Notional Defined Contribution Pensions with Public Reserve Funds in Ageing Economies: An Application to Japan

Abstract

Several developed and developing countries have recently adopted a notional defined contribution (NDC) approach to old-age pension reform. The NDC is essentially a non-pre-funded defined contribution retirement system, in which contributions are credited with a rate of return related to aggregate payroll growth, and individual account accruals are maintained in a book-keeping system. Payouts are annuitized based on the expected mortality of each succeeding retiring cohort. NDC plans may be identified with appropriately calibrated Pay-As-You-Go plans in demographic equilibrium, but the two paradigms diverge when demographic shift is introduced. This paper investigates the key actuarial and economic implications of alternative NDC rules, with a particular focus on Japan, the world's most rapidly ageing economy. We examine the potential role for pension reserves in transitioning to an NDC system, and we show these can be used to smooth the impact of demographic transition to an older society. Finally, we show that countries such as Japan could elect to use pension reserves accumulated in the past to facilitate the transition to an NDC system.