The Impact of DC Pension Systems on Population Dynamics

Abstract

This study investigates the risk inherent in defined contribution (DC) pension plans on an individual and aggregate basis, based on U.S. data. Our aim is to gain insight into the consequences of a DC pension scheme becoming the predominant pillar of retirement income for an entire society. Using the stochastic simulated output of a DC flexible age-of-retirement model, we first determine the optimal investment strategies. We then examine the demographic retirement dynamics of an entire population of DC pension plan participants.We observe that even for the most risk-averse plan members there is a high level of uncertainty in an individual's age at retirement. At the aggregate population level, we find that this uncertainty does not get dampened to any great extent by a diversification effect. Instead, the central role played by the market in determining retirement dates results in significant variation in the dependency ratio (the ratio of retirees to workers) over time. In addition, an attempt to ameliorate the outcome by introducing additional realistic features in the DC population modeling did little to dampen this volatility, which suggests that countries dominated by DC schemes of this type may, over time, be exposed to significant risk in the size of its labor force.

An Actuarial Analysis of the Payout Options in Nigeria’s Contributory Pension Scheme

“…This is a far cry from the proposed two-third replacement rates suggested by MacDonald and Cairns (2006) which is approximately 67% of the earning before retirement.…”

Getting Feedback on Defined Contribution Pension Plans

“…With the growth of DC pension plans around the world, in both the private pensions and public systems, market rates of return are increasingly likely to play a large role in the retirement patterns of individuals, however, the reverse could also be true (MacDonald and Cairns, 2006). A variety of existing theoretical economic models claim that "demographics matter" (Poterba, 2004); that is, the demographic structure of a population could affect financial markets.…”

“…We refer to this as "modeling feedback". This is a companion paper to MacDonald and Cairns (2006), which examined the labour force implications of a nation-wide pure DC pension system. Using the simulated output from a modelled society populated by DC plan participants, they found that market performance plays an important role in the retirement pattern of workers and creates instability in the ratio of retirees to workers (dependency ratio) from one year to the next.…”

“…Section 2 discusses the previous literature on the relationship between financial market returns, demographics and asset demand in the context of our analysis. Section 3 outlines the stochastic economic model, which is a summary of the model described in MacDonald and Cairns (2006) with the addition of a few new elements. Section 4 describes the feedback model.…”

“…Using the simulated output from a modelled society populated by DC plan participants, they found that market performance plays an important role in the retirement pattern of workers and creates instability in the ratio of retirees to workers (dependency ratio) from one year to the next. The objective of this paper is to incorporate a simple macroeconomic feedback feature into the stochastic simulation model of MacDonald and Cairns (2006) and investigate its effects. If the population's retirement patterns do indeed impact the financial rates of return and wages, this feedback could potentially dampen or exacerbate the swings in the dependency ratio.…”