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Financial solvency of pension systems in the European Union

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  • Tânia Santos
  • Inmaculada Domínguez-Fabián

Abstract

Over the past century, most industrialized countries have adopted public pension systems based pay-as-you-go system, according to which the actual contributors pay the pensions of the actual pensioners, with the expectation that future taxpayers pay their pensions when they retire. The evolution of the pension systems financial position is determined by the influence of demographic and macroeconomic variables. Publications by international data sources, as European Commission (2006) and Eurostat (2008), allow concluding that developed countries face the problem of ageing population, mainly caused by the strong increase in the old-age dependency ratio and by the decline in the fertility rates. Regarding the evolution of economic variables, we should note the decline of the young activity rates and the increase of the unemployment rates of all age groups, which increases demand for pensions and reduces the contributions periods to Social Security systems. We pretend to analyse the equity and financial solvency of the European pension systems. To analyse the equity and financial solvency of the European pension systems, we have proceeded to calculate the value of old-age pensions, the replacement rates (RR) and the internal rates of return (IRR), for each country studied. To calculate the old-age pension, we applied the rules defined by each country, considering various salary scenarios, retirement age decisions and different contribution periods. With the idea of analyzing whether there is harmonization between the European pension systems, we analyze the case of different individuals, and calculate the RR and the IRR individuals would get in each of the European countries. Those countries that provide an IRR over an estimated economic growth will be settled as insolvents in the Samuelson financial sense, and parametric reforms will be raised in order to improve its financial solvency. Among the proposed measures there are the increase of the contribution rate, the increase of the legal age of reform and increase of the number of years of earnings considered for calculating the first old-age pension. We also analyze the combination of these measures. Pension systems of most European countries are insolvent. Proposed measures - as the increase of the contribution rate, the increase of the legal age of reform and increase of the number of years of earnings considered for calculating the first old-age pension, and the combination of these measures - will improve the financial solvency of the European pension systems.

Suggested Citation

  • Tânia Santos & Inmaculada Domínguez-Fabián, 2011. "Financial solvency of pension systems in the European Union," EcoMod2011 2916, EcoMod.
    • Handle: RePEc:ekd:002625:2916
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    References listed on IDEAS

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