Liability of the defined benefit pension scheme is a curse for numerous organizations on this planet, private and public alike. Among the floating solution to the problem, one proposal is to raise the age eligibility of the pension benefit.
Obviously, it is not well received by the elderly or quasi-elderly, as well as the campaigns of the liberal camp. It is reasonable that seniors, after devoting most of their lives to the country, would be object to a break of promises forged long ago. It is also imaginable that for the working class, 40 years of boring work is hard enough to bear while beyond that limit is outright inhumane.
However, why do all the countries around the world choose 60-65 as a cutoff to the working history? Why not 55, why not 70? Inspired by a Q&A session with former Bundesbank president Axel Webber, I set out in this post to investigate the historical root of the magic 65, which sheds interesting light on the political implication of the pension finance.
A Legacy of Bismarck
Enacted in 1889, the Old Age and Disability Insurance Bill is the first national pension scheme the history has ever seen. It may strike casual reader as odd that a diehard arch-pragmatist such as Bismarck would turn out to be a cover-up socialist. And he will be right. Bismarck designed the social security system to be a cheap buyout of the working class support. Therefore, the Bismarckian pension system was designed to be solvent, if not profitable, from its inception.
At first glance, it is remarkably similar to the modern Pay-As-You-Go (PAYG) system. A tax labor income is levied on the employee and the employer. They would split the 19.9% tax levy evenly whose total amount is subject to a ceiling limit. The Government would pay for up-to-3 years of child bearing and a long term care insurance fund after the worker reached 70[1].
However, there are a key difference between the Bismarckian model and the modern PAYG system: the proportional payment. According to the 1889 bill, worker would receive payment proportional to their contribution. It implies that worker is not likely to receive more than they pay. It fundamentally guarantees that the social security will be solvent because of this over-draw protection.
Even without guarantee of the proportional payment clause, the Bismarckian model is very likely to be solvent because not so many people lived long enough to celebrate their 70s birthday. In 1889, the life expectancy in Germany is under 50[2]. Although some claims that the life expectancy is dragged by mainly by high infant mortality rate, the number won’t improve too much. According to life table reported by WHO, a Germany teenage boy at age 15 has a life expectancy of 72.8 years. Good luck in living that long a century ago.
In sum, the Bismarckian pension system is a gold-egg-laying loose rather than a ticking bomb to the Treasury of the German Empire. It has limited downside thanks to the proportional payment clause, while a great upside thanks to the limited life expectancy.
A legacy of the World War I
In 1916, the eligibility age was lowered to 65. Most of the commentators I have read overlooked the fact that it is right in the middle of WWI. In the time of war where every penny matters, why would German government suddenly picked up generosity?
The simple answer is that it is something they must do rather than something they would like to do. 1916 was not a good year for the German Empire. In the western front, a promise of quick and easy victory against France has been proved false. In the age of modern warfare, the world was about to witness the massive slaughter capacity for the first time in 1916, which involved battle of Verdun, Battle of Somme and the Defense of the Hindenburg line. In the eastern front, Russia engaged Germany troops in 1915. Although they proved to be no match of the Germany army, it put German in a strategic disadvantage. In the home front, socialist were active in rejuvenating the class warfare that plagued Germany politics before the world war. Overall, Friedrich III desperately needed the domestic support and he was not getting it.
It is all but natural to understand why the eligibility age was lowered to 65 in 1916. As its predecessor, it is a calculated political bet to shore up the domestic support. It is not expensive in the near future because there are not many people eligible anyway. Yet it makes good public image of a benevolent emperor and provide the right incentive for the working class to put up with the government policy: after all, had the Germany lost the war, there would not be a penny left on the table for the working class.
A Legacy of Politics
So what can we learn from the history?
It is tempting to conclude the takeaway is to go back to the good old days where the pension system is solvent by design. Certainly, there is no business reason to hang on to the age eligibility at 65 when the life expectancy has been prolonged so dramatically during the past century. If we raise the eligible age to 70,75 or even 80, in the spirit of the Bismarckian cunning, the pension system will be solvent instantaneously.
Nevertheless, I think it is not the only takeaway. For Bismarck and Friedrich III, providing and extending pension is not something they would like to do, but something they have to do. It is about politics, not about business. Pension system, from its inception, is not evaluated by its fiscal solvency alone, but also by its political bang of the buck.
[1] “The German Pension System in Brief”, Towers Watson Website, accessed Jan. 29th, 2012, http://www.watsonwyatt.com/us/pubs/insider/showarticle.asp?ArticleID=20358
[2] “Will 75 become the new 65? ”,New letter, Feb, 2011, Abraham financial group, accessed Jan 29th, 2012, http://www.abrahamsengroup.com/content.asp?p=news_past&issueID=1102&articleID=0
