Differentiating indexation in Dutch pension funds

Funded social security programs are particularly vulnerable to economic and financial market shocks. As a consequence of the recent crisis, a large fraction of the Dutch pension funds had to submit restoration plans for the recovery of their bu¤ers. Such plans will have to rely primarily on a mix of reduced benefit indexation and increased pension contributions. Hence, a discussion has now emerged whether indexation should be differentiated across the variousgroups of participants in a pension fund. We investigate this issue numerically, developing an applied many-generation small open economy OLG model with heterogeneous agents. The pension system consists of a first-pillar PAYG component and a second pillar with a pensionfund. In our stochastic simulations, we hit the economy with a variety of unexpected demographic, economic and financial shocks. We compare uniform indexation of pension rights across all fund participants with alternatives such as status-contingent indexation in which pensions are protected against price inflation. While the aggregate welfare consequences are small, group-specific consequences are more substantial with the workers and future born losing and retirees benefitting from a shift away from uniform indexation. Those welfare shifts are the result of a systematic redistribution of welfare rather than shifts in the benefit of risk sharing provided by the system. These results are robust to realistic variations in the initial funding ratio and the equity premium. Under all indexation schemes, the average indexation rate has to decline over time to maintain the fund’s sustainability in the wake of increasinglongevity. An increase in the retirement age that leaves existing pension rights untouched does little to avoid this decline.

Netspar, Network for Studies on Pensions, Aging and Retirement, is a thinktank and knowledge network. Netspar is dedicated to promoting a wider understanding of the economic and social implications of pensions, aging and retirement in the Netherlands and Europe.

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