- 84 -
funding, the lesser the possible degree of adjustment, unless the financial system itself is changed or funds can be drawn from other sources to enable complete adjustment of the benefits.
The financial system chosen for a new social security scheme in a developing country should naturally take into account the ability of the insured persons and employers to contribute, given the state of the economy. On the other hand, the financial system should be such as to avoid frequent revisions of the contribution rate, which would be unsatisfactory from a practical point of view.
Principal financial systems applied in social security
say, two extremes, may be
Two basic financial systems constituting, so to distinguished, system".
viz. the "assessment system" and the "general average premium
Under the assessment system the contribution rate! is so determined that the income during a given period is equal to the expenditure for the same period, with perhaps a margin which would accumulate as a small contingency reserve to cater for fluctuations and unforeseen contingencies. When the period over which the income and expenditure are balanced is equal to one year, the system is referred to as the "annual assessment system". This system is
usually used to finance short-term benefits, but if applied to finance long-term benefits, it would entail frequent upward revisions of the contribution rate. This is a consequence of the general trend in the annual expenditure on pensions to which reference was made earlier. Further, this system would not lead to the accumulation of any sizeable reserves, which, as mentioned earlier, may be desirable under certain circumstances.
Under the
general average premium system, the contribution rate is fixed at such a level that the "probable present value" of future incomes is equal to the probable present value of future expenditures, where both the initially-covered population and future entrants into the scheme are taken into account.
The term "present value" indicates the value obtained by discounting the income Or expenditure flows at future dates to a current date using the rate of discount which corresponds to the rate of interest used in the actuarial calculations. The resulting contribution rate is that which, in theory, may be maintained invariant ad infinitum and would always ensure the solvency of the scheme, although in practice this may not be strictly realised due to changes in the experience from the assumptions on which the calculations are based.
The application of the general average premium system to a pension scheme would lead to the accumulation of a substantial reserve, which would increase continuously for a very long period of time until, ultimately, the size of the fund attains a stable, or relatively stable, level. However, for reasons mentioned earlier, it may not always be desirable to accumulate such huge reserves as would result from the application of this system of financing.
in
In theory, an infinity of intermediate systems of financing exists, but particular mention should be made of the scaled premium system. Under this system the contribution rate is initially fixed
such a manner that the financial equilibrium of the scheme is maintained for a limited period of say, 10, 15 or 20 years, referred to as the initial period of equilibrium. The contribution rate is revised as soon as a stage is reached where the contribution income together with the income from the investment of the reserves is insufficient to cover the expenditure of the scheme; the revised rate operates during a second period of equilibrium until it has to be revised in its turn, and this procedure is repeated periodically.
The scaled premium system combines, to some extent, the advantages of the assessment system and the general average premium system, while, at the same time, minimi sing the disadvantages of either. As compared to the general average premium system, it would start off with a considerably smaller contribution rate, and would lead to the accumulation of relatively smaller reserves. The principle that only the income from the investment of the reserves and not the reserves themselves are used to cover current expenditure enables these reserves to be placed in long-term
In the rest of this paper the term "contribution rate" is used to denote the global rate of contribution required from all the contributing parties.
E-1195-2E: 5