Peter, a 37-year-old senior manager at a midsize German industrial company who makes $140,000 a year, is getting nervous. Talk of cutbacks in Germany's grossly underfunded retirement system has him suddenly doubting that the government will be able to provide him with an adequate pension when he hits 65. Indeed, retirees these days get an average of only $13,000 a year. So, starting next year, he is planning to put up to $280 per month into equity mutual funds earmarked for retirement--even though he'll get no tax break for doing so. Meanwhile, he rails against Germany's leaders. "Never get into the trap of believing politicians," he gripes.
Peter represents a trend that many financial executives see as one of the biggest business opportunities ever in Europe. Citizens' fears about being left destitute by bankrupt government systems, coupled with the advent of a single currency in January, 1999, seem certain to force an overhaul of Europe's troubled state pension schemes. Reform, in turn, will dramatically expand financial markets, increasing European pension assets an estimated ninefold, to $9 trillion by 2020. "Pension reform is the single most important legislative change needed to create competitive capital markets in Germany and the rest of Europe," says Paul M. Achleitner, who heads the German unit of Goldman, Sachs & Co.
Many governments are postponing the inevitable. They fear that offering tax cuts to promote pensions will reduce revenues and swell budget deficits. So jittery investors are creating a supplemental pension market, buying everything from annuities to mutual funds to bolster their retirement nest eggs.
Companies are already positioning themselves for the bonanza. Indeed, the prospect of a huge market for high-return investments was one of the reasons behind Merrill Lynch & Co.'s $5.2 billion bid for Britain's Mercury Asset Management Group PLC in November. In Britain, retailer Marks & Spencer PLC and Virgin Direct Personal Finance Ltd., a venture between entrepreneur Richard C. Branson and Australian Mutual Provident, have started selling pension products by phone.
OBVIOUS APPEAL. Most major U.S. financial outfits, from Bankers Trust New York Corp. to Fidelity Investments, are going after the European market, too. And virtually every big European bank and insurance company is expanding its pension products and services. Executives at Holland's ABN Amro, for example, see pension administration and asset management as a key growth area. The appeal to bankers is obvious. Conventional lending is marginally profitable at best, while asset management can earn pretax margins of up to 40%.
One reason for all the activity is that many Continental pension systems are nearing a crisis point. Most are pay-as-you-go state schemes with no money set aside ahead of time to pay benefits. Many are also over-generous. France pays out nearly 70% of employees' gross salary, and Germany half, compared with about 30% in Britain and the Netherlands. As baby boomers head into retirement, such systems are becoming increasingly untenable. Employer contributions to the system in France, already a punishing 25% of payroll, could hit 50% by 2020 if something isn't done.
In the few nations where significant reforms have been passed, the results have been dramatic. In 1988, Britain started giving tax deductions for personal pensions designed to supplement state benefits. By last year, such products accounted for 27% of the $88 billion in long-term premiums generated by its insurance industry--despite a pension-marketing scandal that dampened enthusiasm. In the Netherlands, the state civil servants' pension fund, Algemeen Burgerlijk Pensioenfonds, which was privatized last year, has $110 billion in assets, second only to the California Public Employees' Retirement System.
Other Continental governments are dragging their feet. Early next year, Italy is expected to begin letting banks and big companies create private pensions--and some 7 million Italians are expected to pour $32 billion into them by 2003. But Prime Minister Romano Prodi faces stiff opposition to cutbacks in the bloated state system. Spain managed only a modest reduction in the minimum retirement payout this summer, to 50% from 60%. And reform is on hold in France. There is a small chance that Germany will pass legislation introduced in late November that would allow companies to create private, tax-deferred pension funds. But other proposed reforms to its system amount to mere tinkering.
Europe's move to a single currency could be the catalyst for change. That's partly because budget-deficit limits mandated under European Monetary Union rules make it increasingly difficult for governments to subsidize state pensions. Monetary union also will make cross-border investment easier by wiping out many of the restrictions on how much the pension funds can invest in foreign currencies.
Even before that happens, market forces are likely to create new options for retirement savers. European mutual-fund assets have nearly tripled since 1991, to $1.8 trillion at midyear, figures Lipper Analytical Services International Corp., and pension jitters have had a lot to do with that growth. For instance, Fidelity's European pension assets under management have doubled since 1995, to $9.3 billion.
BIGGEST BENEFICIARIES. Many companies are already launching alternative pension products. SBC Warburg Dillon Read has developed a way of securitizing part of the value of a retiree's home, which is then paid out in an annuity. And Deutsche Bank subsidiary DWS, Germany's biggest mutual-fund manager, has repackaged equity and bond funds into a pension-investment scheme that has signed up 35,000 customers in the past year. "There's a real change in awareness going on as people realize they have to build a second pension income on their own," says DWS Chief Executive Christian Strenger.
Europe's equity markets will probably be the biggest beneficiaries of that need. In the past, restrictions on pension investments and the conservatism of European investors meant that people saving for retirement mostly stuck to bonds, insurance, and other relatively low-yield products. But the mix is shifting dramatically toward stocks as they seek higher returns. Lipper Analytical figures 32% of overall European mutual-fund investment is now in equity funds, up from 20% five years ago.
Still, there's a limit to how much companies can do without new tax breaks to encourage a shift to private retirement funds. "It will be too late if governments wait until retirees really start hurting," says Paul O'Donnell, a London-based managing director at Bankers Trust. Just about everyone involved knows that. Now, it's just a matter of taking it to heart.