Topic 4: The Pension Design Framework
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Learning Objectives
After reading this topic, you should be able to answer these questions:
- What is the implication of classical, bounded, and ecological rationality?
- How does ecological rationality explain national pension system design?
- What explains the variations in national pension system design?
What do we Mean by Design?
Kumaragamage (2011) broadly defines design as
“a roadmap or a strategic approach for someone to achieve a unique expectation. It defines the specifications, plans, parameters, costs, activities, processes and how and what to do within legal, political, social, environmental, safety and economic constraints in achieving that objective.” (as cited in Schwittay, 2014)
Pension system vary considerably in their emphasis on the ‘five pillars’ in different countries. Individual countries have pension systems that have design features and emphasis that are specific to them. However, these national pension systems also have design features that are common across countries. How can we explain this common but differentiated framework of national pension systems across countries? This is the focus of the discussion in this topic. The goal is to identify an approach that integrates our understanding of rationality and social contracts developed in the previous topics and explains not only the common attributes but also the relative emphasis on the pillars that constitute the national pension systems.
The identification of a framework of pension design is important, as it helps national pension systems respond to challenges like increases in longevity, changes in the labor market brought about by technology and globalization, in an analytical and consistent manner.Without understanding the common framework underpinning pension design and its different characteristics, expediency and adhocism is characteristic of the policy response to challenges to sustainability of pensions and old age security. An example of expediency and adhocism, often driven by asymmetrical vested interests is the popularisation of the defined contribution plans by the financial services industry and policy makers. The defined contribution plans are set as the default and only alternative to the “failing” defined benefit plans. The evidence from the 401(k) plans in the United States, the only large-scale implementation of defined contribution pension plan design, show that such plans have been unsuccessful in securing the retirement finance for the majority of workers (EBRI, 2016, 2017). Nonetheless, such defined contribution plans continue to be adopted as the default alternative to the withdrawal of defined benefit plans in occupational pensions.
Perspectives on Rationality & Pension Design
The alternative perspectives of intertemporal choice and decision behavior that emerge from the three different approaches to rationality discussed earlier, have implications for design governance and investment of pensions.