The next few decades will be a period of rapid demographic change that will present significant challenges to both public and private pension systems. In the next five decades, reasonably conservative estimates are that the proportion of the population aged over 65 in the developed world will roughly double. This shift in the age structure of the population will naturally create wide-ranging economic and political strains, particularly where pension provision relies extensively on pay-as-you-go systems that are inherently sensitive to demographic change.

In addition to stress caused by a shift in the age structure of the population, low fertility experience of many countries, particularly in continental Europe, will lead to substantial declines in the working age population in the next couple of decades. A decline in the availability of workers will pose challenges for firms who are likely to be under increasing pressure to attract and retain key workers. These pressures could lead to a growth in employer-provided pensions.

Reformed public DC plans typically contain a minimum benefit guarantee (DC-MB). This paper explores risk management techniques to control the cost of these guarantees in DC systems with minimum benefit guarantees (DC-MB). The paper finds two approaches are particularly useful. The first approach borrows an idea from the recent catastrophic insurance literature. The guarantee is placed over a ‘standardized’ portfolio, requiring agents to accept any ‘basis risk’ if they chose a non-standard portfolio. However, for large conversions from DB to DC-MB plans, in which there is little or no DB benefit remaining, the government must still worry about any ‘implicit guarantee’ that might extend beyond the standardized portfolio which might entice agents to accept a lot of basis risk (a ‘Samaritan's Dilemma’). The second method, therefore, uses a more brute force approach: private portfolio returns in the good states of the world are taxed while returns in the bad states are subsidized. Both options are very effective at controlling guarantee costs, and they can be used separately or together. Calculations demonstrate that all of the unfunded liabilities associated with modern pay-as-you-go public pension programs can be eliminated under both approaches even at a modest contribution rate.

Social Security is a financial asset whose ‘purchase’ is compulsory for most working individuals. This paper shows that the return on Social Security during the individual's working lifetime is related to the rate of change of aggregate labor income. If an individual's labor income is strongly related to aggregate labor income, then the Social Security asset is a particularly unattractive asset. In this situation, the individual would benefit from a reformed Social Security system that would permit investment of retirement funds in other financial assets. This paper investigates how this aspect of Social Security risk varies across groups of individuals who differ according to gender; education; race; and age. The main finding is that there are important differences across groups in this component of Social Security risk, as captured by the sensitivity of individual-level income growth to changes in the SSWI. This element of risk is most important for women, especially women who are young-to-middle aged and with more education. This analysis suggests that women would have more to gain, compared with men, from a reformed Social Security system.

Like most countries, China faces a rapidly aging population and a looming social security crisis. Prefunding and unifying a fragmented system are at the heart of the government's projected reforms that are intended to prevent this crisis. The Chinese plan to set up individual accounts to deal with these problems is retarded by three key factors:

1 transition costs must be covered in any move toward prefunding, and the Chinese government is still trying to figure out how to accomplish this;

2 the current social security system is characterized by fragmentation and decentralized administration, which lead to principal–agent/ moral hazard issues that make it more difficult to cover transition costs, decrease early retirement and increase compliance;

3 the funds that have accumulated have not been invested in diversified portfolios by competitive management and have not earned a high rate of return.

This paper focuses on these three problems as well as the complex interactions between pension, financial market and state-owned enterprise (SOE) reform. We summarize the bold steps that the government has announced during second half of 2001 to link pension, financial market and SOE reform.

During the past twenty years, swap contracts have become key financial ‘adapters’ linking diverse national financial systems to the global financial network. Today banks and investment companies around the world use swaps extensively to manage their currency, interest-rate, and equity-market risks and to lower their transaction costs. Yet pension funds, which have grown rapidly over that same 20-year period, hardly use swaps at all. This paper suggests how pension funds could use swaps to achieve the risk-sharing benefits of broad international diversification and hedging while avoiding the ‘flight’ of scarce domestic capital to other countries. The paper also shows how swaps can be used to lower the risks of expropriation and to lower the other transaction costs of investing in other countries.