Lupus alpha


Equity-based pensions: ‘generational capital’ better than no capital at all

The news that Germany’s coalition government is likely to introduce a new ‘Generationenkapital’ (generational capital) concept in the summer instead of an individually allocated equity-based pension is causing not just state equity pension pioneers such as Norway and Sweden to rub their eyes in astonishment, but many German citizens, too. The returns from this fund should eventually help to stabilise state pension funding, making this, at the very least, a first step towards full funding. This is good news! At the same time, however, high-yield savings in company and private pensions must be bolstered significantly. As a result, equities remain essential.

Ralf Lochmüller, founding partner and CEO of Lupus alpha

The state pension is becoming a major burden for Germany’s younger generation, with EUR 121 billion set aside for it in the federal budget in this year alone – a quarter of the overall budget. If nothing changes, this tax-funded subsidy faces huge increases. Either that, or pension insurance contributions will rise dramatically. According to calculations from the ifo Institute for Economic Research in Munich, these contributions need to be raised from their current level of 18.6% to 25% by 2050. Given the seriousness of this situation, the coalition agreement proposes to channel EUR 10 billion of the budget into a new state pension buffer fund as a first step, with further endowments set to follow over the coming years.

The biggest uncertainty in this discussion centres on one key issue, namely that no decisions have yet been made on injecting relevant amounts of new funding on a regular basis. As things stand, such contributions have to be renegotiated each year. The federal government’s current budget negotiations highlight how difficult it has become to allocate funds since the coronavirus crisis, turning point in history and transition to green energy, and the process is unlikely to get any easier in future.

Equities are the only path to success

Nevertheless, the proposed state pension funding is a positive step in the right direction. However, it will take a long time to have a visible impact, and must meet four essential conditions. Firstly, the federal government must ensure that substantial new funding is injected. Secondly, 100% of this ‘generational capital’ must be invested to generate strong returns and must be broadly diversified across the global equity market. Thirdly, the mandate for managing these funds must be awarded to professional asset managers in a process that reflects the market economy. And fourthly, the stock of capital accumulated must be reliably protected against any political whims.

The Generationenkapital concept will only be part of the solution once all four of these conditions have been met. The baby boomer generation will enter retirement between 2025 and 2035, with many set to draw a pension for up to 30 years. This means a high capital base is needed to noticeably ease the burden on contributors who are still working. Let us assume that EUR 10 billion is injected into the Generationenkapital fund each year for the next 15 years, as is currently being discussed. This EUR 150 billion, including interest and compound interest, could add up to almost EUR 300 billion with a return of 7% p.a. With the same return, this stock of capital could ease the burden on the pension fund to the tune of EUR 20 billion a year. However, according to the German pension insurance organisation, Deutsche Rentenversicherung, EUR 17 billion is already needed to reduce pension contributions by just one percentage point, which means these assets would barely make a dent in the contribution rises calculated by the ifo Institute. Approximately six times the returns would be needed to keep contributions at today’s level.

The time has come to think big!

We therefore need to mobilise far more capital to tangibly ease the burden on future contributors. A package of effective measures is required in order to achieve this. For example, if just 1% of the gross income of insured pensioners is added to the Generationenkapital fund, it will grow by an additional EUR 17 billion per year. Initially, it would also be perfectly justifiable and preferable for the first capital injection to be topped up by existing federal assets. While the government’s equity investment in Deutsche Post AG has already been discussed, the initially large proportion of generational capital it would constitute would quickly become relative. Even a ‘generational capital special fund’ of EUR 100 billion is not a completely far-fetched idea – firstly, because the German state can take on debt on more favourable terms than the capital market returns expected in the long term, and secondly, because equity market valuations are currently comparatively attractive. The motto must be: think big!

In addition to the state pension capital amount, investing in equities is key to building up a sufficiently large stock of capital. To do this, politicians must get over their widespread misgivings about equity investments. The general population is way ahead of them in this respect. While 8.9 million Germans held equities and units in equity funds ten years ago, this figure has now risen to 12.9 million. The overwhelming majority of these new shareholders are younger than 30, while the proportion of female investors has risen to one-third and is still growing. Now would be the ideal time to exploit this equity momentum instead of repeatedly thwarting it.

Three strong pillars are needed

Whatever the coalition agreement ultimately looks like, current circumstances mean the future Generationenkapital fund is only expected to solve Germany’s pension funding to a limited extent and not beyond its limited contribution. At the same time, the two supplementary pension pillars – occupational pensions and private pensions – need greater momentum. More than 20 million workers have an active occupational pension entitlement, and while this is a robust number, it is clearly one that can be improved. Regulation also offers ample potential. Guarantees, a tight corset of investment guidelines and an excessively short-term risk methodology are not conducive to generating the high returns required. The government should also continue to promote private pensions. Only at the start of this year did the federal government launch a ‘private pension focus group’ where associations representing all relevant stakeholders can work on a follow-up solution to Riester pensions. The hope is that government will provide even more attractive incentives for long-term, return-oriented pension savings than before.

Making pensions secure for generations to come is the challenge of the century. All kinds of changes need to be made to tackle demographic change – and there is no time to waste! Some of the most important changes include introducing funding for state pensions, bolstering occupational pensions and promoting private pensions. All three of these are bound by a need for fundamental openness towards equity investments. Other countries such as Sweden and Norway have shown how this can work. It is now time for Germany to resolutely follow their good examples.

General questions or suggestions:
Pia Kater
Press officer, Communications
+49 69 / 36 50 58 - 7401
to our press area
Pia Kater
Press officer, Communications
+49 69 / 36 50 58 - 7401
to our press area