Automatic balancing mechanisms for pay-as-you-go pension finance : do they actually work?

In pay-as-you go pension systems, automatic balancing mechanisms (ABMs) are designed to face adverse demographic and economic changes. In this respect, ABMs can be defined as a set of pre-determined measures established by law to be applied immediately as required according to an indicator that reflects the financial health of the system. The purpose of ABMs is, through successive application, to restore the sustainability of the pay-as-you-go pension system. First, adjustments can be made in benefit levels to reflect changes in life expectancy; second, adjustments can be made through the revaluation of the contribution basis of earlier years; and third, adjustments may occur through the revaluation of pensions in payment. Countries such as Finland, Portugal, Germany, Sweden and Japan, amongst others, have already legislated and included different types of mechanisms into their pension systems. This chapter aims to explore the different mechanisms that have been recently set up and analyse their effectiveness in terms of financial sustainability and adequacy of benefits.