Optimal Balance Between Funding and Payg Pensions: the Case of NDC Pensions

The prospect of a persistent low interest environment has revived the debate on payg versus funding for pensions. This paper analyses the optimal balance between funded and payg from a portfolio perspective following the seminal contribution of Matsen-Thøgersen (2004). Whereas these authors focus on the trade-off between the gains of risk sharing and the cost of the transfer to the previous generation inherent to payg pensions, we make a careful distinction between efficiency and distributional aspects. This allows us to focus exclusively on efficiency when optimizing the balance between payg and funding. To do so, we specify a Notional Defined Contribution (NDC) system that allows for mutual risk sharing of financial and economic risks between generations. In general, we find larger optimal payg shares than Matsen and Thøgersen which are more in line with real world payg shares.