Automatic Balancing Mechanisms in Practice: What Lessons for Pension Policy Makers?

Abstract

Despite numerous reforms and the introduction of automatic or semi-automatic adjustment mechanisms, pension system future solvency is not guaranteed. Then, setting up an automatic balancing mechanism can offer several advantages. This article proposes to detail the specific properties of various adjustment rules prevailing in different countries to see to what extent their understanding may be helpful to determine public choices ensuring sustainable retirement systems. Several of such adjustment rules are possible. Three rules will get our attention. The American case is radical. The prohibition to resort to public debt, the so-called “fiscal cliff”, forces the balance by a drastic reduction of pensions whenever the reserve fund is exhausted. The underlying idea is that this socially unacceptable perspective will force the parliament to take measures to restore solvency. The Swedish approach relies on an adjustment through the general level of pensions to guarantee a notional asset/liability ratio. A huge reserve fund smooths the shock associated with the aging of the population. The Canadian approach is based on an “inadequate rate provision” which increases the contribution rate and a pension freeze as long as the federal and provincial finance ministers do not reach an agreement.