Abstract
This study offers in-depth knowledge of the socio-economic characteristics of funded pension projects. It is based on the financial position of pension market actors during the transition of the pension system to a more funded capitalized scheme, mainly through the option benefit model. This is possible due to the fact that the economy is not viewed as a single earning cohort. The study analytically demonstrates a socio-economic anomaly in the funded pension system, which is in favor of high-earning cohorts at the expense of low-earning cohorts. This anomaly is realized due to lack of insurance and exposure to financial and systemic risks. Furthermore, the anomaly might lead to the pension re-reform back to an unfunded scheme, mainly due to political pressure. A minimum pension guarantee was found to be a rebalance mechanism to this anomaly, which increases the probability of a sustainable pension scheme. Specifically, it is argued that implementing a guarantee with an intra-generational, risk-sharing mechanism is the most effective way to reduce the impact of this abnormality. Moreover, the paper shows the convergence process toward implementing a minimum pension guarantee in many countries that have capitalized their pension systems during the last three decades, in particular in Latin America and Central and Eastern Europe.
Highlights
The latest financial crisis, including the current COVID-19 pandemic, has highlighted the uncertainty of retirement income derived from funded pension plans
The study analytically demonstrates a socioeconomic anomaly in the funded pension system, which is in favor of high-earning cohorts at the expense of low-earning cohorts
After understanding the gap between financial positions, this paper offers an equilibrium array by providing a minimum pension guarantee financed by intra-generational risk sharing
Summary
The latest financial crisis, including the current COVID-19 pandemic, has highlighted the uncertainty of retirement income derived from funded pension plans. Defined contribution (DC) plans are already the main source of financial retirement in Latin American and CEE countries, while it is expanding rapidly in other countries of Western Europe, where they are still voluntary (Grech, 2015). Using simple financial positions embedded in exchange options, this theory implies a tradeoff between insurance and return in pension designs This perspective enables the classic economic funding condition of Aaron (1966) to be enriched through the dimension of risk. The challenge of financing the risk-sharing mechanism has become one of the priorities on the agenda of policymakers during the global economic crisis
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