Pension Systems

Pension systems are based on three parts. The first is the public pension system, which can be imposed by law or can be a defined benefit. The second pillar represents occupational commissions for pensions, which are usually prior constituted. These pensions are administrated by independent or affiliated pension funds through group insurance contracts, and even sometimes by companies. The third pillar represents voluntary individual savings administrated by insurers, mutual funds, investment companies or even by individuals themselves. As a general rule, a balanced proportion of the three is the best solution and allows benefiting from the advantages of all systems and allows the distribution of risk.

The public "pay-as-you-go" system is usually designed to prevent poverty of pensioners and to reach distributive objectives. They also allow a fair distribution of inflation between generations and of risks such as wars, recession, natural disasters, etc. Many countries have replaced taxing salaries for pensions with taxing prices. The disadvantages of this system are that the elderly depend on the younger generations to support the pension system, and it is vulnerable to unemployment and aging of population, two increasing phenomena in many developed countries.

The third and second pillars are usually pre-funded and encourage private savings for retirement. In most cases, these are less vulnerable to demographic changes than pay-as-you-go systems, but inflation and disasters still represent important risk factors.

The structure of the pension systems has considerable differences from state to state, mainly because of different development and history. Countries such as Germany and France are suspicious regarding private pension funds due to previous inflation problems, whereas countries like Great Britain or the United States, in which the population is unsatisfied with solutions offered by the state tend towards private pensions. The importance derives from the size of the accumulated actives administrated by institutional investors.

In most industrialized countries the main pillar for founding the pension commission consists of a compulsory public pension plan, often completed by a private pension system. As a rule, the public pension system is based on the pay-as-you-go system, meaning that current payment of pensions is financed from the current income of the workforce. The main source of financing is usually comprised by both employers and employees, and the rate of contributions can vary, from 6.4% in Canada to 32.7% in Italy. In most countries the contributions paid are equal both for employers and employees, but in some countries, such as France the employers contribute more, and the state also has an extra contribution of 1.6%. The relative welfare of pensioners compared to the active workforce depends on the taxation mechanisms of payments made to them. Almost all countries use price taxation in order to allow a constant real pension. In most counties the eligibility of pension related payments requires a certain age and a minimum period of contribution. Retirement age usually varies between 60 and 65 years, but some countries also allow early retirement if a minimum contribution level is reached. The amount of the pension depends both on the period of contribution as well as of income.

In most countries, the public pension system is completed by the private system. The commission for pensions can be ensured either by the pension system or by individuals themselves. In many cases, companies are inclined to offer retirement commissions in order to attract employees. The taxation and regulation framework has an important influence on the increase of the ways through which the employers are involved in this occupational pension system. Companies can set up reserves, provide life insurance or deposit the money at an external pension fund. The occupational pension system has two types: the defined benefit type and the defined contribution type.

The first type means that the employer supports an additional risk regarding unexpected salary or inflation increase. The employer will also be disadvantage by the reduction of the retirement age and by payments made outside the system. In countries such as France, Switzerland and Australia the pension commission supported by the employer is compulsory. Pension funds sometime ensure their portfolio at life insurers, and by offering a guarantee, the defined benefit plan offers individuals a low level of risk. The disadvantages are that employee mobility is restricted and that the employees' pensions are exposed to the risks that the company is exposed. This risk is reduced by these fund being administrated by independent entities, or the compulsory insolvency insurance. In a defined benefit plan, the pension level is pre-established and the participants contributions are determined in relation with this level. This formula takes into account the duration of the employment and salary level.