How an ex-business wise man got it wrong about bond yields

In a daily newspaper of 8 October 2018, an ex-professor for financial and economic policy recommends increasing the “spread of funded occupational pensions” (2nd pillar) and “pressing for the offer of a low-cost standard private pension product” (3rd pillar). The main argument for this was a comparison of the “total collective” of those insured with private pensions and those insured with the German Pension Insurance Association (DRV).

No permanently low interest rates on the capital markets?

His recommendation is to buy funded annuities, also for diversification purposes, then one would benefit from future increases in capital income.

Connoisseurs of the subject know that whoever buys a 10-year Federal Treasury note with a 0% interest coupon today – after a change in the market interest rate the next day to, for example, just over 2% p.a. – suffers a loss of up to 20%, because the Federal Treasury note can only be sold at the price of a good 80% of the nominal value. After all, the buyer wants to make sure that he will receive the 2% pa. indirectly through the discount on the stock market price, despite the 0% interest coupon, and the yield effectively corresponds to the market interest rate, which has risen to 2%.

Without foreign exchange control, international demand, including that from offshore funds, for capital investment opportunities will keep domestic interest rates low.

Longer life expectancy of private pensioners increases their funded returns?

The chief economist believes that people can estimate their life expectancy “quite well” themselves, and therefore usually more long-lived people choose private pension insurance. After comparing the total collective of private pension and DRV pension, the funded pension would then tend to be more profitable, among other things because capital market returns are rising again in the long term. However, this tends to compare apples with pears.

This applies expressly to the return from the perspective of the overall collective of private pensions vis-à-vis DRV. The longer life expectancy of private pensioners increases their return relative to that of the DRV pensioners as a whole, who on average have a lower life expectancy, i.e. receive pensions for less time, which reduces the return. And also because future pensioners are more likely to choose a private pension if they expect a long life expectancy, i.e. those with a shorter life expectancy are underrepresented there.

The fact that insurers are exposed to the risk of restructuring and insolvency, along with more than half a dozen options for reducing the pension level for private pensions, is ignored. It is also indirectly suggested that pensioners with longer life expectancy would be given the resulting increase in returns on private pensions as a gift, as it were. However, their longer life expectancy, which is particularly noticeable among higher earners, is already taken into account in the calculation with additional margins of caution and safety in the premiums to be paid, and must therefore be financed in advance.

Cockaigne of capital cover through fundamental error about the collective?

By contrast, the overall collective of DRV pensioners consists largely of compulsorily insured persons, especially employees who have no choice in the DRV, which is why life expectancy is lower on average here. However, this is not at all the group that has a choice between DRV and private pension: rather, the voluntary pensioners – those with higher incomes – with higher life expectancy than the compulsory insured and also longer than the average of all those insured with DRV should be considered here. Only they can choose whether to pay into the DRV or like the privately insured – possibly also combined for risk diversification.

This sub-collective of voluntarily insured persons is therefore at stake because of the question of whether and how they pay in for pensions. Consequently, the DRV consequently yields a significantly higher return for these (due to longer life expectancy) than for the collective as a whole, which the ex-economy method only uses for comparison. So even if the return for the total collective of private pension policyholders is higher than that of the DRV in many years to come, taking into account their longer life expectancy, this will not be the case for those voluntarily insured with the DRV by a long way. And certainly not for those who consciously decide to pay into the DRV and do not refrain from doing so because of known serious illnesses and the fear of shorter life expectancy, the so-called self-selection that private pensioners also expect.

Cross-subsidisation by the precariat – also in the DRV

It is a fact of experience that the life expectancy of the precarious is up to more than 10 years shorter than that of the wealthy – in England the gap is up to more than 20 years.

Of course, those voluntarily insured under DRV ultimately benefit from “cross-subsidisation” by those compulsorily insured as a result of the observed strong income dependency of life expectancy, which, however, has long been accepted politically. And, in addition, through self-selection (addressed by the ex-professor), when voluntarily insured persons decide whether (and, if so, how much and for how long) they want to pay into pension entitlements, or whether this is less worthwhile for them due to lower life expectancy (as soon as they recognise this).

These voluntarily insured persons are thus also misled by the ex-economist because he combines them with the total collective of all compulsorily insured persons in the DRV.

Rather, the hope that voluntarily insured persons who consciously decide to pay into pension entitlements will perhaps in the even more distant future be better off with private pensions than in the DRV will probably vanish into thin air.

“The Chief Economist: Voluntary pension contributions would be a fatal solution” – really?

The focus is essentially on additional private and occupational pension provision. The reference to diversification means for those who have the choice that they do not make private provision alone, but (also) via DRVs, especially voluntarily, if they expect high life expectancy – otherwise it is more likely to be with other assets.

Alternatively, assets are a more flexible way of providing for retirement; but not for everyone, because up to more than 27% of Germans have no savings – in some federal states more than 44%.

For connoisseurs of the matter, the 2nd and 3rd columns can prove to be a honey trap due to the prospect of tax savings in the deposit phase. However, as an old-age pensioner – not only in the case of increasing old-age poverty when you need every cent – you will certainly have to spend years thinking about how you could have avoided the shift of taxes into old age.

Misleading due to lack of distinction between younger people and those close to pensioners

Rising interest rates will simply not do much good or harm to those close to retirement. They must be based on the current situation: High DRV pensions with still low contribution rates.

Younger people, on the other hand, have to plan for several decades until the start of retirement. But: you can build up assets and later decide on a case-by-case basis for flexible consumption or for (partial) retirement – perhaps only after the age of 75/80.

As a fact of experience, it can be said that the cost of a private pension (of the same amount) has roughly tripled in the last 35 years – in the case of the DRV pension, politicians have roughly halved the pension level during this period.

Few people – those who are not compulsorily insured, the very wealthy – will be able to afford to do without any kind of pension, for example if they can live on the interest and earnings alone without consuming the capital. If you have some assets, you might ask yourself if it is not enough to insure longevity after your 80th birthday? Those who have nothing will already have to cut back on their living standards today and then keep this standard of living in old age, or hope for a raffle every week.

Alternative for the poor: selling rubbish or begging

Some sites on the Internet give recommendations on how to earn money without formal employment. For example, to make bargains at flea markets or save things from the garbage to resell them more expensively online, for example books or things you no longer need. Or ask others for money, preferably in a pedestrian zone – even if you will spend a lot of time on the road in bad weather. If you don’t look needy enough for others to feel sorry for you, you can consult a style advisor – but you shouldn’t look too daunting or even dangerous, and you shouldn’t beg obtrusively. The most important techniques can be learned on the Internet – plus practice and experience. If you have a dog with you, you may be even more successful in asking for money for its food. Sometimes it helps to look up into the night sky in August for the Perseids, and then, when a shooting star is sighted, to make a wish, possibly from a long wish list. But you must not betray your wishes to anyone, otherwise they will not come true.

by Dr. Johannes Fiala and Dipl.-Math. Peter A. Schramm

by courtesy of (published on 30.01.2019)


and (published in February 2019 under the heading: “Bond yield? Alternative for the poor: selling rubbish or begging)

and (published in issue 32., 14.02.2019 under the heading: The statutory pension cannot beat the capital market in the long run)

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About the author

Dr. Johannes Fiala Dr. Johannes Fiala

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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