Reforming an Unsustainable Public Pension System: The German Case Anette Reil-Held Mannheim Research Institute for the Economics of Aging (mea), University.
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Reforming an Unsustainable Public Pension System:The German Case
Anette Reil-HeldMannheim Research Institute for the Economics of Aging (mea), University of Mannheim, Germany
BPI Asset Management Conference on Pensions,
Lisbon, 18 March 2005
www.mea.uni-mannheim.de
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
Outline:
History of the German Pension System
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
Main Features of theGerman Pension System
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:
„pension insurance“
• Financed by contributions (19.5% of gross wages) and state subsidy (one third of pension expenditures)
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
Outline:
15-64/65+
….and Old Age Dependency.….and Old Age Dependency.
Italy GER Portugal
DK
Abbildung 4: Rentnerquotienten bei verschiedenen Erwerbsszenarien
50%
60%
70%
80%
90%
100%
110%
120%
130%
140%
J ahr
E1
E2
E3
Pensioners Employees
50%
90%
Ballooning System DependencyBallooning System Dependency
[75%]
[125%]
Demographic Change:1. Baby Boom/Bust Transition
Demographic Change:1. Baby Boom/Bust Transition
Birg/Flöthmann, IBS, Univ. Bielefeld 1999
Schaubild 1.6Entwicklung der Altersstruktur der Bevölkerung in den alten und neuen Bundesländern
1997
-1.000.000 -500.000 0 500.000 1.000.000
0
10
20
30
40
50
60
70
80
90
100
110
Männer (neue L.) Männer (alte L.) Frauen (neue L.) Frauen (alte L.)
2025
-1.000.000 -500.000 0 500.000 1.000.000
0
10
20
30
40
50
60
70
80
90
100
110
Männer (neue L.) Männer (alte L.) Frauen (neue L.) Frauen (alte L.)
2050
-1.000.000 -500.000 0 500.000 1.000.000
0
10
20
30
40
50
60
70
80
90
100
110
Männer (neue L.) Männer (alte L.) Frauen (neue L.) Frauen (alte L.)
2100
-1.000.000 -500.000 0 500.000 1.000.000
0
10
20
30
40
50
60
70
80
90
100
110
Männer (neue L.) Männer (alte L.) Frauen (neue L.) Frauen (alte L.)
1997 2025
2050 2100
Demographic Change:2. Increasing Life Expectancy
Demographic Change:2. Increasing Life Expectancy
75
77
79
81
83
85
87
89
1970 1980 1990 2000 2010 2020 2030 2040
Alter
Life expectancy 65 year old men
Life expectancy 65 year old women
zusätzliche demographische Belastung durch den Anstieg der Lebenserwartung von Männern bzw. Frauen
Additional Benefits = Additional Financial Burden
male
female
47
Weak Economic GrowthWeak Economic Growth
GDP growth rate: GDP per capital level:
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
Increasing taxes/contributions is no solution in the large EU countries:
Increasing taxes/contributions is no solution in the large EU countries:
International Labour Costs per hour in Euro
25,4
19,3 19,4
21,3
24,1
40,9
48,2
45,2
43,9
42,0
1617181920212223242526
2000 2010 2020 2030 2040
Pro
zen
t
40
42
44
46
48
50
Pro
zen
t
Beitragssatz (linke Skala)Bruttorentenniveau (rechte Skala)
2010
2020
2030
1. Growth: Stabilize Contribution Rate 1. Growth: Stabilize Contribution Rate
Need Benefit Cuts!
2. Babyboom/bust: DB->NDC (demography indexed PAYG),
Prefunding
2. Babyboom/bust: DB->NDC (demography indexed PAYG),
Prefunding
Birg/Flöthmann, IBS, Univ. Bielefeld 1999
Schaubild 1.6Entwicklung der Altersstruktur der Bevölkerung in den alten und neuen Bundesländern
1997
-1.000.000 -500.000 0 500.000 1.000.000
0
10
20
30
40
50
60
70
80
90
100
110
Männer (neue L.) Männer (alte L.) Frauen (neue L.) Frauen (alte L.)
2025
-1.000.000 -500.000 0 500.000 1.000.000
0
10
20
30
40
50
60
70
80
90
100
110
Männer (neue L.) Männer (alte L.) Frauen (neue L.) Frauen (alte L.)
2050
-1.000.000 -500.000 0 500.000 1.000.000
0
10
20
30
40
50
60
70
80
90
100
110
Männer (neue L.) Männer (alte L.) Frauen (neue L.) Frauen (alte L.)
2100
-1.000.000 -500.000 0 500.000 1.000.000
0
10
20
30
40
50
60
70
80
90
100
110
Männer (neue L.) Männer (alte L.) Frauen (neue L.) Frauen (alte L.)
1997 2025
2050 2100
Solution: Partial funding
(pillars
2 and 3)
Abbildung 4: Rentnerquotienten bei verschiedenen Erwerbsszenarien
50%
60%
70%
80%
90%
100%
110%
120%
130%
140%
J ahr
E1
E2
E3
Pensioners Employees
50%
90%
Index to System DependencyIndex to System Dependency
[75%]
[125%]
2. Babyboom/bust: Demography-indexed PAYG and
Funding
2. Babyboom/bust: Demography-indexed PAYG and
Funding
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
System dependency ratio
General idea of system with “sustainability factor”:
2. Babyboom/bust: Demography-indexed PAYG and funding
2. Babyboom/bust: Demography-indexed PAYG and funding
22
11
2
11 211
211**
tt
tt
t
ttt CONTCONT
CONTCONT
AGE
AGEAPVAPV * [(1-
2
1
t
t
SDR
SDR) * +1]
where: APV = average pension value AGE = average gross earnings CONT1,2 = contribution to first and second pillar SDR = system dependency ratio (number of equivalence pensioners / number of equivalence contributors)
Annual Pension Increase
Change in earnings,net of contributions
(aggregate, lagged)
Change in system dependency ratio
(„sustainability factor“)
The German pension indexation formula
Babyboom/bust: Fill gap with private pensions
Babyboom/bust: Fill gap with private pensions
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
55%
60%
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
2022
2024
2026
2028
2030
2032
2034
2036
2038
2040
Jahre
Bru
ttor
ent
enn
ive
au
Rentenniveau der gesetzlichen Rentenversicherung nach Einführung des Nachhaltigkeitsfaktors
Riester-Rente bei einem Nominalzins von 4%
Riester-Rente bei einem Nominalzins von 6%
PAYG pillar 1 reduced by sustainability factor
Funded pillars 2 and/or 3 at a
4% saving rate(return = 4% / 6%)
48%
…if there were only sufficient time:
Room for Prefunding
…if there were only sufficient time:
Room for Prefunding
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
E D F I GB NL US CH
Public Pillar Occup. Pillar Private Pillar
How to fill the gap, the 2nd pillar
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%)
How to fill the gap, the 3rd pillarHow to fill the gap, the 3rd pillar
50%
Successful?Don‘t know yet ...
3. Longevity: Increase Retirement Age
(Can‘t do all by savings ...)
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 employersWorn-out argument see 1960-72; since then four (healthier) life years more, until 2035 another three yearsEffective vs. statutory retirement age; expectational effectsactuarial adjustments are absolutely necessaryIncrease earliest retirement age
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
Where do we stand?
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