Book reviews for The Journal of Pension Economics and Finance reflect reviewers' own views and in no way represent the views of the institution(s) with which they are affiliated.
The concept of notional defined contribution (NDC) was formulated in the early 1990s and implemented from the mid-1990s in Italy, Latvia, Poland and Sweden. At the time of the reforms these countries faced different problems: Italy, Latvia, and Poland had to deal with urgent matters of financial stability (i.e. how to finance legacy benefits and privileges and how to raise retirement age, especially for women), while Sweden had other priorities. The driving force for reform derived from the need to ensure transparency in the pension system, with the greatest possible intergenerational fairness and financial stability in the long run, regardless of demographic and economic cycles.
In these countries, as in the case of most public pension systems, current pension expenditure was financed by the contribution revenues, in accordance with the PAYG principle. The innovative idea was to switch over to the award formula and indexation rule typical of funded, defined contribution systems.
The pension system thus becomes a sort of ‘virtual bank’ where individuals are the holders of a bank account in which contributions are first deposited and subsequently withdrawn month by month as pension (with insurance for the ‘longevity risk’). This particular pension system does not contemplate any capital accumulation; any buffer fund there may be constitutes a tool in the hands of the administration to achieve objectives more socially useful than boosting the system funding.
The new scheme created thus allowed for the elimination of work disincentives and the non-transparent redistributions of traditional defined benefit (DB) schemes, ensuring an essential uniformity in the implicit returns to system participants without the transition costs and risk shifting that occur in the context of a switch to a funded defined contribution (DC) scheme.
The birth of virtual capitalisation systems (NDC) may arguably be seen as a major ‘genetic innovation’ in the run of public pension systems. Here, a significant contribution to putting this innovative approach into circulation came from the World Bank and the Swedish Social Insurance Agency, through the two conferences of Sandhamn (September 2003) and Stockholm (December 2009) and relevant publications, respectively in 2006 and 2012.
‘Progress, Lessons and Implementation’, the first of the two volumes based on the 2009 reports and discussions with the benefit of excellent editing, brought light to bear on over a decade of experience in the first countries to have adopted the NDC system, illustrating the response of the system to the recent economic crisis and progressive increase in average life expectancy, as well as the progress so far made in countries going through total or partial transition towards the new scheme.
In the first, introductory chapter R. Holzmann and E. Palmer illustrate the issues addressed in the publication, outlining the general conclusions, while in the second chapter Chlon-Dominczak, Franco, and Palmer enter into detailed scrutiny of the first NDC pension systems implemented in the 1990s. Some interesting and curious aspects emerge in discussion of the debate that led to definition of the new pension systems. In Sweden, for example, discussion of the rate of notional capitalisation to be adopted lasted from 1992 to 1994, eventually favouring the growth rate of the average wage rather than growth of the total payroll. The fruit of Sweden's wide-ranging debate is a model constituting standard reference for countries moving on to NDC or contemplating the possibility.
In Italy, on the other hand, the process of NDC reform shows up the negative repercussions of failure to conduct open and inclusive debate in terms both technical (for example, the coefficients used to compute the annuities were to be revised every 10 years, beginning in 2005) and political (successive governments have made a series of modifications that clash with the contributory principle).
The author of Chapter 3, Whitehouse, looks into an issue widely debated amongst economists. The question is whether DB systems can, with due modification of the parameters, achieve the same aims of fairness and sustainability typical of the NDC systems. In this respect, the critical remarks of the authors commenting on the chapter are by no means unanimous. The advocates of NDC systems highlight that the modifications to be made to the DB systems decrease unavoidably the degree of transparency of the pension system and the confidence of the citizens.
In the second part of this book readers are immediately presented with the opportunity to weigh up the differences of opinion through the analysis of the reform recently introduced in Norwegian legislation set out in Chapter 4 by Christensen, Fredriksen, Lien and Stolen. Many of the components of a complete NDC scheme have been introduced in the Norwegian pension reform as from 2011 (adjustment of pensions for changes in life expectancy, flexible retirement from age 62 based on actuarial neutrality, and new rules for pension indexation), but the new Norwegian scheme is only quasi-NDC in the sense that there is no mechanism linking the final balance with the demographic and macroeconomic environment.
Part II also offers studies of the recently legislated NDC reform in Egypt and of proposals for NDC-type reforms in China and Greece. In Chapter 5, Maait and Demarco illustrate the origins and structure of Egypt's NDC reform, introduced in June 2010 but yet to be finally implemented due to the social-political vicissitudes following upon the Arab spring of 2011. In connection with Egypt's NDC pension system reform, it is worth noting a feature not generally contemplated in NDC systems, namely the indexation of NDC individual accounts with the average annual interest rate on government bonds and Treasury bills, with a guaranteed minimum rate equal to GDP growth.
Bingwennel, in Chapter 6, and Oksanen, in Chapter 7, analyse the various options for reform of China's patchy pension system along the lines of a hybrid system with FDC and NDC components. Using the China Pension-System Simulation Model, various NDC reform scenarios are opened up, providing evidence of the macroeconomic effects in terms of projection of the balance between contributions and expenditure, and of the assets accumulated by the system.
The hasty reform of the Greek pension system implemented in the first half of 2010 in order to respect the economic adjustment programme (European Commission 2010) provided the cue for Nektarios to propose, in Chapter 7, a reform project based on the Swedish NDC model with the aim of restoring the confidence of the Greek people in the nation's long-term pension commitment.
Volume 1 closes with Chapter 9, where Fajnzylber and Robalino compare the impact on fiscal expenditures and the distribution of pensions resulting from the introduction of an F.D.C. type of scheme with that of an NDC type, taking reference from the case of Chile. In other words, the article illustrates the consequences of the hypothetical adoption of an NDC type system in Chile instead of the 1981 reform, which, by contrast, provided for transition towards a fully funded scheme. From the microeconomic point of view, the article consists in verification of a concept widespread among economists, namely the alleged ‘superiority’ in terms of the returns accruing to the participants in capitalisation systems (linked to financial market returns) over the PAYG systems (linked to real economic growth).
Some NDC systems have shown serious criticalities calling for intervention to guarantee greater actuarial equity and/or to improve the financial sustainability of the system.
In particular, reference is to Italy, called upon to correct the ‘incongruities’ that have emerged with the system and, above all, those created by a series of clumsy interventions by politicians intent solely on filling the government coffers without a thought for the rationale on which the new system was based. Reference here is in particular to the pension adjustment mechanism, flexible retirement, the inequalities created in applying annuity divisors (by age rather than birth cohort) and the failure to separate old-age pension from social assistance with clear identification of the relative sources of financing.
On the contrary, Sweden has another major challenge to face up to, for it will have to achieve greater equity amongst the various generations, minimising the equalising impact of A.B.M. and determining when and to what extent it may prove expedient to resort to buffer funds.
