Taking stock of implicit pension liabilities

The vast majority of public pension schemes in the euro area have a pay-as-you-go set-up and are therefore unfunded by design, with current contributions being used to pay current benefits. Implicit pension liabilities (IPL) measure governments’ long-term commitments. While IPL and conventional, explicit government debt differ significantly, in some situations the implicit liabilities can convert into explicit debt. This is the case when structural shortfalls arise within the pension system, which require financing. Accrued-to-date gross IPL estimates will yield large, positive values for all countries with pay-as-you-go systems – even those with perfectly balanced schemes. Accrued-to-date IPL are therefore not a measure of fiscal sustainability. In contrast, net IPL estimates that include both future rights and contributions to the scheme are better suited for sustainability analysis. We calculate both gross and net IPL estimates under such open system approach based on the long-term projections of the Ageing Report. The net variant provides insights into the extent to which pension systems can be considered underfunded given current policies. The analysis of IPL can help identify the future costof current pension policies as well as the impact of pension reforms. They can also complement conventional debt and deficit measures, provided such analysis is part of a comprehensive fiscal sustainability assessment.