Increasing life expectancy and NDC pension systems

Abstract

AbstractIn this paper, I study how pay-as-you-go pension systems of the notional defined contribution type can be designed such that they remain financially stable in the presence of increasing life expectancy. For this to happen three crucial parameters must be set in an appropriate way: the notional interest rate, the adjustment rate and the annuity conversion factor. I show that there exist two main approaches to implement a stable system. The first uses period-specific annuitization and indexation rates that correct for labor force increases, which are only due to rises in the retirement age which are necessary to ‘neutralize’ the increase in life expectancy. The second approach uses cohort-specific annuitization and indexation rates that are larger than in a stationary situation. This is due to the fact that a continuously increasing life expectancy leads to higher internal rates of return that can be passed on via the indexation.