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Reforming an Unsustainable Public Pension System: The German Case Anette Reil-Held

www.mea.uni-mannheim.de. Reforming an Unsustainable Public Pension System: The German Case Anette Reil-Held Mannheim Research Institute for the Economics of Aging (mea), University of Mannheim, Germany BPI Asset Management Conference on Pensions , Lisbon, 18 March 2005. Outline:.

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Reforming an Unsustainable Public Pension System: The German Case Anette Reil-Held

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  1. www.mea.uni-mannheim.de Reforming an Unsustainable Public Pension System: The German Case Anette Reil-Held Mannheim Research Institute for the Economics of Aging (mea), University of Mannheim, Germany BPI Asset Management Conference on Pensions, Lisbon, 18 March 2005

  2. Outline: 0. The German Pension System 1. Problems and Challenges: - Ballooning dependency ratio of monolithic PAYG systems - Two dimensions of demographics change - Weak economic growth 2. Causes and Cures: - Growth: Stabilize contribution rates, foster prefunding - Babyboom/bust: Subtle shift between 1st and 2nd/3rd pillar - Longevity: Shift of retirement age

  3. History of the German Pension System • 1880s: Bismarck installs funded system (ret.age=70) • 1957: Adenauer converts to pay-as-you-go (ret.age=65) • 1965: Indexation to gross wages • 1972: Introducton of „flexible“ retirement age (effectively age 60) without actuarial adjustment • 1992: Indexation to net wages, 3.6% actuarial adjustments (starting from 2001!) • 1999: Indexation to life expectancy (revoked in 2000) • 2001: Riester Reform: Introduction of multipillar system • 2003: Rürup Commission: Ret.age slowly increasing to 67, Indexation to system dependency ratio (NDC) • 2004: Reform law to establish sustainability factor

  4. Main Features of theGerman Pension System • Obligatory,designed to maintain the standard of living in retirement: ubiquitious! • Pensions are roughly proportional to labour earnings over the whole working life („point system“) • Only few redistributive properties: „pensioninsurance“ • Financed by contributions (19.5% of gross wages) andstate subsidy (one third of pension expenditures)

  5. Outline: 0. The German Pension System 1. Problems and Challenges: - Ballooning dependency ratio of monolithic PAYG systems - Two dimensions of demographics change - Weak economic growth 2. Causes and Cures: - Growth: Stabilize contribution rates, foster prefunding - Babyboom/bust: Subtle shift between 1st and 2nd/3rd pillar - Longevity: Shift of retirement age

  6. Italy GER Portugal DK 15-64/65+ ….and Old Age Dependency.

  7. [125%] [75%] Ballooning System Dependency Pensioners Employees 90% 50%

  8. 1997 2025 2100 2050 Demographic Change:1. Baby Boom/Bust Transition

  9. 7 4 Demographic Change:2. Increasing Life Expectancy Additional Benefits = Additional Financial Burden female male

  10. Weak Economic Growth GDP growth rate: GDP per capital level:

  11. 0. The German Pension System 1. Problems and Challenges -- Ballooning system dependency of monolithic PAYG systems -- Two dimensions of demographic change -- Weak economic growth 2. Causes and cures: Keep public systems, foster private savings 1. Growth: Stabilize contribution rates 2. Babyboom/bust: Partial transition to more funding 3. Longevity: Shift of retirement age

  12. Increasing taxes/contributions is no solution in the large EU countries: International Labour Costs per hour in Euro

  13. 1. Growth: Stabilize Contribution Rate 2010 2020 2030  Need Benefit Cuts!

  14. 1997 2025 2100 2050 2. Babyboom/bust: DB->NDC (demography indexed PAYG), Prefunding Solution: Partial funding (pillars2 and 3)

  15. [125%] [75%] Index to System Dependency Pensioners Employees 90% 50%

  16. System dependency ratio 2. Babyboom/bust: Demography-indexed PAYG and Funding General idea of system with “sustainability factor”: Budget equation of a PAYG system: cont_rate  wage  NWORK = repl_rate  wage  NPENS Hold cont_rate = repl_rate  NPENS/NWORK = constant!  repl_rate has to be proportional to NWORK/NPENS

  17. 2. Babyboom/bust: Demography-indexed PAYG and funding Annual Pension Increase Change in earnings,net of contributions (aggregate, lagged) Change in system dependency ratio („sustainability factor“) The German pension indexation formula

  18. 48% Babyboom/bust: Fill gap with private pensions Funded pillars 2 and/or 3 at a 4% saving rate(return = 4% / 6%) PAYG pillar 1 reduced by sustainability factor

  19. …if there were only sufficient time:Room for Prefunding

  20. How to fill the gap, the 2nd pillar 2nd pillar: Promotion of occupational pensions • Traditionally played a minor role in Germany • => Introduction of additional subsidies were introduced with the „Riester reform“: • general right to convert part of the salary into contributions to pension plans for each worker • pension funds are now eligible for subsidies/tax relief • ==>successful: broader coverage (2001-2003: +14%)

  21. How to fill the gap, the 3rd pillar Successful? Don‘t know yet ... 50%

  22. 3. Longevity: Increase Retirement Age(Can‘t do all by savings ...) • Very unpopular •  late start (2011), slow phase-in (1 month p.a. until 2035) • Current high unemployment •  cause and effect? •  have a regular check of labor market situation •  put pressure on employers • Worn-out argument •  see 1960-72; since then four (healthier) life years more, until 2035 another three years • Effective vs. statutory retirement age; expectational effects • actuarial adjustments are absolutely necessary • Increase earliest retirement age

  23. Where do we stand? The most pressing pension problems have not been resolved in *any* of the four large continental EU countries: - Neither dimension of demographic change fully addressed  Ballooning contribution rates  Weak economic growth Four essential reform steps (GER): x. Growth: Raising contribution rates is not an option 1. Babyboom/bust: Change PAYG systems from DB to DC  2. Fill gap with private savings (natural limits): tbd 3. Longevity: Shift of early and normal entitlement ages: tbd

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