Downsides of actuarial fairness in occupational pensions

One type of collective funded pension systems features uniformity pricing (U.-P.), whereby each year of the active life, participants contribute a stable percentage of their income, allowing them to accrue stable annual pension rights to exercise throughout the retirement phase. In turn, the timing of the contributions, and so the effective return on investment they generate, is not accounted for. The collective nature of the system calls for unique contribution and annuitization policies, which, at the aggregate level, ensure that the fund can honor all pension promises without externally-sourced financing. Not everyone contributes to ensuring such financial soundness equally. Indeed, ignoring the investment horizon of pension contributions causes pension benefits to be backloaded, hence benefitting participants who experience significant labor income growth throughout their careers. In turn, U.-P. makes winners and losers. Turning to a more actuarially fair system can be done via making either contribution or accrual rates variable across time. In the former case, the pension system is of the defined-benefit type; in the latter case, it is of the defined-contribution type. This change can be ex ante organized to ensure equal levels of financial soundness for the pension fund, pre- v. post-reform. However, we highlight that new contribution or annuitization policies may cause participants to retire sooner, and even more so if their contribution to the balance sheet of the fund is significant. If this behavioral response is not anticipated, we show that the new policies of the fund are likely inefficient by causing participants to save improper amounts, and that the government experiences a significant loss in tax revenue. Such effects are amplified when participants’ levels of career income growth and life expectancy are positively correlated.