Automatic balancing mechanisms for mixed pension systems

Automatic balancing mechanisms for mixed pension systems

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Speaker(s): Carmen Boadas Penas (University of Liverpool), Humberto Godinez-Olivares (QRI International LLC), Steven Haberman (CASS Business School)

The decline in fertility rates, the increase in longevity and the current forecasts for the ageing of the baby-boom generation all point to a substantial increase in the dependency ratio, and this will raise serious concerns for the sustainability of Pay-As-You-Go (PAYG) pension schemes.

Consequently, many European countries have already carried out some parametric reforms, or even structural reforms, of their pension systems. Specifically, two-thirds of pension reforms in OECD countries in the last 15 years, OECD (2011), contain measures that will automatically link future pensions to changes in life expectancy, compared with only one country (Denmark) a decade ago.

Other countries, such as Sweden, Latvia and Poland, combine funded and PAYG elements within a compulsory basic pension system. These mixed systems have been advocated, particularly by the World Bank, as a practical way to reconcile the higher financial market returns compared with GDP growth with the costs of a scheme with a greater funded element.

With this in mind, the aim of this research is threefold. First, using nonlinear optimization based on Godínez-Olivares et al (2016), it seeks to assess the impact of a compulsory funded pension scheme that complements the traditional PAYG. Second, we study the consequences of introducing a sustainability factor linked to life expectancy (or any other demographic factor) on the financial stability of mixed pension systems. Finally, in the case of a partial financial sustainability, we design different optimal strategies, that involve variables such as the contribution rate, age of retirement and indexation of pensions, to restore the long-term financial equilibrium of the system.

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