The welfare consequences of the recent major proposals for public pension reform, prefunding, coverage reduction, and privatization, are analyzed, taking account of adverse selection in annuity markets. Prefunding is shown to reduce the premium for private annuities and improve the welfare of every individual if the economic growth rate is lower than the interest rate. A higher replacement ratio is shown to increase the premium for private annuities and reinforce the relative cost advantage of public pensions. The analytical results give an economic rationale to maintaining a large pay-as-you-go program even in the situation of the economic growth rate being lower than the interest rate. Also examined are the welfare effects when incorporating the amortization of the unfunded pension debt, as well as the necessity of imposing a minimum coverage regulation on private annuity contracts when privatizing the public program.
For these decades the economies in most of the industrial countries have been growing at slower rates than the interest rates and the populations are getting older. Under such economic and demographic conditions, their public pension programs are requiring more contributions than ever. One of the reasons is attributed to the pay-as-you-go financial schemes and several reform plans are controversially proposed. In this chapter I will focus on the following three major proposals: prefunding, coverage reduction, and privatization.
These proposals share the same idea that in a graying society longevity insurance should be provided by the market rather than the government. Prefunding proposals attempt to switch the financial scheme from pay-as-you-go to fully-funded. Coverage reduction proposals advocate to reduce the replacement ratio of the public program and make private annuities play as important a role as public pensions when people finance their