Conceptualizing, measuring and financing the legacy costs in an NDC reform

Abstract

AbstractThe paper provides a framework for the conceptualization, definition and measurement of the legacy costs that needs to be addressed in a reform that transforms an unfunded (or non-financial) defined benefit (NDB) scheme into an equally unfunded notional (or non-financial) defined contribution (NDC) scheme. During a transition from NDB to NDC a financing gap typically arises due to accrued to date liabilities from the old system in excess of the NDC scheme's sustainable flow of benefits. This gap – or legacy cost – needs to be estimated and best explicitly financed. We illustrate different techniques to gauge the scope of the cost. The paper applies the proposed approach to a hypothetical NDC reform in China.