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WEB SESSION

10 Oct 2023

NF: How an Imaginary Pension Fund Can Help Steer a PAYG System

Notional Funding: How an Imaginary Pension Fund Can Help Steer a PAYG System

The aging population presents serious challenges for traditional pay-as-you-go pension systems. Longer life expectancies increase pension expenses while low birth rates weaken the future contribution base.

A buffer fund can help alleviate these problems. However, this raises questions about how much insured should contribute and how big the fund should be. Ideally, the contribution rate should be stable, but it also needs to be based on observable quantities and transparent rules.

Notional funding (NF) provides a coherent solution to this problem. It takes the liabilities of the PAYG system as seriously as those of the funded system. In NF, the PAYG system is treated as if it were a fund-ed system without assets to cover liabilities.

In NF, the pension contribution consists of two components: the funded contribution (C1) and an additional contribution (C2). The funded contribution equals the present value of the annual accrual. The additional contribution corresponds the imputed re-turn on missing assets. If the total actual contribution equals the sum of these two components (C1+C2), the level of unfunded liabilities remains stable. However, there may be cases where a decreasing unfunded liability is desirable, such as when the pension system faces declining labour due to low fertility rates.

The NF model also provides a consistent basis for automatic adjustment of pension expenditures. In the extreme, the contribution rate can be fixed, transferring the need to adjust financing entirely to pension benefits. However, necessary adjustments can be divided to adjust pension benefits and contributions in the desired ratio.

In this web session, we will illustrate the NF model in the context of a simple old-age pension system, where the contribution level and/or benefit level are adjusted annually based on different return and birth rate scenarios. The effects of different policies will be examined on a yearly and generational basis.

Participants

The web session is suited for pension actuaries and other professionals working with social security pension financing.

Technical Requirements
Please check with your IT department if your firewall and computer settings support web session participation (the programme Zoom will be used for this online training). Please also make sure that you are joining the web session with a stable internet connection.

Purpose and Nature

The objective of this web session is to illustrate the idea of Notional Funding and show how this approach unifies the analysis of funded and pay-as-you-go systems. In a first part, we will define the concept of NF and compare it with PAYG and fully funded systems. The second part is devoted to numerical results in the context of a stylised pension system. First, we show how different fertility scenarios affect contribution rates and benefit levels. Then, we will look how NF adapts to different asset return realisations. This is done by means of simple scenarios as well as by means of more realistic stochastic scenarios. In this online training, we will examine the questions of risk sharing between pension benefits and pension contributions, as well as the question of intergenerational risk sharing.

Language

The language of the web session will be English.

Lecturers

Ismo Risku
Ismo is the Head of Planning Department at the Finnish Centre for Pensions, the central organization of the Finnish earnings-related pension system. The responsibilities of the department include making long-term assessments of the Finnish pension system. He has actively developed methods and practices to assess the future prospects of the Finnish pension system, including intergenerational aspects of pensions. He has been involved in Finnish pension reforms for the last two decades. He holds a licentiate degree in economics from the University of Helsinki and is a Fellow of the Actuarial Society of Finland.
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