The German Retirement Benefit Formula: Drawbacks and Alternatives

We identify several objectionable features of the German retirement benefit formula. Groups of insureds with higher than average life expectancy are subsidized by the rest of the members because the formula neglects differences in group-specific life expectancy. Moreover, undesirable long-run effects arise if the earnings ceiling is raised or mandatory membership is extended, or if life expectancy rises or the rate of population growth declines. We present three alternative formulas. In particular, a return-rate formula that rewards contributions with the internal rate of return of the pay-as-you-go pension system is superior to the current formula. This formula corresponds to the concept of ''notional defined contribution'' pensions that has been recently introduced in several countries.