The Role of Revaluation and Adjustment Factors in Pay-As-You-Go Pension Systems

This study examines the role of revaluation and adjustment factors in pension systems. The first part sheds light on the determination of revaluation and adjustment factors according to the General Social Security Act (Allgemeines Sozialversicherungsgesetz — ASVG) and how these factors have evolved over time. The analysis shows that since the mid-1980s the revaluation factors have been set more or less in line with the inflation rate; in other words, contributions have not, in fact, been revalued in real terms. The author then demonstrates that such a system eventually conflicts with principles of intragenerational and intergenerational fairness. In such case, the mere extension of the assessment period may entail substantial reductions in pension benefits. When we consider the Austrian situation, extending the assessment period from 15 to 40 years may cause the average pension to drop by 11% to 36% (depending on the underlying assumptions). Capping maximum losses at 10% certainly is a solution for persons aged 35+ at the cutoff date, but anyone younger than that would have to bear the brunt of such a pension reform measure. In the light of the problematic fairness aspects of the current revaluation regime, relating the necessary reform of the Austrian pension system and the concomitant paring of benefits too closely to the effects of this revaluation regime does not seem to be the right approach. In a new (harmonized) system, the revaluation factors should at any rate be linked to wage growth. The last section of this paper focuses on issues which are crucial in wage-based revaluation regimes and which are mainly related to the emergence of demographic shifts. Some of the questions tackled are: Should revaluation be based on the growth rate of average earnings or of the total wage bill? Is the 80-45-65 formula frequently cited in the pension reform debate in Austria consistent in itself? Should automatic adjustment factors (sustainability factors) be built into the pension system, and if so, which ones? Does it make any difference then whether we are dealing with a traditional pay-as-you-go pension model or a notional account system?