Pension reform plans strongly opposed

In September 2000, the German government will present a draft bill on pensions reform. At the core of the planned reform is a dual pension scheme, consisting of both state and private pensions, with employees obliged to pay 4% of their gross income into company or other private schemes. The government's aim is to respond to future increases in the number of pensioners and decreases in the number of people in employment. By encouraging private pension schemes, employers' and employees' contributions to state retirement pensions, which make up a considerable proportion of non-wage labour costs, are to be stabilised at a maximum level of 22% of pay (shared equally by employers and employees). Trade union criticisms centre on the fact that the reform will put an end to the principle whereby employers and employees pay equally for retirement pension provision. Women's groups argue that the reform will have negative consequences for women, while many critics fear that the changes will increase poverty among older people.

At the end of May 2000, Walter Riester, the minister of labour, presented the "Social Democratic Party (Sozialdemokratische Partei Deutschlands, SPD) and Alliance 90/The Greens (Bündnis 90/Die Grünen)" coalition government's plan for pensions reform. Although the draft bill on the reform was not due to be submitted until September 2000, the proposals immediately attracted fierce criticism, not only from the parliamentary opposition, but also from trade unions, women's organisations and other groups.

The necessity for the reform is explained by the growing expense of pension schemes in an ageing society, due not only to an increase in the number of pensioners but also to an increase in average life expectancy. As indicated by table 1 below, if the German pensions system continues unchanged, the level of the full statutory retirement pension (Rentenniveau) will be about 88.5% of the average net earnings of all employees in 2030, while the level of joint employer-employee contributions will increase to 24%-25% of pay. Mr Riester argues that the pension level will decline if the contribution level is pegged at a maximum of 22%, as desired. To prevent this, private pension provision is to be extended. This will also lead to a more stable pensions scheme for the younger generation. At present, 85% of total pension payments are financed by the state pension and only 15% by private pensions.

Table 1. Forecast of pension developments without reform
. 2000 2030
Joint employer-employee contribution 19.3% 24,0%-25,0%
Level of statutory pension (% of average earnings) 70.0% 88.5%

Source: Federal Ministry of Labour.

Content of the pensions reform

Dual pension scheme

The core of the reform is replacing the current "pay-as-you-go" state pension system (whereby current pensions are met from the contributions of those currently in employment) by a "dual" pension scheme, consisting of both a pay-as-you-go state pension and a private pension. Mr Riester wants to encourage properly funded private alternatives, as a supplement to the state system. Contributions to the state pension scheme should be stabilised in the long run through private pensions. The equally divided joint employer/employee contribution to the state system which is currently (since 1 January 2000) set at 19.3% of gross income should be increased to no more than 20% by 2020 and no more than 22% by 2040. State pension levels should accordingly be reduced from the present 70% of average earnings to about 64% in 2030 and 54% in 2050. To fill the gap left by the reduction in state pension provision, employees will be obliged to pay 0.5% of their gross income, tax-free, into company or private schemes, with this contribution rising by 0.5 percentage points each year until 2008, resulting in a contribution total of 4%. This is seen as necessary because the receipts from an environmental tax reform which is to be used to lower contributions to state pensions is not sufficient for this purpose. Table 2 below sets out the effects of the proposed reform.

Table 2. Effects of the new pensions reform
Year 2010 2020 2030 2040 2050
Joint employer-employee contribution <19% 20% 22% 22% /-22%
Employees' additional contribution 4% 4% 4% 4% 4%
Level of state pension (% of average earnings) 68.48% 67% 64% nd 54%
Level of state plus private pension 70.3% 71,88% 74% 78% 82%

Source: Federal Ministry of Labour, own compilation.

It is planned that families with low incomes will receive financial subsidies (with the sum depending on the individual case) through tax arrangements, in order to allow them to make the 4% contribution into a private pension scheme.

New pensions formula

A new formula for calculating pensions is seen as necessary to keep the level of statutory pensions at a minimum of 64% of average earnings and the level of contributions at a maximum of 22% of pay in 2030. The complex formula for calculating an individual's retirement pension entitlement currently involves factors such as the length of time they have received a pensionable income, the level of this income and periods of time taken out of paid employment for reasons such as childcare. In 1997, the previous conservative government introduced a "demographic factor" into the pensions formula in response to people's increasing life expectancy, with the effect of reducing pensions while lowering non-wage labour costs.

The reform will abolish this demographic factor and replace it with a "compensation factor", also aimed at dealing with the longer life expectancy and lowering the contribution burden on the younger generation. The new factor will include the private pension. The result of the new arrangements will be to cut index-linked increases in pension levels. The weight of the new factor is dependent on the number of years a private pension has been in place prior to retirement age. It is planned that times in which it is difficult to make private pension payments - ie times of unemployment or physical incapacity to work - will be excluded from the calculation. The government argues that this will make the new formula socially acceptable. According to the Ministry of Labour, the complete effect of the compensation factor will be visible only after 2050, because by then people who have been able to invest in private pensions throughout their whole working life will be receiving pensions.

Tax exemptions for occupational schemes and private funds

Under the reform, contributions into occupational pension schemes should attract exactly the same tax exemptions as those into private funds, which was a central demand of investment and banking companies. By making occupational schemes attractive, the government may assuage opposition to the reforms from trade unions, which strongly criticise the fact that employers are excluded from financing the private schemes (see below). The extent of occupational pension schemes in west Germany has decreased since 1996. According to a study by the Munich-based social research institute, "ifo", the proportion of industrial employees in west Germany who are covered by definite commitments for occupational schemes is now 64% - the lowest level since 1984 when the institute started to collect data. The figures for east Germany are even lower: in 1999, only 16% of industrial and manufacturing employees were covered by occupational schemes. The institute does not expect their number to reach the west German level and believes that a general increase in the figure is dependent on changes in the general framework. Only if employees co-finance occupational pensions do companies seem more willing to introduce such pension schemes.

Women part-time workers

Under the reform, it is planned to increase pensions for women who work part time because they have to care for children. In calculating their pension entitlement, the value of women's part-time income during the first 10 years' of a child's life will be increased by 50%, up to a maximum of 100% of full-time income.

Rapprochement between government and opposition

The government had initially planned to introduce a "basic cover" (Grundsicherung) for pensioners - a form of minimum pension. However, the opposition Christian Democratic Union (Christlich Demokratische Union, CDU) rejected this idea and, as the government is seeking cross-party support for the reform, Mr Riester promptly withdrew the proposal. Furthermore, the CDU made its acceptance of the reform dependent on an increase in the financial subsidies for private pension contributions of DEM 30 per month for every child in a family. This subsidy would be offset against the planned tax benefits for low-income families and would cost about DEM 20 billion, within the framework of DEM 20,000 billion for the reform previously set by the Chancellor, Gerhard Schröder. The CDU also made demands about the mechanism by which pension levels are adjusted (Rentenanpassung). Pensions are generally increased in line with rises in average incomes, but Mr Riester planned instead to increase them in line with inflation in 2000 and 2001 - leading to a rise of only 1.8%. Following talks with the CDU, it has now been agreed that the link with income increases will be resumed from 2001.

After the government had made these concessions to the CDU, the latter's parliamentary leader, Friedrich Merz, said that a deal would be possible in October 2000. It is still unclear if the Party of Democratic Socialism (Partei des Demokratischen Sozialismus, PDS) will participate in the talks over a deal. While the SPD had promised that PDS would participate in the discussions, the CDU is strictly against this. As the CDU generally seems to be in agreement with the government's plans, the position of the PDS has lost its importance. As most parts of the pension reform (apart from the new pension formula) require the consent of the Federal Council (Bundesrat) (essentially parliament's upper houses), support from the opposition is required in order to find a majority in the Council.

New rules on pensions for physical incapacity to work are also to be developed and come into force at the beginning of 2001.

Criticisms

The head of the Confederation of German Employers' Associations (Bundesvereinigung der Deutschen Arbeitgeberverbände, BDA), Dieter Hundt, stated that he preferred the government's original reform plans and warned against a compromise with the parliamentary opposition. Mr Hundt said that there is still a risk that state pension contributions will rise to 22% of pay by 2020. In his view, the value of the state pension could be lowered to 20% of average earnings in the future, supplemented by private and occupational schemes.

The German Federation of Trade Unions (Deutscher Gewerkschaftsbund, DGB) has demanded that employers should pay half of the new private pension contribution and that the value of the state pension should remain at 68% of average earnings. The DGB vice-chair, Ursula Engelen-Kefer, has proposed a compulsory general collectively agreed "capital provision" (Kapitalvorsorge) at company level, which would be jointly financed by employers and employees. Ms Engelen-Kefer and the DGB chair, Dieter Schulte, also stated that the maximum contribution to private pension schemes should be 2.5% of gross income, rather than the planned 4%, and that the contribution should be shared by employees and employers, rather than being paid only by the former. Furthermore, they insisted that private pension schemes should be seen as a form of life insurance, which should remain a voluntary addition to the state pension and not replace it. DGB is not opposed in principle to pensions built up on the capital market, but these should be financed jointly by employers and employees. Ms Engelen-Kefer called for a "real" pensions reform which includes all employed people - ie based not just on the "typical" employment relationship but also taking into account changing working lives. She said that the first step in this direction had been taken in 1999 by including those in "marginal" part-time employment in the social security system (DE9912228F), thereby increasing the number of employees making a contribution to the system.

DGB, along with organisations such as the German Association of Cities and Towns (Deutscher Städtetag) among others, also oppose the government's pensions reform because they believe that it will lead to a rise in the number of poor older people. Experts have calculated that in 2030 an average pensioner retiring at the age of 65 will receive only 64% of average net earnings instead of 70%, a level that falls below 61% if one includes the expenses for private pensions. Employees retiring at 62 would receive less than 54% of average earnings. As the level of social security benefits stands at 40% of average net earnings, an average employee already needs 30 years of contributions in order to receive pensions above the social security benefit level. Employees with a lower income or with a shorter period of contributions run the risk of receiving pensions which are only slightly above the level of social security benefits, particularly since it might be more difficult for them to raise the money for private pension schemes. At present, about half of male employees and about 95% of women are already entitled to pensions that are lower than the "ideal" norm. These figures raise the fear that greater poverty among older people might be result from Mr Riester's plans. The German Association of Cities and Towns has stated that this might lead to a higher burden for local authorities, because these people will need social benefits which will have to be financed at local level. Critics also state that, while the savings rate in Germany is already quite high, private provisions for old age are only possible for people without economic or health problems. For people with a low income it will be difficult to raise enough money for private pensions, even though they will receive public support, and it is these people who will be most affected by the lowering of the state pension level.

Women's groups claim that the reform might have negative effects on women. They point out that private pension funds mostly calculate their contributions in a different way than the state pension: women have to pay higher contributions to private schemes due to their longer life expectancy, while the state pension scheme is neutral concerning gender. As with private health insurance, women must pay higher contributions to private pension schemes or receive pensions 20% lower than men's. As it is also planned to lower widow's pensions from 60% to 55%, women who have not been in paid employment will be disadvantaged as well.

Government reactions

An SPD social affairs expert, Ulla Schmidt, has responded to these criticisms by presenting a calculation showing that the "ideal" pensioner in 2030 who has made contributions for 45 years will receive a monthly state pension of DEM 2,666, which is about DEM 600 more than today taking inflation into account. It is planned that employees with low incomes - single persons with an annual net income of up to DEM 35,000 and married couples, with both partners paying towards a private pension, with an annual net income of up to DEM 70,000 - will receive an annual government subsidy of up to DEM 1,000 per head. The minister for finance, Hans Eichel, considers DEM 19.5 billion to be necessary for funding this support measure. Ms Schmidt also promised that the government will protect women from higher contributions for private pensions and will oblige insurance companies to offer "gender-neutral" schemes.

The IG Metall metalworkers' union has already announced that it is planning active resistance to the pension reform plans. Mr Riester wants to calm this conflict with IG Metall, and not only because he was the union's vice-president before becoming minister for labour. Therefore, he planned to meet IG Metall representatives on 12 September 2000 in the hope of finding a joint position on the pensions reform.

Commentary

There is no doubt that the pensions system needs to be reformed. However, a reform should guarantee that every pensioner is able to have a decent standard of living. To guarantee this, the calculation of state pensions should be based on modern life patterns, which differ from the conception of the ideal pensioner retiring after 45 years of full-time employment. On the whole, women have never fitted into this concept and changes on the labour market mean that it no longer applies to the majority of men. At the same time, company pension schemes seem to be a more adequate addition to the state pension than private pensions, which should remain merely an additional provision for those who are able to pay into an appropriate fund. Finally, although the tripartite National Alliance for Jobs has agreed on lowering non-wage labour costs substantially (DE0005260F), this should not release employers from the principle of joint funding of social protection and lead to a one-sided burden for employees, as would occur with the proposed new private pension contribution.

The exact content of the final pensions reform is uncertain at present, especially as there is a dispute within the SPD over whether the proposed pension level might be unconstitutional as it is not equivalent to the contributions made obligatorily by employees. (Alexandra Scheele, Institute for Economic and Social Research, WSI)

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