Saving for the future: Evaluating the sustainability and design of Pension Reserve Funds

Abstract

In several countries public finances are under pressure by pension obligations rising due to downward trends in fertility, increased longevity and financial markets with low interest rates. For these reasons, the establishment of Pension Reserve Funds (PRF) has flourished. Regardless of the specific objectives that these PRFs may have, a critical issue is to assess their sustainability over the long-run. Moreover, this sustainability analysis is particularly complex, due to the interaction between the macroeconomic environment, financial performance and the labor market.In this article, we use a projection model aimed to evaluate the sustainability of the PRF in a small open economy such as Chile. The case of Chile is interesting because it shares common features with economies open to international markets that have either defined benefits pension schemes and/or defined contribution schemes with minimum pension guarantees. Moreover, since the Chilean PRF features relatively well defined contribution and withdrawal rules, we have a framework against which our methodology can be used to explore the effects on PRF's sustainability of altering these rules.Our methodology takes into consideration the stochastic nature of macroeconomic, financial and labor market variables in order to evaluate the sustainability of the PRF. In contrast to deterministic measures such as funding ratios, our methodology is more appropriate to assess the role of the contribution and withdrawal rules for PRFs in evaluating the key underlying risks and their consequences for the sustainability of PRFs.