Why increasing longevity may favour a PAYG pension system over a funded system

Area of Science:

• Economics
• Demography
• Public Policy

Background:

• Traditional pension system analyses often use simplified demographic models with constant mortality rates.
• Existing models may not accurately capture the financial implications of increasing longevity.

Purpose of the Study:

• To investigate the impact of increasing longevity on the relative advantages of pay-as-you-go (PAYG) versus funded pension systems (FS).
• To challenge the conventional use of time-invariant mortality in demographic models for pension system comparisons.

Main Methods:

• Utilizing demographic models that incorporate increasing longevity.
• Contrasting the financial implications of PAYG and FS under evolving population dynamics.

Main Results:

• Increasing longevity makes the PAYG system more advantageous than the FS.
• For longer-living workers, funding current pensions is less costly than funding their own future retirement.
• The current effect of increasing longevity on pension systems is substantial, exceeding traditional biological interest rate considerations.

Conclusions:

• The PAYG system may be superior to the FS in populations with increasing longevity.
• Demographic models for pension analysis should account for time-varying mortality.
• Policy implications for developed countries suggest a potential shift in optimal pension system design.