How to make the Hungarian pension system self-sustaining and equitable, without extra costs

Hungary has to report to the European Commission by the middle of next year on how it plans to reform its pension system to ensure long-term and medium-term sustainability, and put it into effect by the end of the first quarter of 2025. József Banyár, economist of the Corvinus University of Budapest has come up with a solution. He presented an improved version of the German pension system, based on the individual points system, in the September issue of the journal Közgazdasági Szemle.   

The Hungarian pension system today is essentially a single pillar system, which is a classic, pay-as-you-go, state-organised pension system, where the main rule is that the old-age pension is at least 43 percent of net average earnings, indexed to the increase in average net earnings, depending on length of service, with a minimum period of 15 years, calculated from 1988 and onwards, and which increases the pension from this level unevenly, by 1-2 percent per year. High career average earnings are fully phased in from 2012 only, although they are take into account degressively above a certain level. Raising children only counts towards length of service. 

“I am proposing a pension system that makes it easy for active people to understand, accept and  take it for granted that today’s performance determines tomorrow’s pension. In the current Hungarian pension system, the indexation of new pensions (“valorisation”) is essentially based on the net wage index, while existing pensions are based on the price index. However, the wage index is generally higher than the consumer price index, which is why the benefits of older retirees are increasingly lagging behind those of recent retirees,” said József Banyár, researcher of Corvinus. As an example, he added: someone who retired in Hungary twenty years ago, having earned an average wage for 45 years, has less than half the pension of someone who retired this year in Hungary, having earned an average wage for 45 years. In the German system, the amount would be the same. 

For now, 11 European countries use the German points-based pension system in whole or in part. This makes it easy for everyone to see how much pension they can expect at any given time, and also takes childcare into account. 

Eight elements of the German pension system should be introduced 

According to the economist, two elements of the German system are definitely worth adopting. On the one hand, the introduction of individual accounts instead of the current solution, because it is more predictable and fairness aspects can be better enforced. The pension rate is proportional to the pension points accumulated. By default, one point is awarded for contributions paid on average annual salary, up to twice the average salary per year may be taken into account. Pension points can be “bought on the market”, but can also be awarded without having paid contributions, e.g. for unemployment, caring, higher education studies, childcare. The value of the pension points is adjusted annually by the gross wage index (adjusted by the sustainability factor) to ensure that old and new pensions are indexed in the same way. The study also proposes a method for calculating the transition period. When adapted in Hungary, the value of a point could be adjusted so that the total volume of pensions calculated from it is the same upon retirement, but would guarantee that the pension retains its value decades later compared to that of pensioners retiring in the future with similar relative performance. 

Another aspect of the German system that is worth adopting is that the Germans also adjust pension points by a sustainability factor – reflecting the change in the ratio of pensioners to contributors – and by a possible change in the (basically stable) contribution rate. With this automatic and self-sustaining smoothing mechanism, the equality of revenue and expenditure can be continuously achieved – with the contribution rate unchanged (but also in case of a possible change in the contribution rate).  

József Banyár argues that six more elements should not necessarily, but advisably be included.. These include a cap on contributions, and separate points for bringing up children – either by fully adopting the German system, where 1 pension point is awarded in the first 3 years of each child’s life (which parents can split between themselves), and then 1/3 point a year until the 10th year, up to a maximum of 3 children. It is also worth noting that the age limit is the same for both men and women and that earlier retirement is possible with a lower amount (i.e. the age limit is flexible). Suppose a mother with three children has 40 years between her first and last year of work and has missed 16 years of work to raise children: she would, for example, receive (almost) the average pension of 40 years (37), whereas the current Hungarian system would calculate the pension based on 24 years. Other features of the German system that could be introduced are the absence of arbitrary changes (e.g. stable contribution rates, no one-off special benefits, so that the politics of the day has no influence on the system) and the existence of a recapitalised, state-organised pension sub-system, which can be joined voluntarily and where retirement savings are held, accumulated and invested individually. 

Three key areas where the German pension system could be improved 

Although it is not part of the current German scheme, the Corvinus associate professor would expand it with three elements when implemented in Hungary: age limit indexation linked to life expectancy, mandatory pension sharing, and enrichment of the recapitalised state subsystem.  

• As a first element of the expansion, taking into account the increase in life expectancy, the author would continue the age increase completed in 2022, after the – presumably temporary – reversal of the decline due to covid. This could be restarted in a few years’ time, by adding about 1-2 extra months a year to the age limit. In relation to the age limit, the Women40 rule, which currently allows women to opt for a pension after 40 years of work, would be extended to the other sex and would require 43 years of work (Men-Women43: which would subsequently increase at the same rate as the general retirement age), given that the age limit for women was 62 when it was introduced, but is now 3 years more. This could be taken advantage of by those without tertiary education who are expected to live shorter lives after 65, and who could thus spend more time in retirement, catching up with the length of retirement of graduates who retire later but live longer. 

• It would introduce a family pension as an improvement on the German system. The proposal has two parts: pension rights acquired during marriage would be automatically – and not optionally, as in Germany – divided (“pension sharing”), and the pension of married couples would be set as a double pension instead of the current widow’s/widower’s pension, with the surviving spouse’s pension being around 65-70% of the joint pension (but fixed). This way, the size of the widows’/widowers’ pension would not depend on which spouse dies first. 

• As a third new element, József Banyár would link Pillar I (state) and Pillar III (investor) more closely in the recapitalised subsystem: The record-keeping of members’ data would be carried out by Pillar I, while Pillar III market service providers would invest the money in the accounts, but from “blind accounts”, i.e. they would not know whose money they are managing. This would significantly reduce the costs of the current Pillar III. And it would make retirement savings (using the nudging technique proposed by Nobel laureate Thaler, which is becoming increasingly widespread in the field of pensions) the default, and would regulate pensions coming from the two systems as a succession of benefits rather than as parallel benefits, replacing the current expensive and complicated mechanism of private annuity. 

“In addition to the one-off increase that would occur if men43 were introduced, the reform would not require any more resources for pensions than at present, as the introduction of an automatic smoothing mechanism could be interpreted as a freeze on the total pension payable as a share of GDP. In addition, part of my proposals is to separate the pension fund from other items and make it self-sustaining“, stressed József Banyár. He added: “After 2013, the share of pensions in GDP has been declining, so the state has been saving money in the pension fund. There is now room for a higher pension indexation than at present, which would also avoid old pensions drifting away from recent ones, which is currently the case ”