Defined Contribution Pension System Research Articles

Institutional Design of Pension Systems Versus Labor Market Structure: What Matters Most?

Abstract Since the 1980s, policy makers have favored Defined Contribution (DC) pension systems as the alternative to address the unsustainability of Defined Benefit systems. While DC schemes offer benefits and economic advantages, they also present challenges and limitations. We evaluate the mandatory DC pension system for workers in the private formal sector in Mexico, introduced in 1997. We intend to determine for which workers the design of the system is effective and for which workers it is not. The Mexican labor market has high levels of informality and workers constantly flow in and out of the formal sector. Our findings support the view that workers’ personal characteristics place them in the structure of the labor market that in turn determines pension benefits. We analyze involvement with the formal sector and the pension system and identify 3 groups of pension participants that reflect the structure of the local labor market: occasional workers, frequent interruptions, and workers with high participation rates. We conclude that frictions in the labor market prevail over the good intentions of the pension design, like reducing informality and encouraging saving for retirement. Our results show that the system properly serves only 36% of affiliated workers. We explain why very few workers report behaviors consistent with high participation, and why most affiliates have insufficient participation to receive pension benefits. We shed light on the relationship between the structure of the labor market and the design of the pension system and their impact on workers’ future pension benefits.

Intergenerational risk sharing in a defined contribution pension system: analysis with Bayesian optimization

AbstractWe study a fully funded, collective defined contribution (DC) pension system with multiple overlapping generations. We investigate whether the welfare of participants can be improved by intergenerational risk sharing (IRS) implemented with a realistic investment strategy (e.g., no borrowing) and without an outside entity (e.g., shareholders) that helps finance the pension fund. To implement IRS, the pension system uses an automatic adjustment rule for the indexation of individual accounts, which adapts to the notional funding ratio of the pension system. The pension system has two parameters that determine the investment strategy and the strength of the adjustment rule, which are optimized by expected utility maximization using Bayesian optimization. The volatility of the retirement benefits and that of the funding ratio are analyzed, and it is shown that the trade-off between them can be controlled by the optimal adjustment parameter to attain IRS. Compared with the optimal individual DC benchmark using the life cycle strategy, the studied pension system with IRS is shown to improve the welfare of risk-averse participants, when the financial market is volatile.

Investigating pension choice factors among the faculty of public sector universities in Pakistan

PurposeThis research designed, optimized and tested a context-specific scale to evaluate public sector employees' pension choices.Design/methodology/approachThe authors developed the scale using a comprehensive process of interviews and focus groups with experts across academia and finance. The authors used the refined scale to collect data from 564 faculty members in public sector universities following a multistage systematic cluster sampling technique. The findings revealed diversity in choice across different socio-economic and demographic variables.FindingsThe results revealed that items related to the defined benefit pension system explain most of the data variance and are preferred widely. This is followed by a preference for monetizing pension benefits and a defined contribution system. These findings indicated the need for flexible pension plans.Practical implicationsTherefore, the progressive movement towards monetization and the shift from defined benefit to a defined contribution pension system due to economic pressures must be accurately calculated and introduced where it is suitable.Originality/valueAlthough the theory of introducing a defined contribution pension system and monetization system is appealing, its practical implementation may not be encouraging for all employees.

A Worker’s Backpack as an Alternative to PAYG Pension Systems

Abstract Facing an ageing population and historical trends of low employment rates, pay-as-you-go (PAYG) pension systems, currently in place in several European countries, imply very large economic and welfare costs in the coming decades. In an overlapping generations economy with incomplete insurance markets and frictional labour markets, an employment fund, which can be used while unemployed or retired, can enhance production efficiency and social welfare. With an appropriate design, the sustainable Backpack employment fund (BP) can greatly outperform (measured by average social welfare in the economy) existing PAYG systems and also Pareto dominate a full privatization of the pension system, as well as a standard fully funded defined contribution pension system. We show this in a calibrated model of the Spanish economy, by comparing the effect of its ageing transition under these different pension systems and by showing how a front-loaded transition from the PAYG to the BP system can be Pareto improving, while minimizing the cost of the reform.

Problems of Pension Provision Caused by COVID-19

The corona virus infection (COVID-19) had a destructive impact on the finance and economic system. There were interruptions in business processes, general slowing-down in economic activity, sharp rise in unemployment rate and initial drop in asset value due to finance market contraction. Monetary-credit and taxation-budget policy resulted in even higher interest rates, sharp growth in budget deficit and state debt. These factors affected both the state pension distribution and defined contribution pension systems. The goal of the research is to assess the impact of the corona virus infection (COVID-19) on financial wellbeing of the population and economic development of the country. Conditions were studied, when pensioners could invest their savings. The following methods of academic investigation were used: analysis, forecasting, synthesis, induction, deduction, observation and comparison. A conclusion was drawn about the adverse impact of the pandemic on the pension system and changes in the global inflation and unemployment rates during the period of pandemic worsening in 2020–2021. Forecasts of the mentioned indicators were calculated up to 2024. Feasible measures of people support during the pandemic were proposed. The problem of pension system vulnerability to cyber attacks and various frauds was highlighted.

The Logical Sustainability Theory for pension systems: the discrete-time model in a stochastic framework under variable mortality

Abstract The aim of this work is to provide the logical sustainability model for defined contribution pension systems (see [1], [2]) in the discrete framework under stochastic financial rate of the pension system fund and stochastic productivity of the active participants. In addition, the model is developed in the assumption of variable mortality tables. Under these assumptions, the evolution equations of the fundamental state variables, the pension liability and the fund, are provided. In this very general discrete framework, the necessary and sufficient condition of the pension system sustainability, and all the other basic results of the logical sustainability theory, are proved. In addition, in this work new results on the efficiency of the rule for the stabilization over time of the level of the unfunded pension liability with respect to wages, level that is defined as β indicator, are also proved.

Private benefits, fiscal costs and economic resource costs of the private defined contribution pension systems in Turkey

ABSTRACT This study addresses economic issues associated with the private defined benefit pension system in Turkey. Findings show that the new Turkish pension scheme has generated significant welfare improvements for individual investors, but at a loss in tax revenue and an economic resource cost to the country. If the bank-administered Tax-Free Contribution Accounts and/or Tax-Free Savings Accounts, similar to those operating in Canada, were adopted in Turkey and the requirement of holding government securities was lifted, such schemes would provide contributors with benefits similar to what they currently enjoy under the new Turkish scheme, while eliminating the economic resource costs of administration and improving their net fiscal impact.

The Effects of the Minimum Pension Reform in a Defined Contribution Pension System: The Case of Chile

The Effects of the Minimum Pension Reform in a Defined Contribution Pension System: The Case of Chile

Pension and Active Ageing: Lessons Learned from Civil Servants in Indonesia

Many developing countries are currently facing an ageing population without sufficient preparation for old-age financial adequacy, an important component in active ageing. One question is whether a pension system can create old-age financial adequacy. At the same time, many countries are shifting their pension systems from a defined benefit to a defined contribution pension system to improve the welfare of older people while maintaining state budget sustainability. Indonesia is not an exception. This paper learns from civil servants in Indonesia, where the retirement payout from the existing pay-as-you-go, defined benefit system is meagre. The system is to be transformed into a defined contribution one. Using a simulation method, this paper examines whether the proposed system will provide a better retirement payout, which is higher than the minimum wage and will allow retirees to maintain their pre-retirement income. This paper concludes that the proposed system alone is not sufficient to create old-age financial adequacy and, therefore, is less able to contribute to active ageing. To improve the retirement payout, among other things, the retirement age should be raised and made optional, and the accumulated savings should be re-invested during the retirement period.

Optimal portfolio selection for a defined-contribution plan under two administrative fees and return of premium clauses

We study a defined contribution pension system with the return of premium clauses, which is embedded with two administrative fees: the charge on balance and the charge on flow. The fund wealth is invested in financial market with a riskless asset and a risky asset modeled by a constant elasticity of variance process. We use the Weibull model to characterize the force of mortality. The dynamic programming principle is applied to derive optimal investment strategies explicitly when the pension member has constant absolute risk aversion and constant relative risk aversion. We illustrate how the certainty equivalent of the expected utility works for comparing the two fees. Finally, we give a numerical analysis to highlight our results.

The role of a longevity insurance for defined contribution pension systems

This study analyzes a longevity insurance for defined-contribution (DC) systems, using the case of Chile to evaluate its potential implementation.In the current context of increasing longevity and low interest-rates it has become important to find the most efficient formulas for both funding pensions and covering longevity risk, not only for countries with mandatory DC systems, but for pension systems in general.The proposed longevity insurance, in addition to covering the risk to survive longer than expected, it is also able to increase the level of pensions paid to insured workers by allowing the use of savings to fund retirement ages with high probability of being alive, and using income from deferred annuities at ages when the surviving probability is low for most of the pensioners.

A Simulation Study of the Effect of Delayed Retirement on Welfare of the Elderly: Evidence from China

In order to cope with population aging and emerging labor shortages, the Chinese government may soon introduce a policy to address this problem by raising the normal retirement age. However, the effects of planning for delayed retirement on the welfare of the elderly remain unknown. From an intergenerational support perspective, we develop a dynamic optimization model that can simulate changes in the welfare of the elderly over the years under different delayed retirement scenarios. Simulation results show that delaying retirement will produce a detrimental effect on old-age welfare. We further analyze strategies to mitigate this adverse effect and improve people’s welfare. First, the delayed retirement policy should raise the pension replacement rate, which could transfer part of the social welfare improvements from delayed retirement to the elderly through the transfer payment mechanism. Second, when adopting a defined-contribution pension system, the delayed retirement could increase the welfare of the elderly and the social well-being. Implications for future research and public policies concerning welfare effects of delayed retirement are discussed.

A benchmarking approach to track and compare administrative charges on flow and balance in individual account pension systems

This article studies the effects on individual welfare caused by administrative charges or fees on balance (assets) and flow (contributions) during the accumulation phase of a defined-contribution (DC) pension plan under the system of individual retirement accounts (IA). Assuming a complete financial market and suitable deterministic functions to model contributions and administrative charges, we are able to contrast the optimal expected utility of terminal wealth generated under both charge schemes. In this framework, we also derive closed-form expressions to determine equivalent administrative charges, that is, the precise level of charges on flow and balance that makes them indifferent to the risk-averse participant. These expressions are independent of the market price of risk, the risky asset’s volatility and the participant’s utility function. Furthermore, our methodology can be helpful for regulators and policy makers aiming to dynamically track the future evolution of administrative charges or to fairly compare costs across DC pension systems, especially those operating under charge on flow.

Intergenerational Risk Sharing in a Collective Defined-Contribution Pension System: A Simulation Study with Bayesian Optimization

Pension reform is a crucial societal problem in many countries, and traditional pension schemes, such as Pay-As-You-Go and Defined-Benefit schemes, are being replaced by more sustainable ones. One challenge for a public pension system is the management of a systematic risk that affects all individuals in one generation (e.g., that caused by a worse economic situation). Such a risk cannot be diversified within one generation, but may be reduced by sharing with other (younger and/or older) generations, i.e., by intergenerational risk sharing (IRS). In this work, we investigate IRS in a Collective Defined-Contribution (CDC) pension system. We consider a CDC pension model with overlapping multiple generations, in which a funding-ratio-linked declaration rate is used as a means of IRS. We perform an extensive simulation study to investigate the mechanism of IRS. One of our main findings is that the IRS works particularly effectively for protecting pension participants in the worst scenarios of a tough financial market. Apart from these economic contributions, we make a simulation-methodological contribution for pension studies by employing Bayesian optimization, a modern machine learning approach to black-box optimization, in systematically searching for optimal parameters in our pension model.

Dynamic discrete-time portfolio selection for defined contribution pension funds with inflation risk

<p style='text-indent:20px;'>This paper investigates a multi-period asset allocation problem for a defined contribution (DC) pension fund facing stochastic inflation under the Markowitz mean-variance criterion. The stochastic inflation rate is described by a discrete-time version of the Ornstein-Uhlenbeck process. To the best of our knowledge, the literature along the line of dynamic portfolio selection under inflation is dominated by continuous-time models. This paper is the first work to investigate the problem in a discrete-time setting. Using the techniques of state variable transformation, matrix theory, and dynamic programming, we derive the analytical expressions for the efficient investment strategy and the efficient frontier. Moreover, our model's exceptional cases are discussed, indicating that our theoretical results are consistent with the existing literature. Finally, the results established are tested through empirical studies based on Australia's data, where there is a typical DC pension system. The impacts of inflation, investment horizon, estimation error, and superannuation guarantee rate on the efficient frontier are illustrated.</p>

Automatic balance mechanisms for notional defined contribution pension systems guaranteeing social adequacy and financial sustainability: an application to the Italian pension system

Since the mid 1990s some European countries (including Italy) implemented a Notional Defined Contribution (NDC) pension system. Such a system is based on pay-as-you-go funding, while the pension amount is a function of the individual lifelong contribution. Despite many appealing features, the NDC system presents some drawbacks: first, it is vulnerable to demographic and economic shocks compromising the financial sustainability; second, it could fail to guarantee adequate pension benefits to pensioners. In order to reduce the first limit, automatic balance mechanisms (ABMs) have been proposed in literature and also implemented in Sweden, while solutions that combine financial sustainability and social adequacy have been applied only in a pay-as-you-go point system. The aim of this paper is to insert into the Italian NDC architecture ABMs that preserve social adequacy under financial sustainability constraints. Godinez-Olivares et al. (Insur Math Econ 69:117–126, 2016) built ABMs for a Defined Benefit pension system using nonlinear optimization techniques to calculate the optimal paths of the control variables representing the main drivers of the system: contribution rate, retirement age and indexation of pensions. Following this line of research, we have developed a nonlinear optimization model for the Italian NDC system based on three control variables: pensions indexation, notional rate and contribution rate. The objective function considers both social adequacy and contribution rate sustainability, under liquidity and sustainability constraints. In the numerical application we apply the model to the Italian pension system and test the sensitivity of the results to different economic scenarios and objective function parameters.

The Motherhood Pension Gap in a Defined Contribution Pension Scheme—the Case of Poland

A gender gap in pensions has recently been discussed in the context of non-discrimination and the sustainability of pension systems. Such systems in Europe are evolving towards strengthening the role of individual contributions from periods of paid work. Among other factors, the women’s pension gap is affected by interruptions in employment arising from care responsibilities. The purpose of this article is to measure the pension gap associated with having children in defined contribution pension systems. Using financial mathematics, the retirement capital of a childless woman (without breaks in work) was determined and compared with mothers of 1–4 children. The results indicate that the motherhood pension gap is approximately 4.5%–9.5%, 7.5%–15%, 9%–20%, and 12.5%–25% for mothers of 1, 2, 3, and 4 children, respectively. Measuring these individual gaps allows the cost of investing in children to be estimated. Significant for systemic and individual decisions is that the gap size is highest by the first and the second child, however the decision about the third child—relevant to the demography as ensuring the generational replacement—means the whole pension gap could rise to 20%. This could help support a policy of counteracting adverse demographic trends in fertility rates through the building of socially sustainable pensions schemes. In terms of future research, it forms the basis for building a gap measurement model that takes into account various drivers of the gender gap.

The need for pension reform in Russia

The relevance of the paper is caused by the fact that the current pension system did not satisfy either citizens, since their pensions were extremely miserable, neither employers due to the high level of contributions to the Pension Fund of the Russian Federation, nor the government, since the low level of pensions caused social and, as a consequence, political tension, nor the subjects of the Russian Federation, since the unfunded pension system obliged the regions to deduct funds from their own funds to cover pension obligations to subsidized regions. The way out of this situation is the creation of a new pension reform, which will increase the size of the pension by increasing the income of the pension system itself. The main goal of the pension reform is to increase the welfare of Russian citizens after they retire. The subject of the study is a new pension reform, the stimulus of which was to become a transition from an unfunded to a defined contribution pension system. The aim of the study is to identify the main economic reasons for creating a new pension reform. Methodology. To study the new pension reform, the main indicators are systematized: the minimum length of service for assigning an insurance pension, the amount of pension points for the period from 2015 to 2024 and subsequent years, and pension calculation formulas. Results. According to the new pension reform, the employee is encouraged to show full salary for employers to pay insurance contributions. The conditions are created to remove real wages from the “shadow”. The unfunded pension system caused social instability, caused a conflict of generations, workers and employers, destabilized the authorities. The new pension reform is designed to provide conditions for mutual assistance of generations and social partnership. The unfunded pension system led to the fact that pension payments were a heavy burden on the economy. The new pension system, at the expense of the funded part of the insurance contribution, creates an investment resource of “long money” (with a demand period of 25-30 years). Thus, the pension system not only serves elderly citizens, but also really works to develop the domestic economy.

The Sustainability of Malaysia’s Defined Contribution Pension System: Implementation of Deterministic Linear Programming

This article investigates, under deterministic linear programming model, asset allocation decision and optimal investment strategy for Malaysia’s defined contribution pension (DC) scheme -Employees Provident Fund (EPF). The model requires generation of scenarios and probabilities to represent future assets and liabilities streams. We employed Vector Autoregressive (VAR) model to generate future returns of five asset classes i.e. equity, money market instrument, Malaysia government bond with 1 and 10 years of maturity date and property. Future liabilities factors were derived from two submodels; population and salary. In population model, the future status of the EPF members was determined using a Markov Chain model. Then, the random factors of assets and liabilities were used in the asset liability model (ALM) based on linear programming (LP) and fixed mix (FM) strategy. The results of the research are grouped in two levels. First, we briefly discuss the finding of the random factor model and then we analyse the optimal investment strategy for the EPF. In terms of finding an optimal investment strategy, the FM strategy generated higher expected terminal wealth than the LP strategy. This finding suggests that FM strategy is superior to the LP strategy. In addition, we find that the higher dividend distributed to the members may result in decreasing of the expected terminal wealth of the fund for both strategies. This portrays that dividend distribution policy may affect the financial soundness of the EPF in the long run

Extending the Retirement Age for Preserving the Costitutive Pension System Mission

This paper examines some issues relating to the establishment of defined contribution pension system. First, it shows that the defined benefit pension system could successfully counteract the financial un-sustainability of the pension system, such as defined contribution pension system. Second, it notes that defined contribution pension system re¬quires the pension amount to be endogenous and, as a consequence, the abandonment of the constitutive aim of the pension system e.g., consumption smoothing. Third, it argues that the extending of the retirement age may counteract the aging of the population and achieve financial sustainability, along with the individual well-being.