Pension Systems

Abstract

Pension systems combine government and privately-sponsored support to finance a suitable standard of living during retirement. Pension systems can be financed through pay-as-you-go (PAYG) or through pre-funding. PAYG pension schemes finance old- age retirement benefits in one particular period with the contributions of the working- age population. Pre-funding, on the other hand, relies on the capital markets. Both financing methods face labour and longevity risk. Benefits differ across pension systems depending on who the main bearer of the risks is. Defined benefit (DB) schemes provide guarantees in the benefit payout, and transfer the financing risk to the sponsor. Defined contribution (DB) schemes guarantee a minimum level of financing, transferring the risk to the retiree. Some pension systems offer hybrid schemes that combine DB and DC features. The benefit design has an impact in the long-term sustainability of the pension system, the standard of living during retirement and the actuarial fairness that represents the link between lifelong contributions and benefits. Recent reforms have reduced benefits to achieve long-term sustainability and solvency caused by population ageing. Future research should focus on the impact of policy design in inequality arising from gender or heterogeneous life expectancy.