Backward-looking and Forward-looking NDC Pension Schemes

In order to spread notional capital accrued at retirement by members of a cohort over their own life expectancies, pay-as-you-go notional-defined-contribution (payg-ndc) scheme uses multipliers (different by retirement age) called conversion coefficients. These are backward-looking (b.l.) in that they relay on survival rates observed for previous cohorts in the past. Under increasing longevity, b.l. coefficients undervalue life expectancies, thus preventing full implementation of actuarial fairness (benefits equivalent to contributions) which is the main objective of ndc scheme. They also engender chronic deficits. Forward-looking (f.l.) coefficients, relaying on forecast survival rates, can improve actuarial fairness. Nevertheless, they face a rather serious political difficulty in that forecasting tools are fallible. This explains why switching to f.l. coefficients is unable to gain social consensus. Apart from this, the paper shows that f.l. coefficients produce ‘overshooting’. In fact, they generate chronic surpluses. The paper also shows that frontloading pension profile helps sustainability because it reduces both surpluses and deficits generated, respectively, by f.l. and b.l. approaches.