How to Make Pension Systems Financially Sustainable?
Takayama, N. Prof. Dr.
Professor Emeritus at Hitotsubashi University
President, RIPPA, Japan

1

Introduction1
This paper gives an overview on how to make social security pension systems
financially sustainable. Ample experiences in developed countries are to be illustrated.
Before taking up the main subject, fundamental characteristics of social security
pensions and a need for periodic actuarial evaluations are explained.
2

Major Requirements of Social Security Pensions
Social security pensions have two major requirements for satisfying the sincere desireof the public. One is financial sustainability, and the other is adequacy of benefits. 2 As a
population aging went on, financial sustainability got more and more serious in almost
all countries, and then a long list of policy options to ensure financial sustainability havebeen demonstrated in the world. They are usually painstaking with tears, quite unpopular
to the public. Nevertheless, many developed countries have already managed to
implement these policy measures.
The other requirement, adequacy, is desired for the elderly to maintain a decent living
standard after retirement. If any pension system fails in meeting this requirement, it willturn to be politically unsustainable.3
Financial sustainability often violates the adequacy requirement, however. 4 Bothrequirements will not always be compatible with each other. Sophisticated balances
between them are necessary for pension policy making.
3

Fundamental Characteristics of Social Security Pensions
There are four major characteristics in social security pensions;・a system of dividing the value-added of the national economy among different
generations
・pay-as-you-go vs funded: output is central・defined benefit plans vs defined contribution ones・lifetime annuities vs fixed-term annuities
A brief discussion of each is presented below.

This paper was presented at the 6th China-Japan Joint Workshop on Pensions, Zhejiang
University, Hangzhou, 20-21 April 2019.
2 Some persons refer to these two requirements as “objectives,” but the genuine objective would
rather be to attain a stable standard of living after retirement.
3 Detailed discussions on the adequacy requirement are beyond the scope of this paper.
4 Many developed countries currently give a greater stimulus to people to participate in voluntary
occupational and personal pensions to make up for the reduced social security ones.
1

1Social security pension benefits for the elderly are mainly financed by contributions
from their children and grandchildren. It is a socialized system of income transfers
between parents and their children. It is also a system of dividing the value-added of thenational economy (an economic pie) between retired persons and actively working ones.
In Japan, for example, 66 million working persons financially supported life of her 127
million whole population (1.9 persons per worker) in 2015. In 2050, 46 million working
generations will be estimated to do so for the total of 100 million persons (2.2 persons
per worker). Actively working persons there will be forced to bear relatively a little bit
heavier burdens during the next 35 years under a declining and aging population. Social
security pensions thus have to flexibly adapt to the changing size of the national
economy, together with the changing distribution of the population.
In a macroeconomic context, social security pensions stand indifferent as to theirchoice of the financing method, pay-as-you-go or funded. It is known as an equivalence
proposition (see Geanakoplos-Mitchell-Zeldes 1998). Namely, pay-as-you-go pension
benefits depend on growth of the future economy, while funded pensions pay theirbenefits by returns from the funded reserve and/or its decumulation. Under an aging
population with a slower growth rate of the economy, the rate of return from investment
or the selling price of the funded assets will consequently decline. The end results will
be indifferent, regardless of pay-as-you-go or funded pensions.
Someone might say that more prefunding of social security pensions will contributeto strengthening their financial sustainability under a population aging. This assertion
is a “complete lie,” quite contrary to the equivalence proposition (above stated) which iscurrently shared as a common understanding among pension professionals in theworld.5
In essence, output is central for pensions in the future. Higher productivity and later
retirement are both crucial. Longer working years corresponding to longer life
expectancy are immensely required. Pension policies have to go hand in hand with
employment policies.
Within the pension system, encouraging later retirement and/or eliminating thework-disincentives are needed. In a microeconomic context, pension entitlements to eachindividual vary between defined benefit and defined contribution plans. Defined benefit
plans first prescribe pension benefits, while defined contribution plans do contributions
and adjust their benefits after. Benefits in defined benefit plans occasionally change inthe course of time, however. Eventually adjustments in benefits are inevitable in bothplans.6
Finally, social security pension benefits are lifetime annuities. Their payment
continues until the death of each pensioner. This makes a sharp contrast to private
pensions whose benefits are usually fixed-term annuities or even lump-sum ones. In thisGlobal diversification of investments from non-mandatory funded pensions might mitigate their
reduced rate of return due to a population aging.
6 Today, the prototype of defined benefit plans is very hard to survive, and they virtually have turned
to become defined contribution ones.
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sense, social security pensions can only serve as the indispensable basic floor of income
security in old age for all persons.
4

Need for Periodic Actuarial Evaluations
Social security pensions are fundamentally financed on a pay-as-you-go basis. They
involve each individual for a long time, say, usually for 60 years or even nearly 100 years
at the longest. The future is quite uncertain, and precise predictions are beyond humanknowledge and skill. There is no single ideal form for pensions, and their system has
thus to be reformed continually with no finish to flexibly adapt the changing
demographic and economic circumstances.
Developed countries generally publish the periodic actuarial evaluation to make thepublic know whether or not the current pension systems are financially sustainable, andwhat outcome will take place if selective reform measures are adopted. In evaluating thelong-term financial performance, the public actuary’s office places basic assumptions at
first on future changes in fertility, mortality, labor force participation, CPI, wage index,
and investment return from the funded reserve. And then it projects long-term changes
in the each number of contributors and beneficiaries, annual revenues, expenditures,
surplus/deficit, and balance of the funded reserve. The special concern is whether or not
the funded reserve will be used up in the future, and when it will run out, provided thatthe current provisions remain unchanged. The actuary’s office usually assumes threecases (optimistic, medium, and pessimistic), at least.
Regarding the projection term, it is 75 years in the US, Canada, and Sweden. It is 65
years in the UK, 50 years in France, and 100 years in Japan. Actuarial evaluations areto be done every year in the US and Sweden, while they are done at least every five
years in the UK, France, and Japan. In the meantime, actual and assumed conditions
will more or less diverge, even when every effort is made, using the best available data.
With the passage of time, fresh data become available, and periodic updates of thefinancial projections are to be done using revised assumptions. In this sense, actuarial
evaluations are more like “projections (投影)” into the future of pension finances basedon currently available demographic and economic data, rather than future “forecasts (予測).”The authoritative actuary office has ideally to be independent of pension
administrations. This is for ensuring neutrality, making its evaluation trustworthy. Thisis the case in the UK and Canada.
5

Major Policy Options for Ensuring Financial Sustainability
There are four major options, as Barr-Diamond (2010) points out.
・Reducing the Level of Benefits
・Raising the Normal Pension Age・Hiking the Contribution Rate・Increasing National Output
Each option is explained below in order.
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5.1

Reducing the Level of Benefits

There are several ways to reduce the level of pension benefits, such as changes in thereference indicator for benefit indexation and for the update of past wages, a delay inthe onset of benefit indexation, a reduction of the accrual rate (and/or the unit price ofthe flat-rate benefit) and a cut of the nominal amount of too generous benefits.
In the past the automatic indexation of benefits to wages and the automatic updateof past wages for new beneficiaries were applied in many developed countries. But,
today, they have changed the reference indicator for these indexation and update inorder to contain the increasing cost for paying the aggregate amount of benefits.
The Iron Lady, Margaret Thatcher executed the representative example, changing
the automatic indexation of benefits to wages into the indexation only to CPI in the UK.
Wages got upward higher than CPI there, and the level of pension benefits began todeteriorate in real terms as time went on.
Japan recently faced wage increases lower than CPI increases (or wage decreases
more than CPI decreases). The government decided to use the lower indicator of themfor benefit indexation from 2021 on.
Furthermore, in 2004, Germany and Japan introduced so-called “demographic
factors” to additionally adjust the level of pension benefits for the time being. Japanthen started to take into account the annual decline in the number of insured persons
and the annual increase in life expectancy, as well, to reduce the benefit level for all
existing pensioners in real terms every year. Germany virtually adopted the similar toolas Japan did. Spain followed suit from 2014, establishing a new revaluation formula.
Spain also began to apply “the sustainability factor” (life expectancy) to calculate
starting benefits of social security defined benefit pensions from 2019 (see Ramos 2014).
Since life expectancy tends to rise over time, this application will indicate that future
retirees will automatically have a lower monthly amount of starting benefits thancurrent retirees with the same employment record, while the total amount received as
pensions over their lifetime would remain unchanged on average cohort by cohort,thereby enhancing intergenerationally more equitable redistributions of retirement
income. This is an adjustment quite similar to that structurally built in the defined
contribution or notional (or non-financial) defined contribution pensions (see Settergren
2001 for Sweden and the cases in Italy, Latvia, Norway, and Poland).
As for a delay in the date of benefit indexation, France, for example, moved the datefrom April to October, i.e. six month later from 2014. The Slovak Republic limited thebenefit increase by fixed amounts for years from 2013 to 2017, while Austria, Greece,
Portugal and Slovenia temporarily froze automatic benefit indexation for all but thelowest group.
Regarding the update of past wages in line with wage increases in fixing the benefit
amount for new pensioners, Germany and Japan changed the indicator from wages
before deducting tax and social insurance contributions, to the take-home pay (wages
after tax and social insurance contributions deducted). The former got higher than the4latter in the aging process. Japan further introduced the demographic factors mentioned
above in updating past wages as an additional adjustment.
A reduction of the accrual rate for the earnings-related component is the mostorthodox means for reducing the level of pension benefits. If the average service(contribution) years get longer in the future, say, from the current 30 years to 40 years,
then, the accrual rate can be reduced gradually from, say, 1.0% per year to 0.75% peryear cohort by cohort, keeping the average replacement rate unchanged. This was donein Japan in the 1985 reform. If the average service years no longer get extended in the
future, a new and lower accrual rate can be introduced for all insurers including theexisting beneficiaries, provided that the current nominal amount of benefits is fully
guaranteed for existing pensioners to receive (従前額保証) for the time being until the
newly determined amount exceeds the predetermined amount. In the meantime, thebenefit indexation is to be suspended. This kind of special treatments enables asmoother transition. This took place in Japan when a drastic reform was done in 1986
for civil servants, and in Greece when unification of all social security pension systems
was legislated in 2016.
As for a cut of the nominal amount of too generous benefits, it is politically mostdifficult. Even if it is accepted by the public, its improving effect on pension financing
might remain much limited. Rather it can help the system to become more equitable.
Followings are a few examples in Japan. A maximum 10% cut of the nominal amountof pension benefits was forced to retired employees in National Railway Company when
they began to receive the supportive grant from civil servants in Central Government in1985. At that time, the funded reserve of the pension system for employees in National
Railway Company ran out. Another maximum 10% cut of the nominal amount ofpension benefits for retired civil servants was executed in 2013 who were receiving a
total of old-age benefits more than JPY 2.3 million per year. The pension systems forcivil servants were keeping their financing healthy, yet this cut was taken to cool down
the intensified jealousy against priviledged civil servants. A 10% cut is just an easy
option for Japanese to make the first compromise, whereas it ensures the pensioners
concerned to keep their living standard little unchanged, thus being regarded notcontrary to public order and morals.
Taxing more on too generous pension benefits is an alternative option.
5.2

Raising the Normal Pensionable Age
Raising the normal pensionable age7 is fairly difficult, since it is easy for people
concerned to promptly know that things are of their own. They hurriedly thinkthemselves as the “losers,” and are likely to violently protest its raising (see the latest

The normal pensionable age is not always the same as the mandatory retirement age or theretirement age in practice. The normal pensionable age is defined as the starting age for receiving
old-age pension benefits with no reduction nor increment. The mandatory retirement age means theage when workers with indefinite-term employment are forced to retire.
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case under the Putin Administration, for example. The Guardian 2018). This policy
option is politically most unpopular.
It takes much time for a majority of the public to understand why this option isnecessary for the pension system to keep its financing healthy and to remainintergenerationally equitable under the lengthening life expectancy.
Polite, patient, and repeated explanations are required before its proposal is made,as to why this policy measure is appropriate, and what will happen in the future
without adopting this option.
In implementing this policy, due lead time has to be build up, say, 10 or 15 years.
During this preparatory period, the government needs to complementarily create or
improve working conditions for seniors, by subsidizing elderly workers who receive
better training for higher productivity (upgraded skills and better job quality), and by
giving subsidies to employers who hire seniors more.
These orthodox approaches might end in vain, however. Rather, persistent deficits incurrent account of the pension system and/or depletion of the funded reserve often
trigger an enforcement of this option, in a much hastier and ruder way (the 2010/2012
reform in Greece, and the 2011 reform in Italy, for example. See OECD 2013 andSegreti-Dinmore 2011).
The less difficult option will be to attain gender equality, by converging the lower
normal pensionable age for women to the same level for men. This is often the case inmany countries. Incidentally, women live longer than men on average.
To cope with rising longevity, some countries (the UK, France, and Sweden) adopt a“trisection” rule of one’s grown-up life stages, thereby regarding the third stage as theperiod of pensioners while placing the first and second stages as the contribution period.
Their recent idea of increasing the normal pensionable age (or extending contribution
years for receiving a full or non-reducing amount of benefits) is based on this rule.
Following this rule, the normal pensionable age is to be increased to 68 by 2046 in the
UK.
Other countries such as Denmark, the Netherlands, and Italy have adopted an
automatic indexation of the normal pensionable age to longevity. Belgium, Finland,
Greece, Hungary, Korea, Portugal, the Slovak Republic, and Turkey follow suit. Once a
one-shot reform for the government to enforce this rule is done, then the ruleautomatically applies thereafter, without any further legislation. Thus, this is regarded
as a wise method to avoid the political risk (see European Commission 2009).
Overall, many developed countries have already increased the normal pensionable
age to 67 or even higher, although they underwent great hardships before enacting theirown legislation. The estimated normal pensionable age of Denmark will reach 74 in the
future, presenting an extreme case.
An advance payment of actuarially reduced benefits is usually admitted from age 60
or 62. The UK is an exception, having no such provisions.

6Some countries such as Japan and Spain set up a temporary bridge to the increased
normal pensionable age, by devising a “partial pension” for those working part timeclose to the normal pensionable age.
An alternative option is to extend the contribution years for receiving the fullamount of benefits. France, for instance, once decreased the normal pensionable age
from 65 to 60 in 1982. This decision was made to enable employment conditions foryoung persons to get much better, by encouraging elderly workers to retire earlier. Since
then, increasing the normal pensionable age has been particularly difficult in France.
The French government has been forced to muddle through pension-sustainability
issues, struggling to work out by devising an extension of contribution years forreceiving the full amount of benefits. It was extended step by step from 37.5 years in1994 to 43 years in 2035.
5.3

Hiking the Contribution RateAs the population aging proceeded, many countries hiked the contribution rate forpensions, little by little. Some countries with a relatively lower rate of contributions canstill further increase its rate. Its increase might do damages to companies’ economic
activity, however. A majority of developed countries have little room for adopting thispolicy, today. These countries are seeking for alternative policy options to raise revenues.
See Section 6 below.
5.4

Increasing National Output
Increasing national output is very crucial, as the present author already discussed it

above in Section 3. This is the policy option outside the pension system. Policy makers
for this purpose are there in the cabinet office other than the ministry in charge ofpensions.
6

Other Options for Ensuring Financial Sustainability
In addition to four major options, there are following five other options more.
・Increasing Transfers from General Revenue
・Expanding the Contribution Base・Coverage Expansion
・Broadening the Social Pool・System Integration/Unification
Each option is illustrated below in order.

6.1

Increasing Transfers from General Revenue
Transfers from general revenue can be increased when the economy is steadily
growing with accompanying increased tax revenues. This was done to realize a jump-up
of the benefit level for Japan’s Kosei-Nenkin-Hoken (KNH) in 1965, for example.
Governments can concentrate the transfer from GR to make it more equitable, by
subsidizing a flat-rate portion of benefits only, stopping help to finance the earnings7

related portion any more. This was done in Japan when the “common” basic benefit was
introduced in 1986.
Transfers from general revenue are sometimes used to make up for a financial loss
in some pension systems. There is a natural limit for this selective use, however.
Increases in transfers from general revenue will probably be feasible when a new tax
is introduced. In France, Contribution Sociale Généralisée (CSG) has been used to newly
finance part of social security pension benefits since 1991. In Japan, an earmarked
consumption tax was introduced in 2014 to lift transfers from general revenue from one
third to one half for financing the basic benefit. Both taxes can be regarded as variantsof the value-added tax, imposing them on not only actively working persons but also
retired ones. They are more equitable between generations than contributions forpensions.
6.2

Expanding the Contribution BaseContributions were imposed initially on regular wages and salaries. Their base canbe expanded to include bonuses and every kind of allowances, for the pension system tohave a possible increase in revenues. This expansion also contributes to attaining more
equitable burdens among different kinds of employees.
Sweden removed the wage cap (ceiling) for employers’ contributions, while keeping
the wage cap unchanged in calculating the amount of pension benefits.
Strengthening measures to collect contributions is another option for increased
revenues. Some countries changed its collection authorities from the social insurance
agency to the tax office. The latter usually have superiority in collection capacity.
6.3

Coverage Expansion
An increase in the number of contributors is another policy option. There may be
persons who meet the eligibility requirements for the program participation, yet are notcovered. These persons have to be encouraged to participate in the pension program.
Relaxing the eligibility requirements is the other policy tool. For instance, atypicalemployees such as part-time employees, temporary staff, contract workers anddispatched employees, can be included in the pension program for employees.
Eligibility requirements can be eased further by applying the program to employees
who are working at smaller business establishments with less than 5 members or even
only one member.
Eligibility requirements may also be relaxed to mandate older employees to pay
contributions after they reach the normal pensionable age and above when they
continue working. This is the case in Germany and Japan.
6.4

Broadening the Social Pool
Some population groups with a declining number of contributors and/or a lower levelof monthly salaries face financial difficulties earlier than others in the pay-as-you-go
8system. Broadening the social pool of pension contributions beyond the boundary ofrespective programs (財政調整) can make their programs financially more sustainable.
It also enables an equal treatment for all pensioners to receive the same amount ofmonthly benefits when they have paid the same amount of contributions during theiractive life, as far as the same cohort is concerned. Or given the same benefit formula, it
enables a smaller gap of contribution rates among different programs. Germany, France
and Japan have such broadened social pool in pension financing (see Takayama 2019 for
the Japanese case). These countries have segmented pension programs separated bydifferent sectors of the population.
6.5

System Integration/Unification
The ultimate goal for pay-as-you-go pension system will be to integrate or unify all

the systems. Germany enacted a law of integrating two major programs for blue- andwhite-collar workers in 2004. Japan took a step-by-step approach for integrating pension
programs for employees, and has unified all of them since 2015 (see Takayama 2018).
Broadening the social pool or integration can save some time before fully fledged
policy measures are implemented.
7Concluding Remarks
Policy measures for ensuring the financial sustainability of pensions mostly takepains and tears. The later pension reforms come, the more painful they are.
If any country has lacked the political will to tackle the problem, letting things run
their course, the outcome would be to excite outrage and despair among the elderly,
together with roaring distrust against the country leaders among the young who would
be most deprived by their extremely high unemployment rate.
Greece serves a typical example of what not to be (反面教師). Pensions in Greece
were once known to be among the most generous in the EU, while Greece suffered fromhigh public debt and deficit. The financial crisis took place there in 2008. The European
Central Bank and other lenders imposed radical austerity packages on Greek people.
Drastic pension reforms and cuts in its benefits were a precondition for the loans
granted to Greece. More than 10 pension cuts were implemented from 2010 (see Nakou
2018). In 2010, Greece was forced to do an outright rise in the normal pensionable age,extend the contribution period, and impose an emergency benefit freeze. In 2012, they
abolished holiday bonuses (the 13th and 14th pensions), and executed additional cuts tothe highest benefits. The cumulative cuts ranged from 14% for the lowest-paid
pensioners to over 40% for the top 2% of pensioners whose monthly benefits were above
EURO 2,000. In 2016, they unified all the pension systems, abolishing all special
arrangements. Existing benefits had to be recalculated by the new method and be frozen
at current levels until their value becomes equal to the value of the respective new
pensions.

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In concluding this paper, the present author would like to emphasize that any
success or failure in pension reforms will depend on whether or not smoother transitions
from the existing system to a new one can be implemented.
Any reform involves both winners and losers. Winners usually have no voice or keep
silent, while losers are most likely to be against the reform, sometimes with loud voices
and radical actions.
Losers have to be limited to those who are financially better-off, enjoying privileged
benefits. It takes some time for them to correctly understand what reform is urgent, andwhy the reform will save the cost imposed on their children and grand-children, or why
the reform will make the system more equitable. It is political leaders that have topersuade them to accept some concessions. Their vested interests have to be preservedto the utmost limit, while their expected rights can be shaken down slowly over time.
Pensions should not make a steep turn.
【Acknowledgements】
The present author is deeply indebted to the valuable comments and helpful advices
from Prof. Wenjiong He, Mr. Chunli Jiang, Dr. Xinmei Wang and Mr. Kei-ichi Fukuyama
for revising this paper. The author is very grateful for research grants from the JSPS
KAKENHI (19H01496, 17H00991 and 16H03629).
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