The German Retirement Benefit Formula: Drawbacks and Alternatives

In this paper we identify a number of objectionable features of the German retirement benefit formula. We show that groups of insureds with higher than average life expectancy, in particular high-income groups, are subsidized by the rest of the membership because the formula neglects differences in group-specific life expectancy. Furthermore, the current formula leads to undesirable long-run effects if the earnings ceilings is raised, mandatory membership is extended, life expectancy rises or the rate of population growth declines. We present two alternative formulas which take group-specific life expectancy into account. In particular, a return-rate formula which rewards each Euro of contributions with the internal rate of return of the pay-as-you-go pension system proves to be superior to the current formula