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Demographic aging renders workers vulnerable to the inherent uncertainty of
unfunded social security systems. This realization has set off a global wave of social
security reforms, and more than 20 countries have set up Individual Accounts (IA) plans
in response. Strengths of IAs are that participants gain ownership in their accounts, and
they also may diversify their pension investments; additionally they produce a
capitalized, funded system that enhances old-age economic security. While IAs reduce
the risk participants face due to unfunded social security system, holding capital market
investments in IAs could expose participants to fluctuations in the value of their pension
assets. Concern over market volatility has prompted some to emphasize the need for
“guarantees” of pension accumulations. This paper offers a way to think about
guarantees in the context of a reform that includes Individual Accounts. We illustrate
that guarantee costs can be important and they can vary significantly with time horizon,
investment mix, and guarantee design. The findings indicate that plan designers and
budget analysts would do well to recognize such costs and identify how they can be
financed.
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