The Expectation for Risk-Sharing Cycle: Theoretical Model and Global Implementation

Ishay Wolf

doi:10.17762/turcomat.v12i3.2250

Abstract

In this paper, we offer an explanation to pension systems cyclical reforms, based on Central East Europe (CEE) countries experience over the last three decades. We claim that in the transition to funded pension design, the government not only transfers longevity and fiscal risks to the individualbut also absorbs risks transferred from the public, where each market actor transfers undiversifiable risks to the other. This hidden risk path that has not been discussed yet in the literature, stemmed from the public expectation to risk premium or adequate old age benefits that evolves to political pressure. The outcomes of this risk path realized in financial transfers, such as social security, means-tested and minimum pension guarantee. Consequently, funded pension designs naturally converge to a new landscape paradigm of risk sharing, including intergenerational and intra-generational play. Financial crises such as the recent COVID-19 pandemic foster the convergence process.

Highlights

Since the 1990s, countries around the globe have introducedpension structural reforms, moving from the public pay-as you-go (PAYG) defined benefit(DB) model toindividual accounts in a multipillar architecture (Ebbinghaus2015)
We further argue that economic shocks, such as the financial crisis in 2008 and lately the COVID-19 pandemic crisis may foster this process, as the risks were realized faster
After developing the theory of risk sharing expectations between the government and the individual, in the second part of this paper, we demonstrate this theory on the experience of Central East Europe (CEE) countries pension reversals

Summary

Introduction

Since the 1990s, countries around the globe have introducedpension structural reforms, moving from the public pay-as you-go (PAYG) defined benefit(DB) model toindividual accounts in a multipillar architecture (Ebbinghaus2015). Governments, in aging Europe, could not obligeanymore to adequate pension level in PAYG DB schemes without raising taxes (Holzmann and Hinz2008). This entailed diverting funds from the public pension system into individually funded accounts. In many countries, these reforms were short-lived. At the onset of the global economic crisis, most countries that had adopted pension privatization reforms either halted them, drastically reduced the private element, or completely abandoned them (Arza 2012; Naczyk and Domonkos 2016; Orenstein 2013; Sokhey 2017). Over the last decades, the trust in the sustainability of the new pension pillar system has been shattered (Ebbinghaus 2015)

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