If Bismarck’s model was still running

For a modern Bismarck, what would a new pension system look like today? Michela Coppola investigates

Michela Coppola

Without too much difficulty, it is possible to imagine that we could live in a world without pensions. So, if a modern-day Bismarck were to emerge in such a situation and introduce a pension system, how would that look?

Two features characterize Bismarckian, as opposed to Beveridgean systems. First is a close link between benefits and lifelong earnings. Second is the financing of expenditures through a pay-as-you-go (PAYG) system, where the compulsory contributions of both employers and employees are paid into a pension fund from which current retirees receive their benefits.

Yet, the Bismarckian system enjoyed in Germany (particularly in the golden era of the) was quite different from the one set up in 1889, which was by no means generous. Initially, it covered only blue-collar and white-collar workers with a yearly income below a certain threshold, so it addressed only 57% of the labor force. In contrast, more than 80% of today’s German labor force is covered.

In 1889, the threshold to claim a pension was set at age 70, about 10 years above the average life expectancy of a 20-year-old man. The few workers who survived until 70 could expect to live – and receive pension benefits – for about 7.5 years on average. Furthermore, to qualify for a pension, individuals had to contribute for a minimum of 30 years. Periods of unemployment or maternity did not count toward qualification and only up to one year of sickness was allowed, although “early retirement” was possible, subject to an invalidity assessment.

Importantly, the pension of the early Bismarck system was thought of as a supplement and not as the mainstay of a certain living standard in old age. Accordingly, the replacement rate was low. An individual who earned the economy-wide average wage would have received a pension worth only 19.7% of earnings. The average old-age pension paid in Imperial Germany in 1891 was a mere 18.2% of the average wage and only 16% of the average wage in the industry and handcraft sector, where most covered individuals worked. In contrast, this ratio was 47%.

The yearly pension benefit was made up of two components: a flat-rate allowance of 50 marks (approximately 7% of the average wage) and a variable relating to the earnings of the individual. The benefits were linked to neither inflation nor economic growth. There were no survivor benefits: if the insured individual died before qualifying, the spouse was only entitled to half of paid contributions.

Another substantial difference concerns financing. Despite the PAYG character of the original Bismarck system, where the contributions of individuals were not capitalized for their own retirement, that scheme was funded. According to law, contributions went to a reserve fund to be invested in the capital market. The accumulated capital stock had to cover the discounted value of about 10 years of pension entitlements.

Due to the small number of pensioners relative to the number of contributors (in 1895 there were 27 contributors per retiree; today there are 1.4 contributors per pensioner) and the small amounts paid out, the system implemented by Bismarck was relatively cheap. Pension expenditure represented less than 1% of GDP. Despite the low contribution rate (approximately 1.7% of the wage), accumulated funds widely exceeded yearly expenditures. By the beginning of the First World War, the pension fund had wealth worth 10 times pension expenditures. Today, retirement age would have to rise to 80 to be comparable

GET WITH THE TIMES

If a model similar to the original Bismarck system were to be implemented today, the retirement age for a pension in Germany would be 80 years for cohorts born in the. It is only when they reach that age that individuals have a residual life expectancy equivalent to 70-year-olds in 1889. However, due to the constant increase in longevity, the retirement age would be set at 85 for the generation born after to keep residual life expectancy at retirement constant.

Besides restricting qualification almost exclusively to years spent working, the qualification period itself would be set at 36 years (if the retirement age is 80). This way, the minimum employment period as a proportion of working life would be equivalent to the one in 1889. And the rights to survivor benefits would be withdrawn from the current system.

Taken together, such a system would drastically reduce the number of individuals entitled to old-age pension today. Simply by stripping back survivor benefits, the number of pensions paid would fall by almost one-quarter. Women would be particularly disadvantaged, as many would fail to qualify. The average length of contribution by women currently receiving a standard old-age pension is less than 20 years, and this includes time spent in maternity leave and unemployment.

Finally, implementing the original Bismarck template today would see a substantial cut in benefits. If the average pension reflected the same proportion of the average wages in 1891, it would mean a monthly payment of €500, well below the value of the minimum pension (Grundsicherung im Alter) currently paid to a single person – and often considered the minimum to avoid poverty. In, the average pension actually received by individuals with long contribution histories was approximately €1,400 per month.

Raising the retirement age, tightening eligibility criteria and lowering benefits would, when linked with the elements of a funded system, dramatically improve the long-term financial sustainability of Bismarckian pension systems. Such an improvement, however, would be achieved at the expense of the adequacy of the pension. Striking a balance between sustainability and adequacy will be the difficult task in years to come. For without considering adequacy, I can well imagine all the elderly who would be living in poverty today. And this could result in similar explosive social conditions to those that caused Bismarck to introduce pensions in the first place.

If Bismarck’s model was still running

For a modern Bismarck, what would a new pension system look like today? Michela Coppola investigates

Michela Coppola

If Bismarck’s model was still running

For a modern Bismarck, what would a new pension system look like today? Michela Coppola investigates

Michela Coppola

Who was Bismarck?

Remodeling Bismarck’s legacy

German pension reformers look for solid ground

The man who measured poverty