Commentary: These Pension Plans Are No Panaceas

Talk to some European fund managers, and you would think they had found El Dorado. After years of debate, Germany drafted legislation in September to shore up the public pension system. A key provision encourages workers to put some of their pay into private retirement funds. The European Commission followed this month with proposals to let Europe's occupational pension funds, which have about $2 trillion in assets, invest mostly in equities instead of low-yielding government bonds.

Fund managers hope these moves will ignite the European equity markets. "[They've] been rubbing their hands together at the prospect," says Thomas S. Marsh, a London-based consultant at Cerulli Associates Inc, which analyzes fund trends. "They think there's going to be a huge market. They think it will grow as fast as the 401(k) market did in the U.S."

JUST A DRAFT. Not so fast. Certainly Germany deserves praise for facing the dreaded pension issue. Europe's pay-as-you-go public pension schemes and many occupational funds--those offered by unions, companies, and professional organizations--are drifting toward insolvency. In a decade or two, there won't be enough young workers paying in to support the growing ranks of pensioners. But the German plan won't create a private-investment bonanza. And the EC "draft directive" is just that--a draft. This is one investment revolution that will happen in slow motion, if at all.

Optimistic fund managers flourish dazzling numbers. Goldman, Sachs & Co. forecasts that the German bill could push $300 billion into private funds by 2010. If other European countries pass similar laws, up to $1 trillion could come their way, analysts estimate.

The truth is it will be years before Europe's workers hand much of their retirement money to asset managers--especially those who invest in equities. A close look at Germany's plan shows why: What passes for radical reform in European pensions is very conservative.

First off, the bill German Labor Minister Walter Riester plans to submit to Parliament in November would encourage workers to channel a slim share of their salaries (0.5% in 2001, rising to 4% in 2008) to personal savings funds--compared with as much as 20% in the U.S. Very little of that is likely to land in stock funds: The proposed law requires pension managers to guarantee retirees a stable or rising income for life. That rule effectively keeps equity funds out because they can't make such guarantees. The winners? Insurance companies, which invest mainly in bonds anyway.

Fund managers in Germany will lobby hard to change the payout rules. "Investors should be allowed to choose between products that have guarantees and those that don't," grouses Wolfgang Raab, a director of the German Investment Fund Assn. But there's no assurance Riester will accommodate them. After all, Germany's insurers are a powerful lobby, and the equity culture has shallow roots.

The EC directive reaches much further than the German plan. If the European Union adopts it in its present form, member countries would have to let occupational pension funds invest up to 70% of contributions in equities, vs. 35%, the limit that generally prevails now.

If enacted, the EU plan might indeed galvanize trading. "This will help make Continental stock markets deeper and more dynamic," says Rudiger von Rosen, managing director of the German Share Institute. But if European fund managers expect that to happen overnight, they're daydreaming. The commission's plans are sure to get mired in EU politics. The core EU countries don't really want to see pension money flooding into equities. They dislike the risk, and they hate to give up a captive market for their sovereign bonds.

Instead, expect most governments to just tinker with their pension laws. In 1995, Italy raised the retirement age for some workers. In France, the government is building a $130 billion reserve fund to make up shortfalls in social security.

Fainthearted European policymakers know that such stopgap measures aren't enough, and they'll eventually have to allow privately managed, equity-based plans a l'americaine. Alas, they'll probably wait till catastrophe strikes before trying such a radical solution.