A 'klassic' approach?
Written by Stefan Giesecke
October 2011
Stefan Giesecke comments on the state of play in the German pensions market
There is a storm brewing in the German pensions market. Current conditions threaten to bring the market into a crisis and place a big question mark over the long term viability of the traditional German pension structure.
The majority of pension plans in Germany follow the 'klassic' structure. Central to these plans are the minimum guaranteed interest rates that providers are obliged to meet, set by the German Finance Ministry.
Klassic plans have been a somewhat unchallenged status quo in the German market for over 100 years and make up around 90 per cent of pension plans taken out in the country. But against the current challenging financial landscape, the cracks in the klassic structure are beginning to show.
A toxic combination of low interest rates, pressure to invest conservatively and looming Solvency II capital reserving requirements are putting a tight squeeze on policyholders' pension pots and providers' ability to meet their guarantees.
Providers are being forced to invest increasingly large proportions of their funds into fixed interest investments to meet guarantees, but with the ongoing low interest rate environment, returns are continuously decreasing.
Additionally, this conservative approach puts a restriction on how much providers can invest in the wider market, effectively limiting the potential for their funds to achieve more attractive long term returns.
The situation is further compounded with incoming Solvency II requirements, as providers face the prospect of having to retain increased capital whilst seeing decreased returns and experiencing growing pressure to meet liabilities.
The German Finance Ministry has taken some action to ease the pressure by proposing a lower minimum guarantee of 1.75 per cent, down from the current rate of 2.25 per cent.
But providers will still need to invest conservatively at this new rate and will still be burdened with meeting guarantees at the current and previously higher rate of 4 per cent, threatening a 'cash lock' situation.
This grim outlook has triggered predictions of a crash in the traditional German life assurance market. Questions are now being asked whether the popularity of with-profits in Germany might reduce dramatically as has been the case in the UK.
And there are other parallels to be drawn with the UK, as both countries face an ageing population with fewer workers to support them. Germany has made proposals to raise the state retirement age and gradually increase tax relief on pension premiums, in a bid to encourage people to make additional pension provisions and decrease the burden on the state, but the country may be forced to take more drastic action.
If the fall in popularity of with-profits funds and the pension reforms in the UK are to be taken as a cautionary tale, a fresh approach to the antiquated klassic plan in Germany is overdue and the market is in need of solutions that better serve the needs of policyholders, advisers and providers.
Looking again at with-profits in the UK, it was the opacity around the way plans allocated premiums that led to policyholders' concerns. As they become savvier, policyholders demand greater transparency around how their premiums were being invested. There is also a need for policyholders to have more flexibility with their plans, such as being able to choose which funds premiums can be invested in.
The German pension market is in need of more practical alternatives to the existing rigid klassic plans, which struggle to satisfy consumers' requirements today and provide sufficient returns for providers. Whilst predictions of a crash in the traditional German pensions market are dramatic, they should not be ignored, and with the financial outlook remaining uncertain, there is a growing need for products to address current challenges as well as those that may be on the horizon.
Written by Stefan Giesecke, Chairman of fpb AG, Friends Provident International's distribution management company in Germany
