Decomposing Notional Defined-Contribution Pensions
A number of countries have introduced notional defined-contribution pensions as a replacement for public pensions of the defined-benefit type. Among OECD and EU countries, for example, these comprise Italy, Latvia, Poland and Sweden. There has been a great deal of interest in other countries in this approach to pension reform.
The motivations for these reforms differed. Undoubtedly, matters of political economy played a role: there was a desire to change the pension system and not merely adjust parameters and rules. Also, reductions in benefits because future pensions would be linked to changes in life expectancy were seen as more palatable to the electorate than cuts in another form.
This paper focuses on the economic issues in these changes. There are four main dimensions:
Benefits based on lifetime earnings, rather than a subset of “best” or “final” years’ pay.
Each extra year’s contribution should give rise to an additional benefit: there should be no ceiling on the number of pensionable years.
Benefits should be reduced to reflect the longer expected duration of payment for people who retire early and, similarly, should be increased for people who retire late.
Benefits should be reduced as life expectancy increases, again to reflect the longer duration for which benefits would be paid.