Abstract
Abstract During the 1990s, some important European countries, particularly Italy and Sweden, have radically transformed their public pension system by adopting defined-contribution rules while retaining a pay-as-you-go financial architecture. This paper inquires into the theoretical properties of these “Notional Defined Contribution” pension schemes in order to identify the determinants of the replacement rates awarded to individuals with different income patterns. Three typical career patterns are taken into consideration, according to whether the individual wage growth is equal to, higher than, or lower than average wage growth. The impact of, and the possible remedies to, a possible discontinuity on the replacement rates is finally discussed by means of a sensitivity analysis of the replacement rates with respect to the career length (for a given retirement age), the retirement age, and the conventional rate of return credited on all individual accounts.
Highlights
Evaluating whether the pensions provided by a public pension system to its members are ‘adequate’ according to some standard is no easy task
The contribution rate whose payment has generated the ‘property right’ on the stream of pensions and the benefit-cost ratio of participation in a pension system; in this perspective, the individual rate of return that, implicitly or explicitly, the individual expects to earn on contributions provides a measure of the ‘adequacy’ of a stream of pension benefits
In order to discuss the adequacy of the pensions that the Notional Defined Contribution (NDC) scheme awards according to the possible different levels of the rate of returns yearly credited on the individual account balances, we will for the sake of argumentation return to the choice already made in section 2 to express both the individual wage growth and the conventional rate of return in terms of a ‘deviation’ with respect to the growth rate of the average wage of the economy, so that (5) becomes: (13)
Summary
Evaluating whether the pensions provided by a public pension system to its members are ‘adequate’ according to some standard is no easy task. The aim of this paper is to investigate how (i.e. to what extent and for what type of career profiles) the NDC quest for both actuarial fairness and automatic financial stability clashes with the traditional defined-benefit strategy to ensure some degree of ‘continuity in the standard of living’ for all members of the pension plan, regardless of their career profile; and since the additional key feature of fair and sustainable NDC schemes is to allow for some degree of flexibility as to the choice of retirement age and contribution rate, we will point out some important tradeoffs that a financially stable NDC scheme produces in the face of the inescapable binding constraint whereby more generous replacement rates ‘require’, ceteris paribus, either higher contribution rates or longer working careers or, lower adjustment rates In this perspective the section provides an analytical framework that allows for assessment of the complex interaction between NDC pensions and different career patterns. According to (3), the relative weight, τ i/i−x of the contributions paid in year i with respect to those paid in year i-x can be expressed as:
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