Financial sustainability and automatic balance mechanisms for NDC pension systems with disability benefits

Abstract

The need for Long term care (LTC) service continues to rise due to the increasing number of elderly in the world, which stresses the healthcare systems. As most of the LTC recipients are over age 65, several authors studied retirement products combining a lifetime annuity with a long-term care benefit (typical examples are Enhanced Pension and Life Care Annuity). The development of an integrated strategy may help to address the issue of the cost of care for pensioners affected by disability. In this paper, we contribute to the debate on the introduction of LTC benefits into a notional defined contribution (NDC) pension system by using a multivariate stochastic model to represent the future evolution of transition probabilities and economic variables, which allows investigation of the financial sustainability of the system in a stochastic environment. The presence of LTC adds new risk elements, such as the uncertainty related to disability rates and mortality rates of the disabled, which may jeopardize the financial equilibrium of the integrated system. To restore the system’s equilibrium, we apply two types of automatic balance mechanisms (ABM), one based on the solvency ratio, and the other on the liquidity ratio. Both act on the indexation of pensions and the notional rate.