Financial sustainability of social protection systems (with particular reference to retirement pensions)

In order to assess the equity and proportionality of the system, a series of indicators are normally used: the pension returns rate and the replacement rate. The pension returns rate equals the final value of the contributions paid over a worker’s active life period with the current value of the retirement pensions that they will receive. The aforementioned rate refers to the ‘returns’ that a person receives from the pension system. Paradoxically, this rate tends to be higher for those who have contributed to Social Secuirty pension regimes within the different countries for fewer years. During the sixties, a series of agreements made among social agents — as a result of a general buoyant economic situation, electoral promises or for various reasons — allowed workers with only a few years of contribution to have access to full pension returns; it was accepted that these people should be given a pension that was much greater than a pension which would correspond to the real contributions made. The outcome of this is the clear lack of proportionality within pension systems.

Figure 6: Dependency rates of retired persons (65+ years old) with regard to the number of active persons (20-65 years old)

Source: Eurostat and author´s personal compilation.

Figure 7: Predictable substitution rates of retirement pensions for a 55-year old person as a percentage of last average salary
Source: Blöndal and Scarpetta (1999) and author’s personal compilation.

The substitution rate indicates the relationship between the last salary for which contributions have been made during the active working life and the amount of the first retirement pension. In general, as can be seen from the Figure 7 the substitution rates in the different Member State countries have been increasing since the sixties. In a system based on distribution, the rate which guarantees the sustainability of the system should be around 60%. On the other hand, there is a tendency for the pensions of lower income groups to benefit from greater levels of replacement given that minimum threshold levels exist.
If countries wish to maintain a distribution system, what should they do to guarantee the system’s viability? Faced with the problem of a lack of equity, they should:
• Actively link up the level of benefits to that of contributions, increasing the reference period of incomes received and use this as a base for calculating ageing pensions (it is necessary to move away from a system which only accounts for the ‘best years’ or final years undertaken by the worker to a system in which the average income obtained over the entire working life is taken into account) and to reduce the replacement rate.
• To pursue an actuarial adjustment in the payment of benefits, so that the longest life expectancy and the different possible ages of retirement are taken into account in order to render the system of pension returns more proportional.
• To make sure that the different Social Security regimes have the benefit of an identical contribution preponderance.
In order to come to terms with the demographic challenge, it is important to put back the age of retirement, at the same time this should not give rise to new rights. This is a move which is currently being introduced in several Member States.

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