Notional Defined Contribution Research Articles

Demography, Economy and Policy Choices: The Three Corners of the Pension Conundrum

Abstract NDC (notional defined contribution) pension systems are usually considered the best in the PAYGO (pay-as-you-go) category: they mimic funding, seem to be well balanced, and have very limited distortionary effects on the labour market. In this paper, after highlighting of few of their weaknesses, I suggest an alternative solution to the pension problem: IPAYGO, or improved PAYGO. Its guiding principle, “everything is relative”, is applied consistently to both the economic and the demographic part of the problem: this makes the system viable in all possible demographic and economic scenarios. Depending on a few explicit policy (parametric) choices, IPAYGO may take very different shapes, and adapt to national preferences, such as early or late retirement, generous or limited pension benefits, and greater or lesser emphasis on actuarial equity. A properly designed IPAYGO, even in its basic form (the only one discussed here), can tackle issues such as inequities deriving from differential mortality (with the richer living longer), pension-induced low fertility, and quasi-capital gains and losses. While IPAYGO is conceived to be an operative instrument, it can also be used to evaluate existing pensions systems, and the phase a population is going through, with a novel measure of the so-called “demographic bonus” (or “malus”).

Financial sustainability and automatic balance mechanisms for NDC pension systems with disability benefits

AbstractThe need for Long term care (LTC) service continues to rise due to the increasing number of elderly in the world, which stresses the healthcare systems. As most of the LTC recipients are over age 65, several authors studied retirement products combining a lifetime annuity with a long-term care benefit (typical examples are Enhanced Pension and Life Care Annuity). The development of an integrated strategy may help to address the issue of the cost of care for pensioners affected by disability. In this paper, we contribute to the debate on the introduction of LTC benefits into a notional defined contribution (NDC) pension system by using a multivariate stochastic model to represent the future evolution of transition probabilities and economic variables, which allows investigation of the financial sustainability of the system in a stochastic environment. The presence of LTC adds new risk elements, such as the uncertainty related to disability rates and mortality rates of the disabled, which may jeopardize the financial equilibrium of the integrated system. To restore the system’s equilibrium, we apply two types of automatic balance mechanisms (ABM), one based on the solvency ratio, and the other on the liquidity ratio. Both act on the indexation of pensions and the notional rate.

The value of pension reforms for late working life: evidence from Sweden

PurposeDriven by the aim to increase the participation of older people in the labour force and to extend people's working lives, the Swedish Parliament passed a bill in 1998 to increase the pension eligibility age from 60 to 61 years and establish a notional defined-contribution (NDC) plan. In this article, the authors investigate the impacts towards the prolongation of working lives expected from such an intervention.Design/methodology/approachThe authors apply a multinomial probabilistic model based on Swedish registry data on the birth cohorts 1937–1938 (n = 102,826) and observe differences in exit behaviour between eligible and non-eligible individuals.FindingsThe authors find that the cohorts eligible to the pension reform exit the labour market at a later age compared to non-eligible cohorts at the 61-years cut-off. The authors also find that the effect persists in the long term. Furthermore, the authors find that both men and women are equally struck by the reform.Originality/valueWhile there exist many descriptive reports and theoretical analyses on the costs and benefits of pension reforms, this study is the first one to empirically analyse the effect of the first European NDC pay-as-you go pension plan on the potential exclusion of old-aged workers.

Fertility, Imperfect Labor Market, and Notional Defined Contribution Pension

What is the relationship between notional defined contribution (NDC) pension scheme and fertility? What are the differences and similarities between NDC pensions and PAYG pensions? How is the return rate of NDC account determined? Do pensions affect the labor market equilibrium and work engagement behavior? This study answers such questions and elucidates the relationship between NDC pension scheme and fertility by considering endogenous labor supply in an imperfect labor market with efficiency wage in a two-period overlapping generations (OLG) model. The analysis reveals that fertility and NDC pension account return rate are positively correlated; hence, increasing the return rate of the NDC account may improve people’s fertility incentives. Second, NDC pension system and PAYG pension is different in children’s externality on the society. Third, the account return rate depends on the wage growth rate, the fertility level and the employment status. Fourth, higher pension benefits could lower the unemployment rate and disincentivize shirking behaviors.

The transition to NDC in Italy: assessing distributive and financial effects

AbstractMoving from a Defined Benefit (DB) to a Notional Defined Contribution (NDC) pension formula creates significant re-distributive effects. We estimate the amount and the intensity of these effects in the case of the Italian transition to NDC, which began in 1995. Based on administrative data of the main Italian pension scheme (FPLD), we study the evolution of yearly inequality within old-age pension benefits. Furthermore, we study the adequacy and the actuarial fairness of the pension system, by estimating the replacement rates and the Net Present Value Ratio distribution for workers who retired in the period 1996–2019. Our results show that the very generous interpretation of acquired rights determined by the 1995 reform has contributed to maintaining a high level of adequacy and a significant level of intergenerational imbalance. The financial costs of this imbalance are estimated and its extent is significant.

Notional Defined Contribution (NDC) Schemes: a pension system alternative

This article aims to discuss the main concepts related to notional defined contribution (NDC) schemes and to analyze the experiences of Sweden, Italy, Latvia, Poland and Norway. The methodology is based on a literature review. The main result was that the extent of NDC as a pension system alternative depends on the degree of closeness to the generic scheme. It is recommended to analyze NDC as an alternative for pension system reforms considering its capacity to control structural deficits. As a limitation, it was not analyzed some possible social impacts of NDC introduction. This article is original because encompasses theoretical and practical aspects of NDC schemes. It is expected that this research can contribute to assist public officials in decision-making about reforms in pension systems.

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.

Does the pension system’s income statement really matter? A proposal for an NDC scheme with disability and minimum pension benefits

This paper develops an accounting model for monitoring the solvency of a notional defined contribution (NDC) pension scheme with disability and minimum pension benefits. Using the annual report of the Swedish pension system as a benchmark, the “Swedish” actuarial balance is extended by adding an income statement fully explaining the reasons behind the changes in the system’s solvency by type of benefit. In line with the reference model, assets and liabilities are measured at present value at each reporting date, and in each period, included as income or expenses on the Income statement. This accounting framework integrates both contributory and social aspects of public pensions and discloses the real cost of the disability contingency and the redistribution through minimum pensions. Apart from Sweden, this proposal could be especially interesting for improving the reporting of public pensions in countries such as Poland, Italy, Latvia and Norway.

Distributional effects of social security reforms: The case of France

AbstractThis paper assesses the impact of two social security reforms using a calibrated, dynamic life cycle model. It quantifies the long‐run distributional impact of two sets of reforms in France: (1) the 2013 reform of Prime Minister Ayrault, which modified the parameters of a defined benefit (DB) plan, and (2) a hypothetical reform that changes the system to a notional defined contribution (NDC) plan, similar to that in Italy. First, on aggregate welfare, the Ayrault reform and the hypothetical switch to NDC yield contrasting results. The Ayrault reform improves aggregate welfare, which is not the case for the NDC reform. Welfare comparisons are made with respect to the “benchmark economy,” where increases in life expectancy occur and are dealt with only through a higher contribution rate. Second, both reforms yield unequal distributions of welfare changes, with low‐skill workers on the losing end. Under the Ayrault reform, low‐skill workers delay retirement by two years, to age 62. Under NDC reform, pensions for low‐skill workers fall substantially as inequalities during the work life translate directly into inequalities in pensions. The switch to an NDC scheme leads to a more unequal society in terms of asset and welfare distribution.

Continuous time model for notional defined contribution pension schemes: Liquidity and solvency

Notional Defined Contribution (NDC) pension schemes are defined contribution plans which are pay-as-you-go financed. From a design viewpoint, the countries where NDCs have been implemented cannot guarantee sustainability due to the choice of notional return paid to the contributions and the indexation rate paid to pensions. We study how the scheme should be designed to achieve liquidity and solvency with a limited set of assumptions in a continuous overlapping generations model that increases traceability of the results. The adequacy and actuarial fairness are also jointly studied in the numerical example for the population of Belgium. We find that the proposed indexation and notional rate act as automatic balancing mechanisms that ensure sustainability and actuarial fairness. However, the effect on pension adequacy depends on the generosity of the annuity scheme at retirement.

A Comparison of Lithuanian and Swedish Old Age Pension Systems

[full article and abstract in English] The aim of this study is to compare Lithuanian and Swedish pension systems from the point of view of their design and performance in order to elaborate reasonable recommendations to Lithuanian pension policy based on the best Swedish experience. Swedish income, premium and guaranteed old-age pensions system are compared with the analogous Lithuanian system of the “first,” “second” pillars and the “social” pensions. The main features of the systems are discussed, and the performance of the systems, mainly from the point of view of adequacy, is compared. The differences in system design and performance are identified, and the possible reasons of these differences are examined. Special attention is paid to differences in financing and the approach to the definition of benefits. The Lithuanian pension points approach is compared to the Swedish Notional Defined Contribution (NDC) approach. Each system is analyzed, and the relevance of transforming the Lithuanian first pillar pensions into a NDC system is examined.

Does the Pension System’s Income Statement Really Matter? A Proposal for An NDC Scheme with Disability and Minimum Pension Benefits

This paper develops a full accounting model for monitoring the solvency of a notional defined contribution (NDC) pension scheme with disability and minimum pension benefits. Using the annual report of the Swedish pension system as a benchmark (TSPS, 2019), we extend the “Swedish” actuarial balance developed by Perez-Salamero et al. (2017) by adding an income statement which fully explains the reasons behind the changes in the system’s solvency by type of benefit. In line with the reference model, assets and liabilities are measured at present value at each reporting date, and changes in present value are reported in each period as income or expenses and are included on the income statement. Our proposed model is a step forward because it, also, incorporates the changes for disability pensions, the value of change in the discount rate and the explicit recognition of non-contributory rights (NCRs) into the Income statement. This accounting framework integrates both contributory and social aspects of public pensions and discloses the real cost of the disability contingency and the redistribution through minimum pensions. The paper contains a numerical example consisting of an income statement for a (fictional) already-functioning system to illustrate the main differences between the Swedish NDC scheme and our model. Mathematical details are presented in a comprehensive technical appendix.

The Notional Defined Contribution Pension Scheme and the German ‘Point System’: A Comparison

AbstractThis paper examines the analytical properties of the German ‘points-based’ pension system. These properties are compared with those of a canonical Notional Defined Contribution (NDC) pension scheme. The paper identifies the circumstances under which the German ‘points-based’ system would mimic a Swedish-type NDC scheme and verifies to what extent the German ‘points-based’ scheme ensures uniformity of individual rates of return for some hypothetical careers. Finally, the paper proposes a set of new possible adjustment rules able to increase similarity between the German point system and the NDC scheme.

Does the NDC scheme mimic the French point system?

ABSTRACTAfter the implementation of the notional defined contribution (NDC) pension scheme in Italy and Sweden in the ‘90s, some authors argued that its design merely replicates the functioning of the points-based pension schemes already in place in France and Germany. The aim of this article is to assess the soundness of this proposition by comparing the properties of the French points-based pension system (FPS) with those of the NDC scheme, which refrains from intra-cohort redistributions by ensuring substantial uniformity of individual rates of return. In order to assess to what extent the FPS also avoids intra-cohort redistributions, we run several simulations for different career patterns. The results of the simulations show that the discretionary adjustments embedded in the FPS are responsible for random, regressive redistributions. Finally, the article identifies the theoretical ‘equivalence condition’ showing that full correspondence between the two schemes would require replacing the discretionary mechanisms of the FPS with an automatic adjustment of point values.

Social Insurance Accounting for a Notional Defined Contribution Scheme Combining Retirement and Long-Term Care Benefits

This paper develops a social insurance accounting model for a notional defined contribution (NDC) scheme combining retirement and long-term care (LTC) contingencies. The procedure relies on standard double-entry bookkeeping and enables us to compile a “Swedish” type actuarial balance sheet (ABS) following a framework equivalent to an open group approach. This methodology is suitable for reporting the system’s solvency status and can show periodical changes in the system’s financial position by means of an income statement. The information underpinning the actuarial valuation is based on events and transactions that are verifiable at the valuation date, without considering expected future trends. The paper also contains an illustrative example to make it easier for policymakers to understand the main advantages and difficulties of our proposal. The policy conclusions stress the need to properly report social insurance benefits to enhance transparency and sustainability and to improve decision-making because it is in the public interest to do so.

Life expectancy inequalities in the elderly by socioeconomic status: evidence from Italy

BackgroundLife expectancy considerably increased in most developed countries during the twentieth century. However, the increase in longevity is neither uniform nor random across individuals belonging to various socioeconomic groups. From an economic policy perspective, the difference in mortality by socioeconomic conditions challenges the fairness of the social security systems. We focus on the case of Italy and aim at measuring differences in longevity at older ages by individuals belonging to different socioeconomic groups, also in order to assess the effective fairness of the Italian public pension system, which is based on a notional defined contribution (NDC) benefit computation formula, whose rules do not take into account individual heterogeneity in expected longevity.MethodsWe use a longitudinal dataset that matches survey data on individual features recorded in the Italian module of the EU-SILC, with information on the whole working life and until death collected in the administrative archives managed by the Italian National Social Security Institute. In more detail, we follow until 2009 a sample of 11,281 individuals aged at least 60 in 2005. We use survival analysis and measure the influence of a number of events experienced in the labor market and individual characteristics on mortality. Furthermore, through Kaplan-Meier simulations of hypothetical social groups, adjusted by a Brass relational model, we estimate and compare differences in life expectancy of individuals belonging to different socioeconomic groups.ResultsOur findings confirm that socioeconomic status strongly predicts life expectancy even in old age. All estimated models show that the prevalent type of working activity before retirement is significantly associated with the risk of death, even when controlling for dozens of variables as proxies of individual demographic and socioeconomic characteristics. The risk of death for self-employed individuals is 26% lower than that of employees, and life expectancy at 60 differs by five years between individuals with opposite socioeconomic statuses.ConclusionsOur study is the first that links results based on a micro survival analysis on subgroups of the elderly population with results related to the entire Italian population. The extreme differences in mortality risks by socioeconomic status found in our study confirm the existence of large health inequalities and strongly question the fairness of the Italian public pension system.

An NDC approach to helping pensioners cope with the cost of long-term care

AbstractThis paper explores a notional defined contribution (NDC) approach aimed at helping pensioners to cope with the cost of long-term care (LTC). It develops the necessary technicalities to fully integrate an LTC benefit, graded according to the annuitant's degree of disability, into a generic NDC retirement framework with a minimum pension benefit for both contingencies. It also discusses the policy implications of various issues that should be taken into account before any decision is made to put the model into practice. Finally, to enable policymakers to better understand how the proposal would function, the paper includes a realistic numerical example.

Closing the gender gap in pensions: A microsimulation analysis of the Norwegian NDC pension system

In this article, we use an advanced microsimulation model to study the distributional effects of the reformed Norwegian pension system with a particular focus on gender equality. The reformed Norwegian system is based on the notional defined contribution (NDC)-formula with fixed contribution/accrual rates over the active life-phase and with accumulated pension wealth being transformed into an annuity upon retirement. A number of redistributive components are built into the system: a unisex annuity divisor, a ceiling on annual earnings, generous child credits, a possibility for widows/widowers to inherit pension rights from a deceased spouse, a targeted guarantee pensions with higher benefit rates to single pensioners compared to married/cohabitating pensioners, and finally a tax system that is particularly progressive in its treatment of pensioners and pension income. Taking complete actuarial fairness as the point of departure, we conduct a stepwise analysis to investigate how these different components of the National Insurance pension system impact on the gender gap in pensions and on general (Gini) inequality in the distribution of pension income within a cohort of pensioners. Our analysis concentrates on one birth cohort – individuals born in 1963 – and we study three different outcomes: the distribution of annual pensions early in retirement (at age 70), the distribution of the total sum of pension benefits received over retirement, and the distribution of the average annual pension benefits received over the retirement phase. In addition, we look at three alternative income concepts. These are personal income, equivalised household income, and finally an original income concept developed for this study: personal income adjusted for the economies of scale enjoyed by couple households.

A Social Insurance Accounting for a Notional Defined Contribution Scheme Combining Retirement and Long-Term Care Benefits

This paper develops a social insurance accounting model for a notional defined contribution (NDC) scheme combining retirement and long-term care (LTC) contingencies. The procedure relies on standard double-entry bookkeeping and enables us to compile a “Swedish” type actuarial balance sheet (ABS) following a framework equivalent to an open group approach. This methodology is suitable for reporting the system’s solvency status and can show periodical changes in the system’s financial position by means of an income statement. The information underpinning the actuarial valuation is based on events and transactions that are verifiable at the valuation date, without considering expected future trends. The paper also contains an illustrative example to make it easier for policymakers to understand the main advantages and difficulties of our proposal. The policy conclusions stress the need to properly report social insurance benefits to enhance transparency and sustainability and to improve decision-making because it is in the public interest to do so.

SOME NOTES ON THE REDISTRIBUTION INHERENT IN THE U.S. PUBLIC PENSION SYSTEM

This paper shows that the U.S. Old‐Age Insurance (OAI) does not eliminate all the regressive redistribution characterizing earnings‐related schemes. The benchmark against which OAI is tested is the one‐to‐one contribution‐benefit rule of the Notional Defined Contribution (NDC) scheme. The paper suggests that by redesigning OAI according to the NDC scheme workers would perceive the higher contributions needed to finance current obligations not as a tax but as an increase in mandatory savings rewarded with the pay‐as‐you‐go interest rate and a stream of pension annuities more generous than that it would be possible to pay at the current contribution rate. (JEL H55, J26)