II. Financing of social protection systems
2 Pension system
2.3 Bridging the gap between revenue and expenditure – Examples
examples of other countries
Pension systems pursue multiple objectives, some complementary, other exclusionary.15 The general features of pension systems across many countries indicate that pension systems must provide financial security and adequate income for older people, but they must also be financially sustainable lest other economic and social balances are disrupted. They have to both secure future spending for pensioners and withstand potential demographic and economic pressures.
Intergenerational redistribution of income also contributes towards social policy goals such as alleviating poverty among older persons. Pension systems must protect against risk during the active period and in old age. Such a variety of objectives typically represents a major challenge for policymakers. The transfer of certain solutions from one country to another might not be acceptable or possible, since pension systems differ and depend on the social contract and the historical development of each country’s system.
Countries have to identify a combination of pension system elements that provides maximum coverage of risks. Pension systems are multi-tiered, combining elements that define both contributions
15 OECD Pensions Outlook 2018, 2018, p. 22.
projections which the European Commission uses for projections of age-related expenditure,13 the contributor-to-pensioner ratio will drop to the extent that in just slightly over 20 years the number of contributors and pensioners will be equal and after 2040 the collected contributions will cover just slightly over half of pension expenditure, which is projected to increase by 4.3 pps of GDP by 2060. These projections assume a no-policy-change scenario. Due to an exceptionally low activity rate of older persons (55–64), Slovenia has one of the lowest average effective ages of exit from the labour force (60.5 years in 2016; only Luxembourg’s is lower). The effects of the pension reform, which entered into force in January 2013, on increased activity of older persons ease off after a certain phasing-in period, meaning that after the end of this period, the assumed activity rates remain largely unchanged in the model.14 The adoption of appropriate measures paves the way for increasing the activity rate. The increase in pension expenditure also reflects indexation and retirement conditions, which remain unchanged for Slovenia throughout the projection period, in contrast to many other countries, which already have stricter retirement conditions from the aspect of retirement age.
13 Projections of age-related expenditure are created by the Ageing Working Group (AWG) at the European Commission’s Economic Policy Committee. Member States have representatives on the AWG. For more on methodology of projections, see also IMAD, 2019, “Long-term projections of pension expenditure – Methodology used by the Ageing Working Group (AWG)”.
14 The currently agreed projection methodology does not assume any other upward convergence in activity rates.
Source: The 2018 Ageing Report, IER calculations using Ageing Report assumptions.
Figure 5: Ratio between contributions and pension revenue, contributor-to-pensioner ratio
0.80 0.90 1.00 1.10 1.20 1.30 1.40 1.50
50 55 60 65 70 75 80 85
2016 2019 2022 2025 2028 2031 2034 2037 2040 2043 2046 2049 2052 2055 2058 2061 2064 2067 2070 Contributors / pensioners
Pension contributions / expenditure *100
Pension contributions / expenditure *100 Contributors / pensioners, right axis
Source: The 2018 Ageing Report, IER calculations using Ageing Report assumptions.
Note: Contributions as a share of GDP remain relatively stable over time, as GDP growth depends on productivity growth and employment trends, while the amount of social security contributions paid depends on the growth of wages (which are assumed to increase in line with productivity growth) and employment trends (Majcen B., Sambt J., 2018).
Figure 6: Long-term projections of pension expenditure and social contribution revenue, 2016–2070, as a % of GDP
6 8 10 12 14 16 18
2016 2019 2022 2025 2028 2031 2034 2037 2040 2043 2046 2049 2052 2055 2058 2061 2064 2067 2070
As a % of GDP
Social contributions Pension expenditure
reformed their pension systems by either tying their pay-as-you go system to a points system (e.g. the point value is determined as contributions from average wage, whereby an individual’s contribution is translated into points) or introducing notional/non-financial defined contribution accounts, where an individual’s contributions are notionally recorded on the contributor’s individual account.19 One of the more important elements of pension reforms has been the introduction of mechanisms that automatically adjust key pension parameters (retirement age, amount of pension, sources of financing) to demographic change, i.e. higher life expectancy, higher old-age dependency ratio, etc.
Since the mid-1990s over half of EU Member States have introduced i) automatic balancing mechanisms, which ensure sustainability of the pension system by adjusting pensions or contributions, ii) sustainability factors, which adjust pensions to projected demographic changes such as life expectancy at retirement, or iii) automatic links between retirement age and life expectancy.20 These mechanisms may be introduced in pay-as-you-go systems as well.
Many countries have also introduced supplementary pension insurance, whose main aim is to reduce individual and collective risk of lower income in old age. With supplementary insurance, individuals are supposed to reduce the gap between employment and pension income. Supplementary pensions are funded, defined contribution systems managed by private institutions and pension funds.21 It is up to each country to decide which risks the supplementary insurance will mitigate (e.g. longer life expectancy, unsustainable increase in public expenditure or provision of adequate pensions) and what its role should be. Promotion of supplementary insurance is also essential for Slovenia, which has the lowest rate of participation in individual supplementary insurance (see Figure 7); in occupational pensions, the situation is better.
19 Boulhol, 2019.
20 ”Pension reforms in the EU since the early 2000s”, 2016.
21 OECD Pensions Outlook 2018, p. 18.
and benefits: pay-as-you-go or funded systems, defined contribution systems, or defined benefit systems (see Table 1).16 In Slovenia the first tier is a pay-as-you-go system with defined benefits. Pay-as-you-go systems disperse risks intergenerationally, but they become financially unviable as the contributing population shrinks. This is also a feature of defined benefit systems.
Longer life expectancy and smaller cohorts entering the labour market reduce the financial sustainability of defined benefit systems. Reforms to improve financial sustainability, however, create the risk of worsening pensioners’ financial position. In order to alleviate pressures on public finances and preserve an adequate level of pensions, countries therefore introduce supplementary insurance pensions, which are investment products with defined contributions managed by private pension funds. A combination of systems where the shortcomings of unsustainable financing of the first tier due to demographic change are supplemented with a stronger second tier covers more risks and increases pensioner incomes.17
In order to improve their financial sustainability, pay-as-you-go pension systems are undergoing changes towards establishing a stronger correlation between contributions and benefits (i.e. amount of pensions), bearing in mind the economic and demographic conditions. One key measure that countries are undertaking to address the challenges of an ageing society is raising the retirement age. In half of OECD countries the retirement age will rise in the future under legislative changes already in place, and some countries are linking retirement age to life expectancy, which will result in an approximately 1.5-year average increase in retirement age in OECD countries over the next few decades. But since this is not sufficient, some countries have introduced automatic links between pension parameters and demographic change to reduce the gap between financing sources and expenditure (see Table 2).18 As early as the 1990s, several countries
16 Social impact of the Crisis…, 2010, p. 8.
17 OECD Pensions Outlook 2018, 2018, p. 18.
18 “Pensions at a Glance”, 2017, pp. 28–29.
Table 1: Four elements of pension systems and their main features
Pay-as-you-go system Defined benefit system
- Spreads risks across generations - Provides workers with a reliable perspective on their retirement income - May become unsustainable if the working age population shrinks - May become unsustainable if balance between contributors and
pensioners changes - Exposed to demographic, productivity and political risks
Funded system Defined contribution system
- Every generation responsible for its own ratio between
contributions and pensions - Automatically reacts to demographic change
- Requires a long period of capital accumulation - Exposes workers to demographic, productivity and capital market risks depending on underlying pay-as-you-go or funding principles - Exposed to capital market risks over the long term
Source: European Parliament. (2010). “Social impact of the crisis - Demographic challenges and the pension system”, p. 8.
for the financing of social insurance – and to increase public savings and hence the national savings rate. The principal characteristic of these funds is that beneficiaries do not own the fund: it is owned by a managing institution or directly by the state, unlike funding from private pension schemes, where contributors have direct ownership of the funds and the schemes are regulated To co-finance pension expenditure, some countries
have set up public pension reserve funds. The role of these is to pre-fund social security benefits with funds that will be integrated into the pay-as-you-go system when pension expenditure exceeds revenue.22 Their purpose is thus to provide a reasonably stable source of revenue for public pensions – these are funds used solely
22 Rangus, 2012, p. 174.
Table 2: Countries with automatic balancing mechanisms, sustainability factors, or links between retirement and life expectancy
Country
Automatic balancing mechanism
Sustainability factor
Link between retirement age and life expectancy
Italy x x
Latvia x
Poland x
Sweden x x
France x
Germany x
Finland x x
Portugal x x
Greece x
Denmark x
Netherlands x
Cyprus x
Slovakia x
Spain x x
Lithuania x
Malta x
Source: “The 2018 Ageing Report: Underlying Assumptions and Projection Methodologies”, 2017, Table II A2.3.
Notes: See source for more notes on individual countries.
Source: Pension Adequacy Report 2018.
Figure 7: Individual supplementary pension insurance policies in selected EU countries – share of participating population aged 15–64
0 10 20 30 40 50 60
Slovenia Lithuania Romania Portugal France Croatia Poland Italy Ireland Estonia Bulgaria Spain Latvia Denmark Hungary Finland Austria Sweden Slovakia Netherlands Germany Belgium Czech R.
Share of population aged 15–64
Source: OECD Statistics, Eurostat.
Figure 8: Funds managed by public pension reserve funds in selected countries at the end of 2009, in % of GDP
0 5 10 15 20 25 30
Poland France Belgium Norway Portugal Spain Ireland Sweden
In %
by law and through supervision.23 A by-country overview shows there is no single mechanism under which public pension reserve funds are financed (contributions, state budget, state property), nor is there a single rule determining when the first transfers will be made into the pay-as-you-go system after the accumulation of funds;24 available data show that the amount of funds under management differs significantly (see Figure 8).