– Why the capital market with compound interest effect does not allow us to expect higher pensions –
For years, insiders have been reporting difficulties in the pension funds in generating the promised returns to finance pensions. While the management
of a Versorgungskammer used to pat themselves on the back year after year because there are also remaining bonds with a 5.25% interest coupon in the securities account, the Federal Law for the Republic of Austria of 31.07.2014 (CELEX no.32001L0024) made them speechless: the liabilities of Hypo-Alpe-Adria expire, and “at the same time, securities including liabilities for such liabilities expire”. In other words: the state is no longer liable – and unfortunately there is nothing in return.
In future, the Finance Minister will also have such opportunities with regard to German government bonds.
Bad bank without banking licence with up to €18bn of unsaleable assets
Of course, the forced members of the pension funds are asking themselves how it can be that the managers of the pension funds decided to invest in junk securities.
The Federal Court of Justice (BGH) (judgement of 09.07.2009, file no. 5 StR 263/08) considers members of the management bodies of pension funds to be public officials in accordance with § 11 I No.2 StGB. For years, the press has been reporting
up to more than 30% asset losses of the insured due to falling interest rates, misinvestments, longer life expectancy and higher taxes on old-age pensions. In individual pension funds, fees for institutional finance houses of up to 30% have been reported. For example, the conviction of a savings bank insurance representative for bribery and aiding and abetting breach of trust in connection with the brokerage of reinsurance policies for a lawyer’s pension plan became known (BGH, judgements of 09.07.2009, Ref. 5 StR 600/07 and 5 StR 263/08; BVerfG decisions of 24.03.2010,
Case no. 2 BvR 2092/09 and 2 BvR 2523/09).
For good reasons, any legal disputes with private or state banks whose advisors, for example, packaged financial products with a guarantee that did not actually exist remain secret. The low costs according to the balance sheet of pension funds are sometimes praised as an advantage of funded schemes. On closer examination, up to more than 10% could be
of costs and fees may be hidden in the individual investments, for example in the case of “alternative investments, spread investments, venture capital, hedge funds, or derivatives”. Certain credit institutions reimburse their customers up to more than 90% of the management costs charged by fund providers. In the balance sheets of the pension funds one looks for such annually paid kickbacks in vain?
Death blow for pension funds by the Federal Social Court ?
The fact that employed doctors and in-house lawyers in particular are regularly subject to compulsory insurance under the statutory pension insurance scheme was established by the Federal Social Court in a ruling of
of 03.04.2014 (case no. B 5 RE 13/14 R). Chamber functionaries who are not trained in actuarial mathematics are of the opinion that it would be best if the dwindling assets were compensated for by as many young contributors as possible, i.e. also employed chamber professionals, analogous to a modified snowball system. Pension funds of some chamber professions provide
The German insurance industry, on the other hand, is now switching from the funded scheme to the so-called open cover plan procedure. This is a step towards the pay-as-you-go system. It shows that the pure entitlement procedure practised to date is inferior to a procedure with apportionment elements.
Fairy tale of the superiority of pension provision based on funded schemes
There was once the idea that the capital market with compound interest could provide much higher pensions for the same contribution than a pay-as-you-go system. This is done with disinformation since
decades until it is no longer possible to close oneself off to reality.
There are now pension points instead of fixed pension entitlements – how much pension a point is worth can then be determined later, according to the financial resources and number available at the time.
of the pension claimants.
It is also made clear that this is not intended to protect previous entitlements, as “generational justice”, i.e. no cross-subsidisation, is required. The pension funds continue to operate with their own accrual model for the previous contribution payments, and can – as is clearly stated – also reduce these pension entitlements if this accrual financing no longer works out, including the current pensions, in particular if the calculated interest can no longer be earned. If the risk-free capital market interest rate has been tending towards zero or less for up to more than 10 years, then it is to be expected that supply will be reduced to less than half of earlier forecasts for this reason alone.
No pension fund will be threatened with insolvency
With the pension chamber it behaves in such a way, as it was once said over the Federal Insurance Agency “the pension is safe”. No one has to worry that the pension fund is going to be
of the pension payments goes broke. Rather, only as many pensions are paid as the pension fund can afford, and, if necessary, the current and future pensions are reduced, or the future pension value of a pension point is fixed in such a way that it can be financed. Individual connoisseurs of the matter believe to have already discovered in isolated cases that the
pensions currently in force, including their increases, would be paid for years partly out of the substance, or at the expense of new contributors.
The flexibility possible by switching to a pay-as-you-go system compared with a life insurer means that the capital can be invested more riskily and thus with a higher return in the long term. This shows the superiority of the pension scheme. However, pay-as-you-go elements and portfolio development are now playing an increasing role, whereas the dependence of development on the capital market is being reduced.
Assured expectation of a pension gap in old age
Some pension funds have never completely abandoned the open cover plan procedure, which is now increasingly provided for. Whether the projected unit credit method for the pension fund is likely to be
was a recent experiment that was introduced after the fact and has now failed? Similar questions are already being asked publicly in the case of the subsidised Riester pension, the capital cover of which is by no means sufficient to compensate even approximately for the reduction in the statutory pension.
The leverage of the compound interest effect with capital cover has been going down since 2001. In the case of private pension insurance policies taken out in 2000 with a single premium and with an annuity starting in 2005 or later
the projected pensions were already reduced in rapid succession to less than half from 2002 until the start of the pension, solely because of the interest rate decline of an assumed 7.5%.
to just over 4 %. Since then, interest rates and thus funded pensions have continued to fall. In the case of funded schemes, pensions are not already stored in bags in the insurer’s vault, but must first be financed from the contributions received and the interest earned on them. A large part of the pensions promised at
Capital cover depends on interest that is yet to be earned over future decades. To what extent this will work out is completely open until the end.
by Dr. Johannes Fiala and Dipl.-Math. Peter A. Schramm
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About the author
PhD, MBA, MM
Dr. Johannes Fiala has been working for more than 25 years as a lawyer and attorney with his own law firm in Munich. He is intensively involved in real estate, financial law, tax and insurance law. The numerous stages of his professional career enable him to provide his clients with comprehensive advice and to act as a lawyer in the event of disputes.
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