Should a Survivorship Dividend Be Included in Notional Defined Contribution Accounts (NDCs)?

Abstract

The aim of this paper is to analyse the role of the survivor dividend in notional defined contribution (NDC) pension schemes. With this aim in mind, we first extend the model developed by Boado-Penas & Vidal-Melia (2014) by allowing for changes in the growth of the active population. We then compute the effect of the survivor dividend on the relationship between the individual’s internal rate of return for contributors who reach retirement age and the system’s internal rate of return. Finally we develop the main entries to include on the system's actuarial balance sheet. The model endorses the idea that the survivor dividend has a strong basis for enabling the NDC scheme to achieve financial equilibrium and that not including the dividend is a non-transparent way of compensating for increases in longevity and/or legacy costs from old pension systems. We also find that the average effect of the dividend remains unchanged for any constant annual rate of population growth, that contributors who reach retirement age always get a higher return than the system does, and that population growth enables cohorts with more years of contributions to benefit to a greater extent from the dividend effect.