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Global Investing: A slow road to German pension reform

By: Tony Major
 Financial Times, June 26, 2002

When Germany's ruling Social Democrat coalition introduced radical pension reforms at the beginning of this year, they were expected to herald a bonanza for the financial services industry as Germans rushed to save for their old age.

Financial analysts held out the prospect of a German savings market that would grow by a mouth-watering €20bn-€40bn ($19bn-$38bn) over the next five years.

But, six months on, barely 6 per cent of the 35m Germans entitled to take out a private pension product have done so. Only 1.9m policies have been sold, though the government says several million more people are set to sign up for corporate schemes.

Banks, insurers and other providers have been putting a brave face on the figures. But their initial euphoria is rapidly giving way to disenchantment.

Allianz, the giant insurer, and Deutsche Bank are among Germany's elite financial institutions that have publicly criticised the reforms.

The common view is that the "Riester" pension products - named after Walter Riester, the labour minister who piloted the reforms through parliament - are too complicated.

"The law is so perfect that no one really understands it," says one Frankfurt-based banker. "It is a typically over-engineered German product."

To add to the gloom, consumer groups have strongly advised the public - faced with as many as 3,500 different products - to take their time before taking the plunge. That advice is echoed by the government's own promotional brochures.

There is little opposition to the principle of reform. It has been hailed as an epoch-making first step. It is the first time in postwar Germany that part of the responsibility for pension provision has been shifted from the state back to the individual. But the Riester reforms have been seen by many as a cautious stop-gap solution, aimed at bolstering a creaking pay-as-you-earn retirement system that is unable to bear the strain of a rapidly greying population.

Like most other European countries, Germany funds retirement benefits by taxing current workers. But, with people living longer and having fewer children, the all-important ratio of workers to dependents is calculated to double over the next 48 years. By 2050, there will be two workers for every senior citizen compared with four workers at the moment.

In such circumstances, the level of taxation required to sustain such a system would be unaffordable, say pension experts. The only solution is to encourage individuals to save for their retirement in individual or group plans by offering subsidies or tax benefits.

The Riester reforms set out to do just that. Starting this year, Germans have been able to put up to 4 per cent of their income into state-subsidised retirement schemes, either individual Riester products or occupational plans offered by their employer.

But the financial incentives, say critics, have not been significant enough.

"It will take more than this to break five decades of reliance on social security," says a Frankfurt fund manager.

Already, there is talk of making the schemes compulsory if the voluntary system fails to attract a sufficient number of savers. Last week, Udo Behrenwaldt, head of Deutsche Asset Management's European operation, said: "If behaviour can't be changed, then maybe, to make the whole system work, one would need to make it compulsory." Joachim Faber, Allianz's head of fund management, has made similar comments.

This would be politically sensitive. But there may be no alternative. Recent polls show that more than 70 per cent of Germans are not interested in pension plans.

Dirk Fach, of PwC Consulting, says the main problem is that there are lots of rival equity-based products that provide better investment returns. A Riester product comes with a "money back" insurance-style guarantee that, by costing more, has a negative impact on the returns to the saver.

But he is optimistic the market will develop. A PwC survey of providers shows that most expect corporate or occupational schemes to account for two-thirds of the pension market over time. The government estimates that 60m workers could join such company schemes.

Mr Fach says: "Providers are beginning to focus on corporate schemes. If they can't reach the public directly [through Riester products], they will try it through employers."

Under the pension legislation, companies have to offer occupational schemes to employees. At present, most small- and medium-sized businesses - the backbone of the German economy - do not offer membership of a company pension scheme.

The potential is there - and the pressure on individuals to save for retirement will only get higher. The government is already gradually reducing pension benefits, and it is widely expected to cut them further as budgetary difficulties mount.

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