Pension reform: Poverty in old age at 85?

The draft law is based on the findings of the "Focus Group on Private Pension Provision", which presented its final report in the last legislative period. A key element is to allow more competition between different pension providers. Until now, providers of Riester pension insurance had to ensure that the pension would be paid for life. In contrast, providers of bank and fund savings plans had to enter into a cooperation agreement with a life insurer and ensure that sufficient residual capital remained for lifelong annuitization at the age of 85. This obligation is now to be abolished.

Instead, savings and fund savings plan providers will in future be able to offer a "time annuity", i.e. a plan for the regular withdrawal of the accumulated retirement savings capital, which must last until at least the age of 85. A later date can also be agreed. Study author Professor Dr. Lukas Linnenbrink: "We expect providers to offer the highest possible time annuities in the competition for customers and therefore only use a final age of 85 as a basis."

"However, research has repeatedly found that people systematically underestimate their life expectancy," says study author Prof. Dr. Matthias Beenken. "This not only applies to Germany, but has also been proven in various countries around the world." This fact also played an important role for the focus group on private pension provision. Their final report on retirement states: "The length of the payout phase should be calculated in such a way that it generally covers a high proportion of the expected retirement period."

This is not the case at the age of 85. According to forecasts by the Federal Statistical Office, 48% (men) and 64% (women) of those born in 1973, who at over 50 years of age are not likely to be among the main target group for the new private pension scheme, will be older than 85. Those born in 2003 will live to 65% and 77% respectively. "This does not even take into account medical progress, such as successes in cancer therapy," says Prof. Linnenbrink.

In an online experiment with over 1,500 representatively selected test subjects, the researchers showed that 58% of those who accepted an offer to annuitize a fictitious retirement savings capital opted for a higher temporary annuity up to the age of 85 instead of a lower lifelong annuity. "The decisive factor was how big the gap was between the two pension offers," says Prof. Beenken. "In a variant with a greater gap at the expense of the insurance company, only 26% chose the life annuity, whereas with an unrealistically low gap, the proportion of those interested in the life annuity only rose slightly to 54%."

"The life annuity must be significantly lower because insurers bear the longevity risk, require a more defensive investment structure and are also legally obliged to calculate without regard to gender, although the life expectancy of women is significantly higher than that of men," explains Prof. Linnenbrink, who is also an actuary (DAV).

Subjective life expectancy is a significant factor influencing the decision to opt for a time annuity versus an annuity. 49 percent of respondents underestimated their life expectancy compared to the statistical life expectancy, by an average of 9.5 years. 24 percent estimated it realistically within a corridor of plus/minus two years, 26 percent overestimated it. Overall, the estimated life expectancy was on average 2.7 years too low. Of the 49 percent of respondents who underestimated their life expectancy, 73 percent opted for the time pension. Among the realistically estimating respondents, the proportions of time and life annuity were around 50 percent each. Although 60 percent of the overestimating 26 percent of respondents opted for the life annuity, 40 percent still opted for the time annuity up to the age of 85.

The experience of how old one's own family members were when they died had an influence on life expectancy. Health restrictions also reduce the estimated life expectancy. However, the influence on the choice between a temporary pension and an annuity is surprisingly low for people with such limitations.

The authors draw several conclusions from the study. They expressly welcome the freedom to choose between time and life annuities. "The experiment has shown that people are more likely to opt for voluntary private pension provision if they have the freedom to choose between different forms of investment," says Prof. Beenken.

However, in her opinion, the minimum age of 85 is set far too low. "There is a great risk of disappointment if people misjudge their life expectancy," Prof. Linnenbrink points out. "But by the time they realize this, it's too late." And Prof. Beenken adds: "It's not just about financial rationality, but also about the psychological burden of suddenly losing your standard of living as a very old person, perhaps becoming a burden on your own children or having to apply for basic income support."

The authors therefore suggest raising the minimum age for temporary pensions to 95. "Then, based on current forecasts, at least more than half of those affected will probably be provided for until the end of their lives," says Prof. Linnenbrink.

The researchers also recommend giving counseling on old-age provision a higher priority in order to compensate for gaps in knowledge about demographics and life expectancy and to better protect vulnerable customers. In the experiment, they were remarkably more likely than others to be unable to make a decision.

This also presupposes that the unequal treatment in the advisory requirements for financial investments, which may be sold without advice ("execution only"), and insurance products, for which counseling is required by law, is eliminated. Sales and counseling for products that can be taken out voluntarily also incur acquisition costs. "The cost cap of 1.5 percent envisaged for the standard private pension product is in any case too low," says Prof. Linnenbrink. "Only last year, the European Court of Auditors publicly reprimanded the fact that the harsh cost cap of the 'Pan-European Private Pension Product' of even just one percent meant that no one was offering this product," Prof. Beenken points out. "We should not repeat this mistake now".