18 July 2002

Commission Economic Paper on Pension Reform

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The paper examines pension reforms under ageing. Reforms are assessed, in particular, with regard to financial sustainability and intergenerational fairness. With stylised facts, ageing is traced to low fertility and increasing longevity. Given these persistent factors, pension systems must be reformed to avoid an unfair burden being left for future generations. Correspondingly, if the demographic factors differ from one generation to another so also should the pension benefits and/or the replacement rate.

The main results for reform blueprints are:

In a Defined Benefit (DB) system, partial pre-funding is needed to achieve intergenerational fairness unless benefits are sufficiently reduced; partial privatisation is an option for the management of the accumulating funds.

Transition from a DB to a Notional Defined Contribution (NDC) system is another reform option; it reduces the replacement rates to levels which match prescribed contribution rates; an NDC public pillar can be accompanied by a second pillar, managed by the private sector.

An effective retirement age increase is necessary to moderate the increase in pension expenditure and to preserve adequate pension levels.

Pension reforms have important effects on public finance target setting.

Pension reform: key issues illustrated with an actuarial model

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