LONDON -- The term "baby steps" best describes how pension reform is progressing in France and Germany.
But as with any child learning to walk, the first few steps are significant.
The governments of France and Germany this autumn are to publish draft legislation aimed at increasing individuals' contributions to pension savings.
But until both countries give capital markets investments the same tax-favored treatment as insurance instruments, there will be little chance for investment bankers and foreign money managers to benefit from increased flows into long-term savings products, observers said.
Both countries traditionally offer generous state-sponsored benefits to retirees through unfunded pay-as-you-go systems, but their governments are inching their way toward more reliance on individual and employer-sponsored pension savings as a way to avoid spiraling costs as their populations age. According to recent research by Merrill Lynch, the number of German pensioners is likely to increase 50% in the next 30 to 50 years while the working population is expected to fall slightly.
Money managers in both countries said insurance companies are likely to benefit most in the short-term from changes to domestic pension provisions.
The French government's proposals are likely to gradually reduce state pension benefits while encouraging occupational savings plans at the company or industry level, said Denis Bastin, European Partner for William M. Mercer Ltd., London.
Most industry observers would describe this as pension reform, but in France "pension" is considered a dirty word and Finance Minister Laurent Fabius has told reporters he is keen not to use it.
"In France, talk about pensions is not a rational debate, but religious warfare," Mr. Bastin said.
At the moment, most French companies offer employees salary-linked savings schemes that tend to be oriented toward long-term savings rather than actual retirement savings.
"These schemes would be a natural platform to use to broaden the system by investing more of the employees' gross salary," said Mr. Bastin.
These savings plans are offered by most midsized to large French companies but the total amount invested in them is relatively small, falling somewhere between 100 billion and 150 billion French francs ($14 billion to $21 billion), according to Mercer's Mr. Bastin.
Jan Mantel, independent consultant for Merrill Lynch & Co., London, expects the French government to restructure the company savings schemes to encourage them to invest more in equities and ultimately resemble 401(k)-type individual savings plans.
"Although they won't call them pension plans, that is the idea behind the reform of these savings schemes," he said. "This will be good for the savings market and will trigger a growth in assets under management, but not by as much as people expect."
French savers already invest as much as 40% of the gross domestic product in mutual funds, second only to the United States, where mutual fund savings represent 65% of GDP, according to research by Merrill Lynch.
But it is still unclear what the government will propose in terms of whether:
* to increase the proportion of salary that can be invested in these vehicles;
* to make these payments mandatory or voluntary;
* to require employers to provide matching contributions;
* contributions to company schemes will be taxed on the same favored basis as payments into the state-backed pay-as-you-go pension system; and
* whether contributions to unit-linked investment vehicles such as mutual funds will receive tax treatment equal to that of insurance products.
The German government, meanwhile, looks more likely to introduce measures to encourage savers to make private arrangements for their pensions than to restructure the corporate pension system.
When the German government announced earlier this year that it would tackle pension reform, industry observers expected state pension benefits to be reduced and contributions to private savings plans made compulsory. But after lobbying from various interest groups, it appears likely the proposal will be watered down so that contributions to private pension plans will be voluntary.
Trade unions and investment bankers are surprised the government has not put German companies under greater pressure to increase their pension schemes. But according to Horstdieter Grohs, Frankfurt-based European marketing director for Foreign & Colonial Management Ltd., the German government was unwilling to stir up further discontent among the domestic companies that already grumble about the high cost of social security contributions they are obliged to make for each employee.
"This is a very sensitive area in Germany," he added.
Reform to corporate pension plans could be a long process and would involve tackling the web of existing laws. German companies that offer pension benefits have to account for them using the book-reserve system. As a result, many German companies tend to insure their pension commitments, because using equities can lead to volatility in the value of the assets on the balance sheet, which translates directly into the profit and loss accounts.
Fewer companies are setting up pension plans because they are costly and complex to administer, said Andreas Schneck, manager of European sales for Frank Russell Co., London.
Last month the Bundesverband Deutscher Investment-Gesellschaften, the German investment bankers association, and the Bundesverband Deutscher Banken, the association of German private banks, came together for the first time to present proposals on how pension reform should occur in Germany.
They proposed that:
* companies be allowed to set up pension plans similar to the Anglo-Saxon model;
* companies be allowed to offer both defined benefit and defined contribution plans;
* the current 10-year vesting periods for corporate pension plans be reduced;
* companies be able to set up individual pension accounts that could be transported between employers;
* contributions to employer-sponsored and private savings vehicles enjoy the same tax benefits;
* all long-term savings vehicles carry the same tax incentives;
* pension plans, banks or insurance companies provide explicit guarantees on their products or implicit guarantees where they are regulated by a supervisory authority to ensure the safety of contributions; and
* tax breaks for contributions to funded pension plans be set at 5% of income.
Mr. Schneck believes these proposals are a step in the right direction. But it is unlikely that a shift to defined contribution plans would be included in the draft legislation to be published later this year.
Current reform initiatives will only gradually move Germany's pension system toward a more Anglo-Saxon model of provision, Mr. Grohs said.
But Messrs. Bastin and Mantel claim neither France's nor Germany's pension system will be sustainably funded to support future payments until contributions to second- or third-pillar schemes are made mandatory.