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:
1. Benefits based on lifetime earnings, rather than a subset of “best” or “final” years’ pay.
2. Each extra year’s contribution should give rise to an additional benefit: there should be no ceiling
on the number of pensionable years.
3. 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.
4. Benefits should be reduced as life expectancy increases, again to reflect the longer duration for
which benefits would be paid.
These issues are considered in turn in sections 2-5 below. They have important implications for the equity of the pension system; in particular, treatment of people retiring at different ages or with different number of years of contributions. They also impinge on questions of economic efficiency: how can the distortions of the pension system on individual work and savings decisions be minimised?