Increasing life expectancy and self-stabilizing pension systems

A comparison between the Swedish and the Austrian model


Markus Knell, Austrian National Bank (Austria)


In this presentation I discuss, how pay-as-you-go pension systems can be designed such that they remain financially stable in the presence of increasing life expectancy. I will particularly focus on the notional defined contribution (NDC) type that has become quite prominent over the recent decades and is used in an increasing number of countries (starting with Sweden). I will contrast the main properties of the NDC system (a “contribution based account system”) with the working of the Austrian APG (a “benefit based account system”). I show that a NDC system is able to automatically react to increasing life expectancy if two crucial parameters are set in an appropriate way. First, the remaining life expectancy (used for annuitization) has to be based on a cross-section measure and, second, the notional interest rate has to include a correction for labor force increases that are only due to rises in the retirement age which are necessary to “neutralize” the increase in life expectancy. It is shown that the self-stabilization is effective for various patterns of retirement behavior and also – under certain assumptions – if life expectancy reaches an upper limit. The Austrian APG currently does not include any mechanism that reacts automatically to increases in life expectancy (or to other demographic fluctuations). I argue that in principle one could modify the rules of the APG such that it would “mimic” the properties of the Swedish model. This, however, would imply that crucial parameters of the system (like the “reference retirement age“, the “reference years of contributions”, the “accrual points” and also the deductions and supplements for late or early retirement) had to be changed regularly (preferably annually). While technically possible, this could turn out to be a politically quite challenging task.