Backward-looking and forward-looking notional-defined-contribution pension schemes

Sandro Gronchi () and Fulvio Gismondi
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Sandro Gronchi: Department of Economic Theory - Sapienza University of Rome (Italy)
Fulvio Gismondi: Mathematics for Economics at Guglielmo Marconi University of Rome (Italy)

No 2/10, Working Papers from Sapienza University of Rome, DISS

Abstract: In order to spread notional capital accrued at retirement by members of a cohort over 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 expectancy, 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 survival rates forecast for the cohort whom coefficients themselves are assigned to, 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. Abstracting from this, the paper shows that forward-looking 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. approaches

Date: 2010-01
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