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The Fully-Funded Pension System

Definition of a fully-funded pension system

Successful Example of a Fully-Funded Pension System

Today’s savings are invested in various assets in order to pay future benefits.

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Wisconsin

Risks and Feasibility

Solidarity

Advantages of the Fully-Funded Pension System

  • No redistribution
  • Assumption of no paternalism
  • Moral hazard
  • False sense of security
  • Crowding out of individuals’ savings
  • Money is still not “off budget”
  • No respect to consumer sovereignty
  • Capital stock can disappear
  • Feasibility of introduction

  • Indifferent to the demographic change
  • No free rider problem
  • Increase of the capital stock
  • Potential for a positive effect on the increase of the retirement rate

http://budgeting.thenest.com/fully-funded-retirement-plan-30188.html

http://www.nber.org/papers/w6149.pdf?new_window=1

http://www.politifact.com/wisconsin/statements/2013/jan/06/scott-walker/walker-says-wisconsins-pension-system-only-one-cou/

The Unfunded

(Pay-As-You-Go)

Pension System

Case Study:

Denmark

Reforms

Three Pillars

“Retirement Reform” adopted by the Parliament in December 2011

High-complexity multi-pillar structure, which includes three pillars:

1. Public Pillar

Two Tiers – PAYG and Funded

2. Occupational retirement schemes

3. Voluntary retirement schemes.

First Pillar

Reform Action

  • Increase of the Normal Retirement Age from 65 – 67 (and linking it to the life expectancy) and increasing of the Early retirement age (VERP) from 60 to 62
  • Reduction of the years receiving VERP from 5 to 3
  • Anticipatory pension – discontinued, but flexi-job maintained.

  • Universal Coverage
  • Mandatory
  • Consists of 2 tires

Second Tier

Expected Effects

First Tier

(residence-based national pension)

  • Consist of funded supplementary schemes with varying purposes
  • Supplementary Labour Market Pension Fund (ATP) – financed through fixed contributions – 2/3 employer and 1/3 employee
  • Deferred retirement (up to 75)
  • Women and men receive the same coverage (dealing with the redistributive effect)

  • Comprises flat-rated base amount connected to the length of residency and supplementary income-tested pension for the poor
  • Normal retirement age 65 M/F
  • Residency 3 years for Danish Citizen and 10 for non-Danish citizen (5 before retirement)
  • Income-tested pension for the poor
  • Early retirement trough anticipatory pensions and Partial Early Retirement
  • The reform proposal is expected to increase the employment supply with approx. 5,000 persons in 2020 and 12,500 people in a long-term perspective. (National Social Report 2012 Denmark)

Reform

Redistribution

and Solidarity

Moral Hazard and Risks

Feasibility

  • Changing demographics put pressure on the system
  • Increased life expectancy created more costs for the pension system

Rate of Return:

  • Wage Growth Effect
  • Population Growth Effect
  • Tax Growth Effect

Between Generations:

  • Early Retirement
  • Inability or unwillingness to pay the pension contributions

  • First generation is the biggest winner
  • "Free lunch at the beginning... but no dinner at the end"
  • Legacy Debt

Within a Generation:

  • Men to Women
  • Higher Income to Lower Income

Outline

  • Introduction
  • The Unfunded Pension System
  • The Fully-Funded Pension System
  • Case Study: Denmark
  • Conclusion

Introduction

Conclusion

  • Why Pensions and Objectives
  • How Pensions Work
  • Aspects of a Pension System
  • Risk
  • Solidarity
  • Moral Hazard
  • Defined Benefit or Defined Contribution?
  • Externalities and Distributional Consequences
  • Inability of unfunded system to protect against all risks
  • Impracticality of fully funded system
  • Hybrid system proves to be more effective

Why Pensions?

How do Pensions work?

Objectives

  • Mitigate against Longevity Risk
  • Equalize Length of Working Life
  • Protect dependents, widows, children
  • Protect against Inflation
  • Maintain income link with the working population
  • Consumption Smoothing
  • Paternalism
  • Savings inadequacy
  • Market Failures in the Annuities Market
  • Financed by a tax on earnings
  • Eligibility requirements
  • Minimum retirement age to draw benefits
  • Early retirement age, full benefits age, delayed retirement age
  • Must have paid into system (worked and been taxed) for a certain number of years
  • Benefits for spouses and dependents

Works Cited

Distributional Consequences

Aspects of a Pension System

Defined Benefit or Defined Contribution?

  • Full defined contribution or some rate of return guarantee?
  • Inter-generational
  • Gender-based
  • Income-based
  • Risk
  • Solidarity
  • Moral Hazard
  • http://www.mwpweb.eu/1/144/resources/publication_1459_1.pdf http://ec.europa.eu/social/BlobServlet?docId=7341&langId=en
  • http://www.globalpensionindex.com/pdf/melbourne-mercer-global-pension-index-2012-report.pdf
  • http://english.sm.dk/international/social_policy_in_denmark/NSR/Documents/National%20Social%20Report%20-%20Denmark.pdf
  • http://www.mwpweb.eu/1/144/resources/publication_1459_1.pdf
  • http://ec.europa.eu/social/BlobServlet?docId=7341&langId=en
  • http://www.imrf.org/pubs/100_percent_funding_goal/100_funding_article.pdf
  • http://siteresources.worldbank.org/SOCIALPROTECTION/Resources/SP-Discussion-papers/Pensions-DP/1213.pdf
  • http://www.economist.com/blogs/easternapproaches/2010/11/hungarian_pensions
  • http://www.oecd.org/daf/fin/private-pensions/50560110.pdf
  • http://www.oecd.org/els/public-pensions/47712019.pdf
  • http://www.imf.org/external/pubs/nft/op/147/

Pensions

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