Why Sweden’s Notional DC Pension System Needs a Calculation Correction

Abstract

This article reviews the reform of the Swedish state pension and identifies a calculation problem: the use of “turnover duration” (TD) to calculate the Notional DC system’s balance-sheet assets. This practice produces varying and inaccurate results, favoring pensioners and placing an additional burden on contributors and on subsequent generations that will contribute. The author proposes the calculation of balance-sheet assets using the concept of a Future Commitment Asset (FCA), the wealth that must be transferred by future cohorts to keep the system operating. An analysis using the TD and FCA approaches in a simple model demonstrates that the FCA method provides accurate results whereas the TD method produces some peculiar ones. The FCA method is as simple to use in practice as the TD method. See critique by Ole Settergren (following article).

Keywords: Contribution Asset, Notional Defined Contribution, Pension Fund, Steady State, Turnover Duration