Pension systems in the eurozone are largely based on the pay-as-you-go principle, in which current employees pay retirees' current benefits. But as the number of current workers shrinks in relation to the number of retirees, the costs will become a severe burden on the economic systems of individual countries, said Peter Heller, deputy director of the International Monetary Fund's fiscal affairs department in Washington. He is also author of the book, "Who Will Pay? Coping with Aging Societies, Climate Change, and Other Long-Term Fiscal Challenges."
"Europe needs to address these structural issues," Mr. Heller said in an interview. "Certainly there is a danger that public pension systems may rely excessively on taxpayers to take care of the deficiencies in investment performance, which is a dangerous assumption."
The number of people aged 65 and older in the 12 eurozone countries — Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal and Spain — is expected to increase to about one in three by 2050, from about one in five currently, according to the ECB report.
In addition to broader objectives for raising employment rates and reducing government pensions-related debt, the proposed reforms center on "a transformation of (pay-as-you-go) systems into so-called notional defined contribution schemes."
Other European countries such as Sweden, Poland, Latvia and Slovakia have already implemented such reforms to its pay-as-you-go systems, and the ECB report encourages those in the eurozone to follow their lead. There are currently vast differences among countries in terms of pension fund assets. For example, the Netherlands' pension assets total more than 100% of its GDP, compared with 3% and 5%, respectively, for Germany and Italy, according to the report.
"There's a basic need for cross-border consistency and for raising the expertise, quality and knowledge (in asset management throughout Europe)," said Richard Hinz, pension policy adviser in the Social Protection Team of the World Bank's Human Development Network based in Washington.
The significant potential for growth in pension fund assets as a result of potential reforms and the aging population putting more money towards retirement also has its downside. The report points to a need for regulations ensuring "the non-speculative character of retirement savings" to avoid "calls for publicly financed bailouts — with an adverse effect on fiscal sustainability."
"Especially in systems where defined contribution pension funds are more common, a fair degree of monitoring and the efficient use of risk management techniques should be assured," and "at a global level more than a domestic level," to reflect the international nature of institutional investors and asset management.