FIAP > Boletín – Recientes > Pension Notes No.52 – The Notional Defined Contribution System: Analysis and International Experience – March 2021
22 June, 2021
Pension Notes No.52 – The Notional Defined Contribution System: Analysis and International Experience – March 2021
The PAYGO systems suffer from growing financial deficits due to population ageing, leading to constant adjustments of their key parameters, such as increasing the retirement age and the contribution rate, and reductions in the promised benefits.
Notional accounts have arisen as an alternative for countries that have not been able to incorporate individually funded elements, due to their inability to finance the cost of said transition. However, these systems do not generate a real accumulation of funds, but rather the contributions of each worker are recorded in fictitious individual accounts (not real), which serve as guidelines for calculating pensions, based on the notional or “Fictitious” accumulated capital, multiplied by a conversion factor that considers the life expectancy and the hypothetical yield of the funds, among others.
All the countries that have adopted the notional accounts system l have high contribution rates, in some cases up to almost three times the average in the individually funded systems of Latin American countries.
Notional account systems reduce the usual underfunding issues of PAYGO systems by incorporating automatic periodic adjustments.
Furthermore, the migration from a traditional PAYGO system to a notional accounts system, does not involve any fiscal transition costs.
Despite the above, the disadvantages of these systems compared to individually funded systems involve financial sustainability, since pensions continue to be financed mainly under PAYGO criteria, and in those cases in which they are partially financed with collective individual funding, there is a political risk that funds will be used for purposes other than those of the system. Returns are also calculated on a fictitious interest rate, anchored to past rather than market parameters. By not accumulating funds, there are no returns that multiply the available funds. Finally, there are no property or inheritance rights.
In view of the above, the migration from an individually funded to a notional accounts system clearly entails a setback and a significant loss for future pensioners.
