Intergenerational value transfers within an industry-wide pension fund —a value-based ALM analysis

Abstract

Intergenerational solidarity is an important topic in the increasing interest in collective pension schemes. How great is this solidarity? Is there a balanced sharing of costs and benefits across age cohorts? The long-term sustainability of any pension scheme stands or falls by the willingness of members to continue to participate; the attitude of younger persons is crucial in this regard.

In this chapter we set out a method by which we can illustrate the way in which the value transfer between generations within an industry-wide pension fund occurs. This method - which we term value-based generational accounting - is ideally suited to investigating how far current policy itself, and changes to that policy, result in a balanced sharing of costs, benefits and risks across the generations participating in the pension fund. The method thereby also forms a good basis for justifying (in advance and in retrospect) the policy that is pursued.

We begin the chapter by explaining the method of value-based generational accounting. We deduce from this that a pension fund can be characterised as a 'zero-sum game'. A change in policy does not create extra value, but does result in a redistribution of value between the parties involved in the pension fund. We then examine the generational effects for a standard industry-wide pension fund the pension fund policy regarding investments, contribution rate setting and indexation policy.

We pay no attention on transfers between members as a consequence of the operation of the uniform contribution rate. We regard this practice as a given. The contribution by Boeijen et al. in this book deals specifically with the pay-as-you-go element from younger to older employees, making use of the technique explained in that chapter. In addition, value transfers can also occur within a cohort. This topic is the focus of the contribution of Aarssen and Kuipers in this book.

It is our view that the proposed method is a valuable addition in the evaluation of current policy and policy variations. The approach of value-based generational accounting should therefore form a part of the decision process regarding the financing policy of the fund. This can prevent undesirable and/or unintended value transfers between generations. The proposed method can assist in searching for a set of policy parameters whereby transfers do not take place, or if they do, they are of acceptable size.

We owe a debt of gratitude to Niels Kortleve for our many discussions on this topic, to Roderick Molenaar for the construction of the deflator set and to Alexander Paulis and Jo Speck for the allocation of the actuarial cash flows to the various generations.