A points-based system operating on a defined-benefit basis makes it possible to rethink how the pension system is steered. Instead of having to repeatedly adjust the system’s parameters on an ad hoc basis, it is possible to define rules of evolution that offer guarantees to policyholders, both regarding their entitlements and the long-term sustainability of the system. Based on simulations of a variety of shocks to the pension system, this note examines which steering rules deserve to be adopted. Two rules absolutely must be adopted: first, the value of the pension point must follow wage growth, and second, the conversion into a pension must take into account the life expectancy of each generation. A third rule, important for the long term, concerns the relationship between the indexation rules for pensions already being paid and the amount at the time of retirement. This rule should serve as a guide for managers in steering the system towards a balance that does not rely on too low an indexation of pensions. Such steering implies a high degree of institutional autonomy for the system, in which managers must be responsible for financial balance as well as for risks relating to the revaluation of pensions.
What steering approach for a points-based pension system?
This note assesses, using simulations, the effects of the various possible rules for designing a defined-benefit system. It then presents different possible steering options, discussing the respective roles that automatic rules and trade-offs made by managers can play.
Reference Note IPP n°43
Presentation
Key Results
- A defined-benefit points-based system must offer guarantees on pension entitlements through a strict rule linking the revaluation of the point value to wage growth.
- The conversion of points into a pension, at the time of retirement, must explicitly take into account changes in life expectancy for each generation.
- Systems incorporating these rules are better able to absorb economic and demographic shocks, thereby ensuring their financial sustainability.
- The indexation of pensions depends directly on the degree of pension advance already granted at retirement and on the growth rate of the total wage bill. It is up to managers to choose the degree of pension advance in order to guarantee sufficient revaluation of pensions already being paid.
- Steering cannot rely solely on indexation rules. In addition to the need for a reserve fund to smooth temporary shocks, managers will need to manage uncertainties relating to long-term growth and the population growth rate.
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