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Pension Financial Security in Germany University of Pennsylvania ScholarlyCommons Wharton Pension Research Council Working Papers Wharton Pension Research Council 1994 Pension Financial Security in Germany Peter Ahrend Follow this and additional works at: https://repository.upenn.edu/prc_papers Part of the Economics Commons Ahrend, Peter, "Pension Financial Security in Germany" (1994). Wharton Pension Research Council Working Papers. 591. https://repository.upenn.edu/prc_papers/591 The published version of this Working Paper may be found in the 1996 publication: Securing Employer-Based Pensions: An International Perspective. This paper is posted at ScholarlyCommons. https://repository.upenn.edu/prc_papers/591 For more information, please contact [email protected]. Pension Financial Security in Germany Disciplines Economics Comments The published version of this Working Paper may be found in the 1996 publication: Securing Employer- Based Pensions: An International Perspective. This working paper is available at ScholarlyCommons: https://repository.upenn.edu/prc_papers/591 Securing Employer­ Based Pensions An International Perspective Edited by Zvi Bodie, Olivia S. Mitchell, and John A. Turner Published by The Pension Research Council The Wharton School of the University of Pennsylvania and University of Pennsylvania Press Philadelphia © Copyright 1996 by the Pension Research Council All rights reserved Printed in the United States ofAmerica The chapters in this volume are based on papers presented at the May 5 and 6, 1994 Pension Research Council Symposium entitled "Securing Employer-Based Pensions: An International Perspective." Library ofCongress Cataloging-in-Publication Data Securing employer-based pensions: an international perspective / edited by Zvi Bodie, Olivia S. Mitchell, andJohn Turner. p. em. Earlier versions ofthese papers presented at a conference in May 1994. Includes bibliographical references and index. ISBN 0-8122-3334-4 I. Pensions- Congresses. 2. Old age pensions- Congresses. 3. Pension trusts- Congresses. 4. Social security- Congresses. I. Bodie. Zvi. II. Mitchell, Olivia S. Ill. Turner,John A. Uohn Andrew), 1949July 9- IV. Wharton School. Pension Research Council. HD7090.S36 1996 331.25'2-dc20 95-37311 CIP Chapter 3 Pension Financial Security in Germany Peter Ahrend Importance ofOccupational Pensions The provision ofretirement income in Germany is principally based on three sources: social security, company-sponsored pensions, and private retirement accounts. However, 80 percent of the working population draw the main part of their retirement, disability, or survivors' income from social security. The financing of Germany's social security system is shared equally between the employer and the employee. The actual contribution rate for each is 9.6 percent of income up to the social security contribution ceilingofUS$ 4,606 per month, in 1994. 1 Social security is based on a pay­ as-you-go system, often referred to as the "contract between the genera­ tions," since the working population finances the current pension pay­ ments (principle ofsolidarity). Because society is aging and contribution volumes are becoming insufficient, the social security system will face severe problems in the future. At present, German social security insur­ ance can rely on a relationship of contributors to retirees of 100 to 44. However, by the year 2040 this ratio is expected to have worsened to one toone. Once reform measures have become completely effective by 2012, the average social security pension will stabilize at a lower level, relative to earnings. The "income gap" opening up between this percentage and the income required to maintain the prior standard of living can only be closed by private retirement accounts and occupational benefits. The ac­ tual extentofthe income gap depends not only on the social security level but also on the net income of active employees, which is determined by the percentage ofgross income payable as taxes and social security con­ tributions. This was 16 percent in 1960, 23 percentin 1970, 29 percent in 1980, and has risen to around 33 percent at present. The resulting de- Percent 01 net active workers' earnings 2) 100 90 80 70 60 50 40 30 20 10 o 1957 1960 1965 1970 1975 1980 1985 1990 1993 Year 1070 % 01 SSCC') EEl 100 % 01 SSCC 0125 % 01 SSCC I 1) ALJ:hor'. calcul8tlc:n 2) BaNd on IndMdual tax 1'I!lI:. 3) Social Sec4¥ity contribltial ceiling Figure 1. Net replacement level ofsocial security, West Germany.' Petl!f'Ahrend 75 velopment ofthe net replacement level ofsocial security over the years is illustrated in Figure 1. The actual income gap for 1994 is shown in Figure 2. In this context it should be pointed out that for a large part of the population the possibility of making private provisions is quite limited since this has to be done from taxed income. In general, individuals can­ not establish individual retirement accounts and receive a tax deduction. Due to the reduction ofthe social security level in the long term, aswell as to the restricted possibilities for private provisions, the subject of oc­ cupational pensions has become an important issue of social policy. To provide an overview of the general economic background to any benefit issues, the development of wages, the cost of living, social security, and productivity since 1957 have been depicted in Figure 3. The Historical Development of German OCcupational Pensions The Early Stages The first German company-sponsored pension plans were established in the middle of the nineteenth century by chemical companies and those in heavy industry. These were characterized by their patriarchal approach and the employee's personal dependence on the employer. Their purpose was to protect old people who could no longer rely on the social network of a large family, since the latter as a "workplace and household entity" disintegrated during the course of industrialization. Employers, therefore, were predominantly driven by "care" motives for their former employees. At the time when statutory disability insurance was introduced for workers (1891) and subsequently extended to sal­ aried employees (1911) company pension plans were already becoming widespread. Their spread was further helped by the inflation of 1923, which completely destroyed any private retirement accounts employees might have made (devalued savings versus provisions out ofcurrent com­ pany earnings). Along with the change in the employer-workforce rela­ tionship that took place between the two world wars the provision of company-sponsored pensions became based more and more on objective reasons rather than on personal motives. The moral concept of respon­ sibility for staffwelfare was replaced by the principle that a pension was a fringe benefit provided by employers. After World War II: Setting the Coursefor the Dominance ofInternal Financing High inflation in 1948, in the aftermath of the second world war, set the course for today's dominance of internal financing for occupational Percent of gross income 100 l I 100 90 soC:iaisec:urftY·coriiriblitkiriceiiiiig··· 90 in 1994 US $ 55,273 o 80 ···t • 80 I I ~····························i 70 I 70 I Average net income 60 60 50 50 40 40 30 30 20 20 10 10 o o 12 24 36 48 60 72 84 96 108 120 132 144 156 168 180 Annual gross income (US $ 000) 1) Author's calcuat:ia'l Laing 1 us 5; :::: OM 1,65 Figure 2. Illustration ofthe income gap. West Germany. 1994' (percentage ofgross income). Percent (1957 = 100) 1.100 1.000 / 985 / / ...... ,. 900 / Average Wages ",/ 831 800 -~.=-=.:.;;.;:;.,-.... 700 600 500 / ..., 400 .....................................................................................................................;/.,0.:;/tI://~~ ······p;:;;d~cti~itY·········· =ated) 300 //~ 319 200 ............. ... _--- ~=:::-__ - ----/.~~~()fLi.".jrl9 ... 100 II J I I 57 60 63 66 69 72 75 78 81 84 87 90 93 Year ') Al.l:hor's calcUation Figure 3. Development ofaverage wages, productivity. social security. and cost ofliving, West Germany.' 78 Pension FI_ncial Security in Germany TABLE 1 Spread ofCompany-Sponsored Pensions in the Industrial Sector in Germany (Western Laender) Companies Emplayees with an Occupational Entitled to Company- Pension Plan SponslYred Pensions (% ofwmpanies (% ofemplayees belonging belonging to the respective grouP) to the respective group) Industry 1981 1 19872 1993' 1981 1 19872 1993' Number ofEmplayees 20-49 50 39 45 27 23 18 50-199 75 75 73 47 46 40 200-999 92 91 91 70 68 62 1000+ 97 99 97 85 91 85 Industry Total 67 61 64 70 72 66 Basic and producer goods 77 72 71 76 83 78 Capital goods 70 62 66 75 78 69 Consumer goods 59 54 57 53 50 46 Food processing 68 64 65 62 59 57 Sources: lifo survey June/July 1981; 'lfo survey November/December 1987; 'lfo survey June/July 1993. pensions, to be examined shortly in more detail. According to the (cur­ rency) Transition ActJune 1948 (Umstellungsgesetz) all pensions directly paid by companies had to be continued to be paid completely, whereas all other kinds ofoccupational retirement benefits were converted at a ratio of 10:1 from "Reichsmark" into "Deutschmark." Encouragement of the internal financing method, which until then was scarcely to be found, was due to economic and fiscal considerations. Like all other economic sectors, the banking and financial sector was devastated, so reconstruction of the economy based on loan capital was impossible. In addition, the tax law of the allied forces (Allied Control Commission Act. No. 12 ofFebruary 1946) imposed marginal tax rates of up to 90 percent
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