Differentiating Indexation in Dutch Pension Funds

31 Pages Posted: 27 Dec 2010

See all articles by Roel M. W. J. Beetsma

Roel M. W. J. Beetsma

University of Amsterdam - Research Institute in Economics & Econometrics (RESAM); European Commission; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute); Tinbergen Institute; Netspar

Alessandro Bucciol

University of Verona - Department of Economics; Netspar

Multiple version iconThere are 2 versions of this paper

Date Written: December 1, 2010

Abstract

Funded social security programs are particularly vulnerable to economic and financial market shocks. As a consequence of the recent crisis, a large fraction of the Dutch pension funds had to submit restoration plans for the recovery of their buffers. Such plans will have to rely primarily on a mix of reduced benefit indexation and increased pension contributions. Hence, a discussion has now emerged whether indexation should be differentiated across the various groups of participants in a pension fund. We investigate this issue numerically, developing an applied many-generation small open economy OLG model with heterogeneous agents. The pension system consists of a first-pillar PAYG component and a second pillar with a pension fund. In our stochastic simulations, we hit the economy with a variety of unexpected demographic, economic and financial shocks. We compare uniform indexation of pension rights across all fund participants with alternatives such as status-contingent indexation in which pensions are protected against price inflation. While the aggregate welfare consequences are small, group-specific consequences are more substantial with the workers and future born losing and retirees benefiting from a shift away from uniform indexation. Those welfare shifts are the result of a systematic redistribution of welfare rather than shifts in the benefit of risk sharing provided by the system. These results are robust to realistic variations in the initial funding ratio and the equity premium. Under all indexation schemes, the average indexation rate has to decline over time to maintain the fund's sustainability in the wake of increasing longevity. An increase in the retirement age that leaves existing pension rights untouched does little to avoid this decline.

Keywords: indexation, funded pensions, welfare effects, pension buffers, stochastic simulations

JEL Classification: H55, I38, C61

Suggested Citation

Beetsma, Roel M. W. J. and Bucciol, Alessandro, Differentiating Indexation in Dutch Pension Funds (December 1, 2010). Netspar Discussion Paper No. 12/2010-080, Available at SSRN: https://ssrn.com/abstract=1730657 or http://dx.doi.org/10.2139/ssrn.1730657

Roel M. W. J. Beetsma (Contact Author)

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Alessandro Bucciol

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