Linking Pensions to Life Expectancy: Tackling Conceptual Uncertainty through Bayesian Model Averaging

Jorge M Bravo,Mercedes Ayuso

doi:10.3390/math9243307

Abstract

Linking pensions to longevity developments at retirement age has been one of the most common policy responses of pension schemes to aging populations. The introduction of automatic stabilizers is primarily motivated by cost containment objectives, but there are other dimensions of welfare restructuring in the politics of pension reforms, including recalibration, rationalization, and blame avoidance for unpopular policies that involve retrenchments. This paper examines the policy designs and implications of linking entry pensions to life expectancy developments through sustainability factors or life expectancy coefficients in Finland, Portugal, and Spain. To address conceptual and specification uncertainty in policymaking, we propose and apply a Bayesian model averaging approach to stochastic mortality modeling and life expectancy computation. The results show that: (i) sustainability factors will generate substantial pension entitlement reductions in the three countries analyzed; (ii) the magnitude of the pension losses depends on the factor design; (iii) to offset pension cuts and safeguard pension adequacy, individuals will have to prolong their working lives significantly; (iv) factor designs considering cohort longevity markers would have generated higher pension cuts in countries with increasing life expectancy gap.

Highlights

This paper examines the policy design and provides comparable cross-country forecasts of the sustainability factors introduced in the national public pension schemes of selected countries—Finland, Portugal, and Spain—to automatically index old age entry pensions to life expectancy developments at retirement ages
This paper examines the policy design and implications of linking entry pensions to life expectancy developments through sustainability factors or life expectancy coefficients in Finland, Portugal, and Spain
The empirical results obtained in the study have important policy implications on the design of sustainability factors linking entry pensions to life expectancy developments

Summary

Introduction

High-income countries have been responding to continuous longevity increases, below replacement-fertility levels, upward trends in old age dependency ratios, low productivity gains and economic growth, rapidly shifting labor markets, declining financial market returns with systemic risks, e.g., a switch towards non-financial defined contribution (NDC) schemes in Sweden, Italy, Poland, Latvia, and Norway; pension financialization, i.e., the expansion of private complementary occupational and personal pre-funded definedcontribution (DC) pensions, and/or gradual parametric public pension reforms (e.g., updates in early and normal retirement ages, modifications in the defined benefit (DB)pension formula), as part of their efforts to reduce or eliminate short-term and long-term imbalances between revenues and expenditures, alleviating the pressure on public finances, together with efforts to preserve minimum pension adequacy [1,2].Recently, in EU countries subject to economic and financial bailout programs (Greece, Portugal, Ireland, Cyprus), pension reforms represented one of the most visible faces of the influence of supranational organizations (“Troika”) on the retrenchments and welfare state reforms. For national public pension schemes, one common denominator in most reforms involves automatic adjustment or stabilization mechanisms, designed to correct the financial imbalance of the pension system, mechanically updating the scheme’s parameters to demographic and/or economic developments. These mechanisms decide in advance how the system will adjust to restore financial solvency if an increase in the old age dependency ratio (e.g., Germany), a decline in the workforce (e.g., Japan), an increase in life expectancy at retirement age (e.g., Denmark, the Netherlands, Portugal, Finland, Cyprus, UK), a decline in wages (e.g., Germany) is observed, or if the system is projected to go into a long-term deficit (e.g., Sweden, Canada, U.S, Spain). Variations of other automatic stabilizers have been elements of many pension systems for decades

Methods

Results

Discussion

Conclusion