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Monthly Report: The long-term outlook for the statutory pension insurance scheme

Monthly Report: The long-term outlook for the statutory pension insurance scheme

The statutory pension insurance scheme has been in positive financial shape over the past few years. This was due to earlier reforms and favourable developments on the labour market. There has been strong growth in employment, especially among those aged over 60. This has made it possible to lower the contribution rate to the statutory pension insurance system significantly, and there has also been a considerable expansion of benefits again. That this will not remain the case is shown by the current Monthly Report, which describes how demographic developments will be placing pension funds under heavy pressure in future.

Growing pressure on pension fund and central government finances

This is due, first, to a sharp fall in the birth rate in Germany. This means that an ever increasing number of pensioners will have to be funded by a progressively smaller number of pension contributors. This will be especially noticeable at the peak of the “demographic hump”, say the Bundesbank’s experts ‒ in other words, when the large baby boomer cohorts enter retirement from the mid-2020s onwards. Second, people have an increasing life expectancy. This positive development will place a strain on pension funding if the retirement age remains unchanged. 

As things currently stand, adjustments will have to be made to the central pension insurance variables in future, say the economists. Otherwise, growth in expenditure will permanently outpace revenues. The key variables of the pension insurance scheme are the pension level (level of provision), the statutory retirement age (pensionable age), the contribution rate for contributions to the statutory insurance pension scheme and payments by central government to the pension insurance scheme (government funds).

One possible approach to reforming the system: raising the pensionable age in line with rising life expectancy

The Monthly Report presents long-term model-based calculations simulating various adjustments to these variables. The economists stress that these simulations should not be regarded as forecasts: the objective is not to predict the future exactly, but to illustrate important trends and correlations. 

In the experts’ view, the simulations make it clear, amongst other things, that the option of having individual variables absorb the demographic burden is hardly convincing: the necessary adjustments appear to be too massive and too one-sided. Current regulations also provide for broad-based burden-sharing, they write. It has, for instance, already been agreed that the pensionable age will be raised to 67 by the beginning of the 2030s. Similarly, international organisations recommend that the retirement age should not be removed from the calculation after that, but that it should be tied to rising life expectancy – in other words, it should be indexed. This is already the case in other countries – Denmark, Finland and the Netherlands, to name just a few. One option would be, post 2030, to link the retirement age to life expectancy in such a way as to ensure a roughly stable ratio of years drawing a pension to years making pension contributions. If life expectancy continues to rise, the additional life time would consequently make itself felt in both a longer retirement phase and a longer working life. If life expectancy were not to increase, the pensionable age would remain unchanged.

The Bundesbank’s economists illustrate this option using a current Federal Statistical Office projection of life expectancy (medium variant): applying the indexation described, the retirement age would rise to 69⅓ in 2070. A person entering retirement in 2070 at 69⅓ years of age has a life expectancy of 89½ (according to the projection). That person would, consequently, draw a pension for just over 20 years. That is a year longer than a person entering retirement in 2031 at 67 years of age in line with the current legal situation. That person has a life expectancy of 86 years, which equates to 19 years in retirement. An extension of people’s working life also raises the question of health. On this subject, the Monthly Report points to various studies according to which rising life expectancy generally also means better health in old age. At the same time, the authors stress that this is not always the case and that adequate protection in the form of a pension for reduced earning capacity is therefore important and necessary. 

Adjustment pressure also from falling birth rates

The Monthly Report points out two further important aspects. First, even with the retirement age indexed in this way, there would still be adjustment pressure from the lower birth rates, which would need to be absorbed by the other variables. However, this pressure would be markedly lower. Second, with a higher retirement age it is to be assumed that persons covered by the statutory pension insurance scheme would work longer. It would therefore be logical for the greater number of contribution years to be factored into the standard recognised level of provision. In 2031, for example, the number of contribution years would no longer stand at 45, as is currently the case, but at 47, because by then the retirement age will have risen from 65 to 67. The pension level would thus show a link between longer periods of employment and higher pensions. 

Any floors in the level of provision would entail additional years of employment and a rising contributions burden

Finally, the article discusses possible floors in the level of pension provision. Acceptance of the pension insurance scheme often hinges on whether the level of provision is considered adequate. Therefore, consideration is being given to floors in the level of pension benefits that would ensure it does not fall below a certain minimum level. Here, too, it would be logical for the pension level to take account of the greater number of contribution years in line with the increase in the retirement age. As the Bundesbank’s economists note, an integral part of a reliable outlook is also that the resulting financial burdens appear sustainable. As they point out, even without an additional floor as support, such burdens are likely to increase considerably both for pension contributors, as well as for the central government budget.

The Federal Government has announced that it is planning a major reform of the statutory pension insurance scheme half way through the next decade and has set up a commission to draft reform proposals by March 2020. The Bundesbank’s experts believe that these political decisions will have far-reaching implications for public finances and people covered by the statutory health insurance scheme. It is crucial, they stress, for the development of the pension insurance scheme to be viewed over the long term, in spite of all the associated uncertainty, and for the financial burdens of reform decisions to be disclosed. The existing official projections end in 2032.

One of the Bundesbank’s tasks is to advise the Federal Government on economic policy matters. In this context, it regularly analyses and comments on short-term, medium-term and long-term developments in public finances – including the statutory pension insurance scheme. The Bundesbank publishes a comprehensive report on the financial development of the statutory pension insurance scheme roughly every ten years. The Bundesbank is also represented in the Social Advisory Council, which advises the Federal Government on issues relating, in particular, to the pension insurance scheme.
 

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