The Basic Concepts

Consumption smoothing throughout the lifecycle and poverty preventing are two fundamental goals of pension systems. The former has traditionally been played by Bismarckian, earnings-related pensions, the latter by Beveridgean, flat-rate pensions. Alternatively, pensions can be computed through personal accounts recording either monetary contributions paid in the system or ‘points’ earned in one way or another before retirement. Fully funded systems always have enough assets invested in the financial markets to extinguish all their liabilities towards workers and retirees. Pay-as-you-go (PAYG) systems have no assets and extinguish their liabilities by resorting to the contribution revenues. Under changing economic and demographic conditions, defined benefit systems ensure solvency by adjusting the contribution rate charged on active workers, whereas defined contribution systems automatically adjust expenditures to the varying contribution revenues.