2024 MATiné

Automatic Adjustment Mechanisms in Pension Schemes –  The Limits of Pension Policies

In recent decades, countries have been responding to demographic, economic and financial uncertainties affecting pension adequacy and/or financial sustainability with systemic and/or gradual parametric pension reforms. These adjustments can be discretionary, by undertaking regular legislative action as circumstances change, or updates can occur automatically by setting predefined rules about how pension parameters should be adjusted based on the evolution of a demographic, economic or financial indicator. 

For instance, these mechanisms decide in advance how the system will adjust to restore financial solvency if an increase in the old age dependency ratio (e.g., Germany), a decline in the workforce (e.g., Japan), an increase in life expectancy at retirement age (e.g., Denmark, the Netherlands, Portugal), a decline in wages (e.g., Germany) is observed, or if the system is projected to go into a long-term deficit (e.g., Sweden, Canada, U.S., Spain). Variations of other automatic stabilizers have been elements of many pension systems for decades. For instance, wage, real GDP, productivity, and CPI price indexation of the earnings tax base and/or benefit payments are now basic features of most earnings-related old age pension schemes. While automatic adjustment mechanisms (AAMs) emerged as a tool to uphold pension adequacy through wage or price indexation, there has been a shift in focus over the last decades towards maintaining financial sustainability.

Although the objective of introducing automatic stabilisers in pension schemes is primarily cost containment, there are other dimensions of welfare restructuring in the politics and social outcomes of pension reforms. They include recalibration and/or rationalisation, i.e., introducing economic and actuarial rationality for validating the advocated changes, enhancing the credibility of the system, social trust, and the support of the intergenerational contract by averting otherwise public finance crises and major pension entitlement cuts in the future, addressing old age poverty, providing socially adequate benefits, and eluding the political risks of regular negotiations between social partners to approve unpopular reforms that involve retrenchments. The rise in old age dependency increases the grey vote, raising discussions about the pro-elderly policy bias and the rise of gerontocracy in pension reform.

AAMs are meant to adjust for future trends and are not a substitute for bold discretionary measures in a financially unbalanced pension scheme. For instance, in a scenario of population ageing linking statutory pension ages to life expectancy alone will be sufficient to prevent the decline in the relative size of the labour force and restore financial equilibrium and equity among generations. To this end, we elaborate on this point and research the effectiveness of the recent retirement age policies adopted in France to stabilise the country’s dependency ratio and the effect of population ageing on the financing of public pension schemes. Empirical results are provided.