What does inter-generational risk-sharing mean?
The main justification for defined benefit plans and hybrid schemes is that they allow for risk-sharing between generations – sometimes referred to as inter-generational solidarity. Pension funds are able to spread surpluses and shortfalls forward in time. In the event of disappointing investment returns, not only current generations, but also future generations bear some of the burden. Of course, in the event of returns exceeding expectations the reverse holds true – both current and future generations share the benefits. Inter-generational risk-sharing means that – with given contribution rates and investment policy – the volatility of pension outcomes is reduced. Economists estimate the welfare gains to reach as much as six percent of wage income, which is equivalent to two years of work for an average employee.
