Backward–Looking and Forward–Looking NDC Pension Schemes

Abstract

In order to spread notional capital accrued at retirement by members of a cohort over their own life expectancy, pay-as-you-go notional-defined-contribution (payg-ndc) scheme uses multipliers (different by retirement age) called conversion coefficients. These are backward-looking (b.l.) in that they relay on survival rates observed for previous cohorts in the past. Under increasing longevity, b.l. coefficients undervalue life expectancies, thus preventing full implementation of actuarial fairness (benefits equivalent to contributions) which is the main objective of ndc scheme. They also engender chronic deficits.Forward-looking (f.l.) coefficients, relaying on forecast survival rates can improve actuarial fairness. Nevertheless, they face a rather serious political difficulty in that forecasting tools are fallible. This explains why switching to f.l. coefficients is unable to gain social consensus. Apart from this, the paper shows that f.l. coefficients produce ‘overshooting’. In fact, they generate chronic surpluses. The paper also shows that frontloading pension profile helps sustainability because it reduces both surpluses and deficits generated, respectively, by f.l. and b.l. coefficients.

The effects of aging on notional defined contribution pension systems: A theoretical investigation

“…According to Corollary 1, in the theoretical version of the NDC case, the increase in life expectancy involves balance surplus. A similar result was found first in Gronchi and Gismondi (), though in a specific case. While generalizing this result, we also prove that it holds independently from the rate of growth of population and provide a simple analytical formulation to quantify this effect.…”

“…We show that, if the pure theoretical NDC version is applied, the increase in life expectancy brings almost a balance surplus, and this result holds even when considering negative demographic trends. A similar result was first observed in Gronchi and Gismondi () and, from this starting point, we propose a mathematical framework to generalize and extend this result. We prove that adequacy and financial sustainability are no longer rival targets when the increase in life expectancy is properly balanced by increases in the different phases of the working life cycle.…”

“…Furthermore, we can consider the practical issues concerning the forecast of life expectancy and the delay in updating survival rate coefficients (see Gronchi & Gismondi, ; Palmer, ). The proposition suggests a sustainable bias in the coefficients used to compute a cohort pension benefit: the average coefficients applied to a retired cohort must be lower than the coefficient corresponding to the posterior parameters.…”

“…Obviously, the use of biased coefficients does not respect the actuarial neutrality properties of the NDC methodology; however, it is a practical solution with an automatic stabilizer based on already measured variations of the survival rates. If compared to perfectly forward‐looking coefficients (see Gronchi & Gismondi, ), in terms of intergenerational effects, applying posterior coefficients when life expectancy increases positively affects pension benefits. However, since all pensions are updated according to the time variation of these coefficients, they avoid the deficit generated by the fully backward‐looking case.…”

Is an Increase in the Minimum Retirement Age Always Desirable? The Case of Notional Defined Contribution Systems

“…without increasing retirement age. The latter scenario shows that, accordingly to the theoretical result of Gronchi and Gismondi (2008), population ageing produces important deficits implying that an NDC system is not sustainable if the population is not stable. Figure 2 shows that the increase in the minimum retirement age (scenario 3) permits to reduce pension deficits and thus produces positive effects, but only in the short and medium run.…”