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Stochastic modelling in policy analysis

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This analysis explores the balance mechanism in Sweden's Notional Defined Contribution (NDC) Pay As You Go (PAYG) pension scheme, focusing on rules for distributing surpluses. With a contribution rate adjusting from 18.5% to 16%, we investigate the total liability as a function of GDP and the potential for an autonomous income source for the elderly. By examining financial stability, demographic factors, and risk allocation, we seek to establish a consistent framework that promotes intergenerational fairness and sustainable pension contributions.

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Stochastic modelling in policy analysis

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  1. Stochastic modelling in policy analysis Danne Mikula, SSIA

  2. * Swedish PAYG pension scheme Designing rules for distributing of surplus of the Swedish NDC Pension Scheme But first we need a crash course in * The Balance Mechanism

  3. Notional Defined Contribution (NDC) Pay As You Go scheme (PAYG) Contribution rate 18.5% -> 16% Total Liability = 2.5 x GDP Buffer Fund = 10 % of Total Liability “Autonomous system” Main source of income for elderly

  4. The Swedish pension reform definesa financially stable pension system • Contribution = Entitlement • Average wage indexation • AnnuityCapital / ”remaining life length” • Balance mechanism

  5. Assets BR = • Liabilities Balance Ratio (BR) BT Assets? But the system is of PAYG type…

  6. Funds + .... BR = Pension liability Balance Ratio an intuitive explanation Over-consolidation (could be removed) In Steady State: Pension Liability

  7. Balance Ratio Define Funds + “Pension Liability in SS” BR = Pension liability

  8. CA = C * T 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 100 95 Pension Liability in Steady State = Contribution Asset (CA) Pensions Contributions (C) age T Turnover duration Average age of contributor Average age of retiree ”...time is money”

  9. Assets BR = Liabilities C * T + F BR = D CA + F BR = D Balance Ratio

  10. Balance Mechanism BR >= 1.0

  11. 1,50 5.0% 1,40 Rate of return 1,30 3.25% 5.0% 3.25% 2% 1,20 1,10 1,00 2.0% 0,90 2000 2010 2020 2030 2040 2050 2060 2070 2080 2090 2.0%, with balancing Balance ratio,Demography = Baseline, growth = 2% over-consolidation ? Big surplus could be accumulated Asymmetric design

  12. ”Automatic balance mechanism”, some properties • Secure financial stability • regardless magnitude or type of financial strain • Allow less stable (“more socially attractive”) systems • deviation from desired indexation only if it is financially necessary • No forecasts, nerveless early reaction to protect liquidity • bookkeeping based on well defined, observable historical facts, increases transparency • Asymmetric construction can allow exploding buffer fund • we need rule indicating when the assets are to big

  13. 1,50 1,40 1,30 1,20 1,10 1,00 0,90 2000 2010 2020 2030 2040 2050 2060 2070 2080 2090 Task: Find the proper BRC level Balance Ratio Ceiling (BRC) Two guiding principles: • Relatively small increase in risk for balancing caused by earlier distribution (<5%) • Consider the intergenerational fairness

  14. Balance Mechanismrestoring the symmetry 1.00 <= BR <= 1.00 1.00 <= BR <= 1.01 1.00 <= BR <= 1.02 “Rule space” … … … 1.00 <= BR <= 1.19 1.00 <= BR <= 1.20

  15. The framework Swedish Pension Model (Micro) Base Line assumptions Pension liabilities • Randomization of • Labour participation • Real return on Buffer Fund • Inflation Different rules for asset distribution 1.00, 1.01, …, 1.20, none UTÖ Model (Cell based) Repeat it “lot of times” Aggregate sums, counts, (Average Gain & St. Dev.) With & Without the rule X Buffer Fund Contributions Pension benefits Balance Ratio (assets & liabilities) Analyse & make your choice Ready!

  16. Here next: Excel based analysis

  17. Recommendationfor the symmetric mechanism 1.00 <= BR <= 1.10

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