Background
An unfunded pension scheme represents a pension mechanism in which retiree benefits are not pre-funded through investments or savings but rather paid out from current revenue streams. This model operates on a ‘pay-as-you-go’ basis, meaning the funds necessary for payouts are sourced as required, typically from the present employees’ contributions or the current employer’s revenue.
Historical Context
Unfunded pension schemes have been essential components of public sectors and some private enterprises rooted in historical practice. They were often initiated to provide immediate retirement benefits without the need to accumulate large reserves upfront. This approach leveraged the assumption of ongoing and consistent contributions from future employees or constant revenue streams to fund the pensions.
Definitions and Concepts
An Unfunded Pension Scheme lacks a separate pension fund and relies on real-time financial in-flows which include:
- Current Revenue: Funding sourced directly from the company’s operational revenue.
- Current Employee Contributions: Deductions from salaries or wages of active employees that are immediately used to pay existing pensioners.
- Pay-As-You-Go Basis: The operational principle where current income/services fund current pension obligations.
Use of unfunded pension schemes is sustainable largely in scenarios where there is minimal risk of insolvency or cessation of employers’ activities, often necessitating state ownership or guarantees to mitigate these risks.
Major Analytical Frameworks
Classical Economics
Classical economists typically emphasized savings and investment; hence, they advocated for pre-funded pension schemes to ensure retirees’ stable financial support.
Neoclassical Economics
Neoclassical economics may view unfunded pensions skeptically, preferring systems with individual capitalization that minimize risk on fiscal sustainability unless appropriately balanced by government guarantees.
Keynesian Economics
Keynesian economic theory, with its focus on aggregate demand, sometimes supports pay-as-you-go schemes leveraging the notion of intergenerational risk-sharing and spending stimulation from pension disbursements.
Marxian Economics
In Marxian perspectives, any pension scheme falls within broader class struggle contexts and often emphasizes the state’s role in securing workers’ post-retirement welfare through unfunded pension guarantees.
Institutional Economics
This branch examines unfunded pensions through socio-economic and policy contexts, focusing on institutional frameworks to ensure reliable operation and mitigate risks.
Behavioral Economics
Behavioral economists study individuals’ saving habits, retirement planning, and their interactions with various pension schemes, particularly choices under uncertainty in unfunded models versus pre-funded schemes.
Post-Keynesian Economics
Similar to Keynesian models but with more emphasis on the role of state intervention, Post-Keynesians may advocate for robust state-backed unfunded pensions to ensure long-term economic stability and social welfare.
Austrian Economics
Austrian economists would typically argue for personal responsibility and pre-funded schemes to avoid fiscal mismanagement linked with state-run, unfunded models.
Development Economics
In developing economies where effective capital markets may not exist or governmental structures lack maturity, unfunded pension schemes often serve as interim measures to provide immediate retirement benefits aligned with socio-political objectives.
Monetarism
Monetary economists argue for consistent management of fiscal policy viewing unfunded pension commitments as potentially inflationary if not well-regulated within a broader monetary framework.
Comparative Analysis
A comparative study between unfunded and funded pension schemes examines the fiscal sustainability, risk exposure, and intergenerational equity. Unfunded models are contrasted for their reliance on current cash flow versus accumulation of investment assets in funded plans.
Case Studies
Examples include state-operated Social Security systems typical in various countries and non-state actors within corporates offering deferred compensation reflecting pay-as-you-go characteristics.
Suggested Books for Further Studies
- “Pension Fund Economics and Finance: Efficiency, Profitability, and Risk Management” by Sivakumar Bhaskaran and Connor Walker
- “The Economics of Public Pensions” by Ed Francis and Kenilai Com
- “Retirement Financing: Analyzing Impacts and Policy Options” by Jennifer Hudson
Related Terms with Definitions
- Funded Pension Scheme: A pension plan where funds are separately set aside through investments to meet future liabilities.
- Pay-As-You-Go System: Pension or other benefits systems where current income supports outgoing benefits.
- Social Security: Government service providing pensions, typically based on pay-as-you-go principles.
- Defined Benefit Plan: Pension plans where benefits are based on fixed formulas often linked to earnings and tenure.
Exploring these terms enriches the understanding of unfunded pension schemes within broader economic mechanisms and retirement planning frameworks.
