Why should the government provide pension?
- Adverse event –> being unable to gain a sufficient income
- Market solution –> in fully funded programs, savings are invested in securities and the gains pay for the pension benefit
What is the problem with fully funded pension programs?
- A poor performance of the market and inflation can lead to low future pensions and the replacement ratio (salary working vs pension) may be low
What is the Pay-as-you-go system?
Pensions collected today go to today’s retirees
What is the pay-go system based on?
Intergenerational pact –> you pay today and someone else will pay for you in the future
What are the pros of paygo?
- Immediate transfer of pension to old individuals even if previous contributions were not paid.
- 1ST GENERATION EFFECT –> Infinite return rates
- LAST GENERATION EFFECT –> negative return rate
What is the earning based and contribution based paygo systems?
Earnings based –> pension is calculated based on the person’s salary (last or average (augmented by revaluation rate)) P=BwL
Contribution based –> sum of contributions paid augmented by r and pension is based on life expectancy
What is the transformation coefficient in pension systems?
Reflects the real life expectancy, it allows to tackle the ageing of the population transferring the burden to the retirees
What justifies state intervention on pension systems?
- Insurance market may experience failures because of adverse selection
- Paternalism –> people might not save enough during their working life for the retirement period
What are the “cons” of a pension system?
- Moral hazard –> ppl will retire asap to benefit from the pension
- Implicit taxation on labor –> the MC of working 1 more year > MR of receiving a higher pension
When is the paygo system in equilibrium?
When contribution rate = equilibrium cont rate
aWNw=PNr
How can we compute the demographics/employment risk?
Nr/Nw
