Demographic Risk Indicators in Pay-as-You-Go Pension Funds

Abstract

This paper deals with demographic risk in private pay-as-you-go pension systems. In particular, it analyzes the financial sustainability of the fund in a stochastic framework. We present a model to investigate the dynamics of these types of pension funds which operate according to the pay-as-you-go rule, focusing on the behavior of the demographic variable "new entrants" and on its influence on the future evolution of the fund. The global asset return and the new entrants variation rate are modeled by autoregressive processes. The goal is to propose risk indicators that can be employed to monitor the solvency of the fund. A numerical application is carried out using the data provided by the pension funds of Italian Professional Orders. The analysis highlights how the variable "new entrants" influences the final value of the fund and the application shows that the proposed controlling model appears effective at providing advance warning of the financial insolvency of the fund.

Keywords: Pension funds, pay-as-you-go, demographic risk, stochastic new entrants

JEL Classification: G23, H55