Intergenerational risk sharing in pay-as-you-go pension schemes

33 Pages Posted: 28 May 2024 Last revised: 5 Nov 2024

See all articles by Hélène Morsomme

Hélène Morsomme

Independent

Jennifer Alonso-García

Université Libre de Bruxelles (ULB) - Department of Mathematics; Netspar

Pierre Devolder

Catholic University of Louvain

Date Written: November 05, 2024

Abstract

Population ageing undermines traditional social security pension systems that combine pay-as-you-go (PAYG) and defined benefits (DB). Indeed, demographic risk, if guaranteed benefits remain unaltered, will be borne entirely by workers through increases in the contribution rate. To avoid a substantial increase of the contributions and in order to maintain simultaneously the financial sustainability and the social adequacy of the public pension system, risk sharing and automatic balancing mechanisms need to be put in place. We present a two-step convex family of risk-sharing mechanisms. The first shares the risk between contributors and retirees through adjustments in the contribution rate, used to calculate the global covered wage bill, and the benefit ratio that represents the relationship between average pensions and wages. The second step studies how the retirees' risk should be shared between the different retirees' generations through adjustments in the replacement rate and a sustainability factor that affects pension indexation during retirement. We perform a detailed study of the effect of social planner's targets and solidarity weight between various generations in a deterministic and stochastic environment.

Keywords: risk-sharing, automatic balancing mechanisms, pension design, ageing

JEL Classification: H55, J18, G22

Suggested Citation

Morsomme, Hélène and Alonso-García, Jennifer and Devolder, Pierre, Intergenerational risk sharing in pay-as-you-go pension schemes (November 05, 2024). Available at SSRN: https://ssrn.com/abstract=4764754

Hélène Morsomme

Independent ( email )

Jennifer Alonso-García (Contact Author)

Université Libre de Bruxelles (ULB) - Department of Mathematics ( email )

Brussels
Belgium

Netspar ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Pierre Devolder

Catholic University of Louvain ( email )

Place Montesquieu, 3
B-1348 Louvain-la-Neuve, 1348
Belgium

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