Sandro Gronchi ( La Sapienza University of Rome) Implementing the NDC model: a comparison between Italy and Sweden
The NDC scheme guarantees actuarial fairness The principal purpose of the NDC scheme is to preclude differences in individual returns on contributions, so as to guarantee actuarial fairness. The NDC scheme conceives the pay-as-you-go system as a virtual bank in which the contributions are deposited up to retirement and from which the pension annuities are withdrawn afterwards. The deposit-exhaustion constraint must be satisfied which means that (on the average) the account balance must be zero after the last annual benefit has been withdrawn. In other words, the money withdrawn must equal the money deposited, including the interest accrued. The deposit-exhaustion constraint relies on conversion coefficients which are entitled to spread the notional capital accrued at retirement over the life expectancy.
The NDC scheme guarantees sustainability The NDC scheme can also ensure sustainability if personal accounts are awarded with a sustainable rate of return. The question is: which is such a rate? In the presence of constant longevity, the sustainable rate is proved to be equal to the wage bill growth rate. In the presence of increasing longevity, the sustainable rate can be determined by monitoring the distance between the mean age at which contributions are deposited and the mean age at which pension annuities are withdrawn. Such a method is called the balance mechanism
Sweden and Italy: different rates of return on contributions A first difference concerns the rate of return on contributions ( indexation rate in the Swedish glossary). Swedish rate appears to be sustainable in the long run since it was put equal to the nominal wage growth adjusted by the balance mechanism. The latter is intended to take into account not only increasing longevity but also variations in employment. The Italian rate of return is at risk since 1) it is the nominal GDP growth instead of the wage bill growth, 2) it takes no precaution against increasing longevity.
Sweden and Italy: different indexation mechanisms A second difference concerns the indexation rate, i.e. the rate at which a pension evolves over time ( adjusting rate in the Swedish glossary). Making retirees return equal to workers return is committed to the indexation rate which must be equal to workers return minus the quota eventually credited to conversion coefficients. The Swedish rate is actuarially right since it equals the rate of return of active workers minus 1.6% credited to conversion coefficients. The Italian rate is actuarially wrong since it equals inflation (instead of the rate of return of active workers minus 1.5% credited to conversion coefficients). Such a choice produces different returns for workers and pensioners which betray actuarial fairness.
Sweden and Italy: different retirement rules A third difference concerns the retirement rules. Notice that the free choice of retirement age (within a reasonably wide range) is a value that the NDC scheme is conceived to allow for. In fact those who retire earlier actually self-finance their choice by accepting lower conversion coefficients. Freedom is not safeguarded by the Italian legislation. Indeed it was safeguarded in the 1996 original draft, but later on retirement rules were very much restricted and now they wrongly refer not only to age but also to contribution seniority. No such neglect is to be found in the Swedish legislation where retirement rules are based on age alone and workers are allowed to retire from 61 to 67 independently from gender.
Sweden and Italy: different survivor choices A fourth difference concerns the survivor benefit. In this area both NDC reforms retained the pre-existing rules. Sweden has retained a 1990 law that had abolished the survivor s pension. Italy kept the survivor s benefit though women s participation rate is increasing. Sweden has retained a 1990 law that had abolished the survivor s pension. Italy kept the survivor s benefit though women s participation rate is increasing. Italy kept the survivor s benefit though women s participation rate is increasing. The Italian choice requires higher contribution rates in order to prevent too low replacement rates. In fact survivor benefit tends to lower annuities because the notional capital accrued at retirement must be spread over a longer period.
Sweden and Italy: different updating of the conversion coefficients The fifth difference concerns the updating of the conversion coefficients. Notice that three main needs should be taken into account: 1) system sustainability requires continuous updating, 2) on the contrary, workers right to plan retirement requires stability, 3) updating must prevent intra generational inequalities, i.e. different mortality tables must not be imputed to individuals in the same cohort. Sweden was able to reconcile these three needs by devising an updating procedure that assigns temporary conversion coefficients to each cohort at the age of 61 which are substituted by definitive coefficients at 65. Italy has chosen an updating procedure that does not satisfy any need. The 1996 reform established that updating takes place every ten years, now insufficiently reduced to three, and that the new coefficients apply to all workers regardless of cohort. Therefore the procedure 1) does not guarantee sustainability, 2) does not allow workers to plan their retirement on the basis of stable coefficients, 3) imputes different mortality tables to individuals in the same cohort.
Sweden and Italy: different tax rates The sixth difference concerns the tax rate. Notice that uniqueness of the rate is essential for sustainability of NDC systems since it prevents temporary unbalances due to changes in the distribution of the overall employment between categories paying different rates. Italy has an overall tax rate of 33% for payroll employees and of 20% for the self-employed. In Sweden the overall tax rate is slightly less then 15% both for payroll employees and for self-employed. Sweden s enormously lower contribution rate is only partly reflected in lower replacement rates, mostly thanks to the absence of survivor s benefits.
Sweden and Italy: different organizations of the pension system Notice that also uniqueness of the pension system is essential for sustainability since fragmentation into different occupational funds generates unbalances (even if the contribution rate would be the same for all funds) due to different growth rates of labor categories. In Italy the NDC reform was not able to unify the pension system, which remains divided into a number of different funds. In Sweden the pension system is totally unified.