Pensions' indexation rules and pensions' expenditure sensitivity to economic growth and demographic shocks

Pension indexation on prices has mitigated the inflationary effects of population aging on pensions. Indexation on prices, however, has several disadvantages, decorrelating income of active and retired employees and bringing uncertainty on the financial balance of the pension system. Following a discussion launched by the Pension Monitoring Committee, this study considers several alternative scenarios in which an indexation of pensions to average wages is modulated by a corrective term to directly manage demographic uncertainty. Using INSEE’s microsimulation model Destinie, we analyze the long-term consequences of these scenarios, through several indicators : the mass of pensions relative to the mass of wages (financial ratio), the average pension relative to the average wage and the net replacement rate of people retiring. As expected, the indexation on average wages significantly reduces the sensitivity of the three indicators to the economic assumptions. The financial ratios for the various economic scenarios lie within a range of one percentage point. The level reached by the financial ratio depends on the magnitude of the given demographic correction. The financial ratio would decrease by one percentage point with a uniform correction of -1.5 point per year and increase instead of two points with a correction based on the ratio between active and retired employees. The financial contribution between old and new retirees also depends on the choice of the corrective term.