” says Klös.
More immediate challenges face occupational schemes, however. The most obvious, as elsewhere in Europe, is the potential impact of Solvency II, although the industry is drawing some comfort from EU reassurances it won’t be crudely applied to pensions. Direkt insurance schemes under which employers take out a life insurance policy on an employee’s behalf, as independent insurance firms, fall under the scope of Solvency II. However, pensionskasse or pensionsfond schemes, despite being classified as specialised insurance companies, are exempt from the Solvency II insurance regulations. So too are the traditional book reserve arrangements, direktzusage, that account for more than half of schemes.
The industry rightly points out that occupational schemes are backed not just by the employer but also, in the case of book reserve schemes, the Pensions-Sicherungs-Verein (PSV), the insolvency protection fund that is roughly Germany’s equivalent of the UK Pension Protection Fund.
“Employees already have a lot of protection,” says Thomas Jasper, head of general consulting at Towers Watson Germany. Ultimately, it’s argued Solvency II would undermine that, not strengthen it. “If it was applied, there’s no question it would be damaging,” says Jasper.
Regulatory upheaval from within Germany, meanwhile, is less threatening. One area we should probably expect change is the PSV. The huge increase in the PSV levy charged to employers in 2009 (up eightfold) sparked calls for risk-based premiums. It follows a court ruling in November that even those that fully re-insured direktzusage schemes or support funds (unterstützungskassen – the fifth and final option for occupational schemes) must still pay the full levy, in contrast to pensionfonds, which are eligible for an 80 per cent discount. The levy has since returned to almost pre-crisis levels, but the debate rumbles on. Doetsch reckons reform in the next 18 months is more likely than not.
If it goes ahead, it will only add to the pressure brought by international accounting standards, which have already seen over two-thirds of DAX companies move towards external funding for their pensions. Mittelstand, small and medium sized business, are likely to increasingly follow suit, as a result of new domestic accounting rules (BilMog) brought in last year, reckons Hans-Werner Rölf, director corporate pensions for Standard Life in Germany. These increase the discount rate companies can use to calculate their pension liabilities from 5.2 per cent to six per cent.
“If companies don’t ring-fence funds for their pension, they will be disadvantaged, especially when they are looking for financing from the banks," says Rolf.
Meanwhile, in its survey of Mittelstand in March, Standard Life found a third offering pensions saw potential for higher participation rates this year, against just five per cent the year before.
The great divide
The biggest disparity between the DAX and smaller companies, however, remains the provision of occupational pensions. Perhaps 95 per cent of larger companies have them, but the figure is much lower among smaller businesses that account for the majority of the German workforce. Overall, take-up of occupational schemes remains at about 50 per cent of the workforce.
Whether that will change is less certain. Two factors give cause for hope, according to Frank Neuroth, ERGO management board member in charge of company pension schemes. The first is that it's a problem the government is aware of: a survey by the federal statistics bureau earlier this year confirmed ERGO’s findings. Neuroth says he wouldn't be surprised to see moves at least pushing companies to promote salary sacrifice.
The second, though, is those high profile, demographic trends that give Germany such a problem in the first place. Employees will increasingly expect pensions, and increasingly be in a position to demand them.
Pete Davy is a freelance journalist