The lower house of the German parliament late last month approved a measure which would reform Germany's pension system and make it difficult for plan participants to invest in stock mutual funds. Under the measure, the size of state pensions would decline over the next 30 years, individual contributions to privately-funded pension plans would rise and the state would offer cash grants or tax incentives to those who join the private plans, said Dieter Braeuninger, senior economist at Deutsche Bank Research in Frankfurt.

However, the plan includes tough restrictions on private investment. Government subsidies and tax relief will be limited to pension plans that can guarantee participants will get back, at a minimum, the amount of the premiums they have paid. This provision appears to make difficult, but does not rule out, investments in stock mutual funds, said Braeuninger.

"Mutual funds are not excluded from the new funded pension plans," said Braeuninger. "The crucial point is, however, that the providers of pension plans must guarantee that at the start of the benefit phase, the accrued benefits/claims are at least as high as the amount of contributions paid into the plan. This makes it very hard for the fund industry to offer an attractive product with good earnings prospects."

Braeuninger is skeptical about the reform's new provisions that make investing in mutual funds almost impossible. Mutual funds are a very sensible vehicle for saving for retirement, especially for younger people and those in their '40s, he said. These people can benefit from the high growth potential of the stock markets without having to take high risks.

"On the German market, the risk of an equity portfolio is not higher than the risk of an investment in bonds if the investment period is longer than twelve years," said Braeuninger. "Unfortunately, German politicians seem to mistrust this fact and the proper functioning of modern capital markets and modern fund management. The logic behind their approach [in the proposed pension reform] is that the new privately-organized funded scheme should still be oriented around the traditional [risk-avoiding] German state pension scheme, which is not a good idea."

There is little chance that the anti-mutual fund reforms taking place in Germany's pension system will spread to other countries in Europe, said Braeuninger. In other European countries, the equity culture is much more developed than it is in Germany, he said.

"And the approach to establish unnecessarily restrictive and inflexible safety standards is a typical German one," he said.

The upper house of the German parliament will review the bill Feb.16, according to Braeuninger. The bill is expected to pass, since, even critics of the reforms agree that there is need for reform in the pension system, he said. However, since the changes proposed in the bill would take place gradually, over eight years, the reform will have little immediate impact on the pension system, said Braeuninger.

"Compared with the previous proposals of the bill, the reform is very weak," said Braeuninger. In the previous bill, the government had proposed more substantial cuts in pension benefits, said Braeuninger. That version was strongly opposed by trade unions and the traditionalist social democratic wing of the Social Democrats, he said.

"The newest version of the bill is much more moderate," Braeuninger said.

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