Abstract
Motivated by declining support for mandatory participation in pension arrangements, we explore whether the intergenerational risk-sharing benefits that these arrangements offer suffice to ensure their survival when participation becomes voluntary. Funded systems with asset buffers are particularly interesting since these buffers make contributions more sensitive to financial returns. Equilibria are characterised by thresholds on the young’s willingness to contribute. Standard values for our parameters yield two such equilibria; only the one with the higher threshold is consistent with the initial young being prepared to start the system. An advancement relative to the related literature is that the equilibria feature a non-zero probability of collapse. Finally, we explore the social welfare maximising values for the pension parameters for various levels of uncertainty and risk aversion.
Highlights
Participation in most pension arrangements is mandatory, but this obligation to participate is increasingly being questioned
Our results suggest that the collapse of well-designed pension arrangements with intergenerational risk sharing produces a substantial welfare loss
If the generation decides to participate, the current young receive a pension benefit θ (φ′) when they are old. This benefit depends on the particular type of pension arrangement and it may depend on the future state of the economy
Summary
Participation in most pension arrangements is mandatory, but this obligation to participate is increasingly being questioned. Bovenberg et al (2007) explore the problem of negative buffers that may deter new cohorts from entering the pension arrangement, while Westerhout (2011) quantifies the feasible amount of risk-sharing when the old are bound by their pension contract, but the young are free to choose whether they will participate The latter refuse to join the pension fund when it is under financial distress. Beetsma et al (2012) explore the specific case of a funded pension system without a buffer and with financial market uncertainty as the only source of risk Their system collapses either immediately or never.
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