Pay-as-you-go system: Pay-as-you-go is the system in which the contributions of current insured persons are used to fund the pensions of current pensioners.
Defined contribution system: This is the system whereby the contributions paid by insured persons during their work life are accumulated in individual accounts and invested. The contributions and any returns from the investments comprise their personal savings that will fund their pension and support their standard of living during retirement. The amount of the pension is proportionate to the amount accumulated in their individual accounts.
Individual Account: The account within the new auxiliary pension system (TEKA) where each insured person’s contributions and return on investments are accumulated and that will be the basis for the calculation of the life-long, monthly auxiliary pension awarded upon retirement.
Fiscal risk: The risk for a pensioner of a Pay-as-you-go system to receive a lower pension because of fiscal restrictions due to the poor outlook of public finances.
Demographic risk: The risk for a pensioner of a Pay-as-you-go system to receive a lower pension as a result of deteriorating demographics, i.e. fewer contributions due to a lower number of newcomers joining the workforce and the disproportionate increase in the number of pensioners that share these contributions.
Market risk: The risk faced by defined contribution systems due to market fluctuations.
Risk diversification or spread: This is a term used in investments. Different assets are subject to different risks. Combining them in a portfolio spreads the risk and reduces the overall risk associated with a portfolio in the sense that it reduces the fluctuations of its value. The concept however is far broader and older. For example, a farmer growing many different types of crops is essentially spreading the risk associated with poor weather, market conditions or crop disease thus lowering the risk to their income.
Diversification in an insurance system is achieved when different parts of the pension are subject to different risks. In our new social security system, the three parts of the pension will be exposed to three separate and independent risks (fiscal, demographic and market risk).
The amount of the main contributory pension, that is paid according to the pay-as-you-go system, depends on the number of contributors (workers) divided by the number of pensioners and is subject to the demographic risk. The new, defined contribution auxiliary pension is subject to the market risk. Finally, the national pension, which is funded by the State budget, is subject to the fiscal risk.
The three pillars of pension systems
The three distinct pillars of pension systems are the state pension, the occupational pension and the personal pension.
The first pillar is the main, state scheme which is mandatory. Its benefits, in the form of regular pension payments, are guaranteed by the State and are usually defined. The scheme may be managed directly by the State or by public entities setup for this purpose. The pension benefits are guaranteed by the State.
The second pillar schemes, known as “occupational schemes”, are linked to employment or occupation. These schemes are funded by employer (not always) and employee contributions which are saved, invested and used to finance future pension benefits. Additionally, they often cover various risks such as death, disability and longevity.
The third pillar comprises a person’s overall savings for their old age. These savings are distinct from any personal savings that can be used in the short term. Third pillar schemes are generally contracts signed by individuals with service providers such as insurance companies (excluding group insurance contracts) or other organisations.