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Evolution of pension systems

El principal reto al que se enfrentan las pensiones públicas en este punto de su historia es el de lograr un punto de equilibrio y sostenibilidad.

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The origin of pensions can be traced back to ancient Rome with the retirement benefit that Octavian Augustus guaranteed for discharged military personnel.

The Aerarium Militare offered a compensation package of twelve years pay or a plot of land, once someone had served in the army for between 16 and 25 years, all paid for out of the public coffers.

The Roman Empire was also responsible for the first private systems to complement state care in old age. These were the Roman Collegia, private associations that were initially created to ensure burials and which gradually added other services, such as providing food.

The fall of the Roman Empire changed the landscape and during the Middle Ages progress in terms of state-sponsored pensions came to a halt. Pension systems did not evolve much further for centuries. In fact, rather than remaining, they were wiped out, at least those financed by the State.

Pensions over time: from private to public

The story of pensions over the next few centuries had more to do with private rather than public initiatives, and was closely linked to the world of insurance. So much so that many public pension systems originated with specific insurance for certain situations, such as widowhood, as we shall see later on.

It was in the 17th century that private pensions began to become popular, promoted by religious orders, guilds and workers’ associations, in order to provide their members with an income or better living conditions.

This led to initiatives such as that of Duke Ernest the Pious in Gotha, Germany, who in 1645 established a fund for the widows of the clergy and another for teachers in 1662, the former idea spreading to other European countries at the beginning of the eighteenth century.

In the United States, the first pension per se was created in 1636 in the Plymouth Colony, and was intended for soldiers. Other colonies such as Virginia, New York, Rhode Island and Maryland followed some years later.

In 1644, the Virginia Law Title IX established a pension for men wounded during expeditions against the Indian tribes, and in 1675 it was extended to the widows and orphans of soldiers.

At the same time, other private initiatives to improve retirement were emerging, such as the so-called tontines, devised by the Neapolitan banker Lorenzo Tonti. Tonti’s system consisted of a private agreement among several people to contribute to a fund and to distribute it at a given future time among those who survived. It was similar to life and retirement insurance, created at the behest of Cardinal Mazarino to finance economic recovery after a long war.

In 1791, Lafarge set up the Lafargue tontine during the French Revolution, and this model became quite popular in Europe and the United States. It did, however, degenerate into murders among the members of the tontines so they could collect more money when the time came. In Spain, tontines were eventually banned in 1926.

The industrial revolution and company pensions

Between the 17th and 19th centuries, the industrial revolution and the emergence of capitalism changed the working landscape. Many people moved from the countryside to the city and working conditions deteriorated, with long hours and low wages.

The result was that when it came time to retire or when they could no longer work, many people had no financial resources to support themselves. This ushered in a new milestone in the history of pensions: the proliferation of private pension systems set up by companies.

The promoters of the systems in this case were either the companies themselves or charitable organizations, and they were financed by inputs from both the companies and the workers. At a certain age or after a certain number of years of service, the employee could retire and receive a pension.

This is the germ of today’s occupational pension plans, of which the American Express plan is considered to be the first, in 1875.

Otto von Bismarck and the first national pension system

The first public response to the growing labour movement and the rise of socialism occurred in Germany at the hands of Chancellor Otto von Bismarck. He first instituted health insurance for workers in 1883, to which he added accident insurance in 1884. Finally, in 1889, he introduced the first modern pension system, which still operates today in many countries.

The retirement age was initially set at 70 years, although it was later reduced to 65. This figure has remained a fixed feature of many pension systems when, in fact, it was the result of the conditions of the time and life expectancy at the beginning of the 20th century.

Bismarckian pensions operated on a contributory pay-as-you-go basis, whereby the contributions of existing workers financed ongoing pensions. This is why it is referred to as intergenerational solidarity, since one generation effectively pays for the pensions of the previous, already retired, cohort.

Other European countries gradually adopted their own systems, to a greater or lesser extent based on this model, as part of the evolution of pensions in Europe.

For example, the United Kingdom opted for a variant of this model based on the Beveridge Report, which was published in 1942. This report advocated introducing a minimum system to fight poverty with a fixed and equal welfare pension for the majority of workers.

In other words, it was welfare-based and had a strong redistributive component. In short, Bismarck’s system had more incentives for the middle class, while the Beveridge system sought to level the playing field between classes.

In the United States, Social Security as such was introduced in 1935, and since then various benefit systems have been established, although the level of this cover is still far below the European systems and depends almost exclusively on the worker.

Evolution of pensions: changes and new systems

In contrast to the pay-as-you-go models, new options emerged, such as the individually funded systems, which are a different and more widespread pension model in Latin America.

Under this system, there is a direct relationship between the worker’s contributions and their pension. The intergenerational solidarity component disappears and each worker collects what they have accumulated in terms of contributions and investments.

The model implemented in Chile, in 1981, during the dictatorship of Augusto Pinochet, serves as the model for a large number of the systems in Latin America. Many countries have opted to complement the strictly individually funded systems, where the State does not intervene, with mixed systems where it does guarantee a minimum pension.

Future challenges

The main challenge facing public pensions at this point in their history is to achieve a point of equilibrium and sustainability, especially in pay-as-you-go systems.

The aging of the population and longer life expectancy are putting the conventional Bismarckian model in jeopardy, while individually funded schemes create significant social differences and are difficult to implement in countries that already use a pay-as-you-go system.

In this sense, a growing trend is to include or encourage private investment as a complement to state pensions while looking for ways to make the system more resilient and sustainable.