Notional Defined Contribution Pension Systems in a Stochastic Context

Ronald Lee

Edited by Alan J. Auerbach

in Social Security Policy in a Changing Environment

Published by University of Chicago Press

Published in print June 2009 | ISBN: 9780226076485
Published online February 2013 | e-ISBN: 9780226076508 | DOI:
Notional Defined Contribution Pension Systems in a Stochastic Context

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This chapter explores a new approach to Social Security reform that is known as “Notional Defined Contribution” or “Nonfinancial Defined Contribution” (NDC). This chapter uses a stochastic macroeconomic model for forecasting and simulating the long-term finances of NDC-type public pension programs in the context of demographic and economic trends in the United States. While NDC plans are seen as having various potential advantages over traditional pay-as-you-go (PAYGO) systems, the focus of this chapter is on their financial stability over the long term. Around the world, PAYGO public pension programs are facing serious long-term fiscal problems due primarily to actual and projected population aging and most appear unsustainable as currently structured. The stochastic population model is based on a Lee-Carter mortality model and a somewhat similar fertility model. The feasible internal rate of return for a PAYGO system with stable population structure equals the rate of growth of the population plus the rate of growth of output per worker. Evidently, stochastic simulation of the system's finances can reveal aspects of its performance that are not otherwise obvious and can assist in improving system design. This promises to be a valuable use for stochastic simulation models of pension systems.

Keywords: pay-as-you-go; PAYGO; pension; Lee-Carter mortality model; stochastic simulation; system design

Chapter.  10872 words.  Illustrated.

Subjects: Public Economics

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