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FIAP > Boletín – Recientes > Pension Notes N° 70 – Automatic Adjustment Mechanisms: Role and Lessons for the Pension Systems – April 2023
24 May, 2023

Pension Notes N° 70 – Automatic Adjustment Mechanisms: Role and Lessons for the Pension Systems – April 2023

The Automatic Adjustment Mechanisms (AAM) seeks to implement changes to the benefits and parameters of the pension systems (contribution rate, official pension age) that allow long-term improvements in financial balance or pension adequacy, in a process the least politically tainted, based on technical arguments (such as population aging due to lower fertility rates and higher life expectancy, as well as economic and financial trends). In this way, the political risk of inaction or wrong action on pension reform is greatly reduced.

Unlike PAYGO programs, in which the adjustments made to their parameters are essential to improve the financial balance and alleviate the tax burden, in individually funded systems the adjustments are necessary to ensure the adequacy of the pension amounts in the face of increases in life expectancy and economic and financial trends. In this case, the longer life expectancy upon retirement implies a reduction in pensions that can be financed with the same accumulated savings if the key parameters that determine pensions are not adjusted (pension ages, contribution rates and taxable ceilings).

One way to address this challenge is to make discretionary adjustments in contribution rates and/or official retirement ages, which take into account improvements in the longevity of future retirees. The other alternative is to define an AAM that is as technical as possible, in order to adjust these variables over time.

The review of international experience shows a variety of ways in which AAMs are applied in pension systems: (i) 7 countries adjust the statutory retirement age according to changes in life expectancy (Denmark, Estonia, Finland , Greece, Italy, Netherlands and Portugal); (ii) 6 countries adjust pensions in relation to changes in life expectancy, the size of the active population, the wage bill or GDP, including the so-called “sustainability factors” (Estonia, Finland, Greece, Japan, Lithuania and Portugal); and (iii) 7 countries have a “balancing mechanism” in pension commitments (Canada, Germany, Finland, Luxembourg, the Netherlands, Sweden, and the United States). The balance mechanisms are designed with the primary objective of guaranteeing a balanced budget for the pension system, both in the short, medium, and long term.

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