Understanding the Effect of Market Risks on New Pension System and Government Responsibility

TL;DR

This paper analyzes how market risks affect the sustainability of the New Pension System by using Monte Carlo simulations to model risks and assess the potential for corpus depletion and government costs.

Contribution

It introduces a quantitative approach using Monte Carlo simulations to evaluate market risk impacts on NPS sustainability and government financial exposure.

Findings

Market risks can significantly threaten pension corpus sustainability.

Monte Carlo simulations effectively model risk impacts on pension funds.

Government costs to hedge risks are quantifiable and substantial.

Abstract

This study examines how market risks impact the sustainability and performance of the New Pension System (NPS). NPS relies on defined contributions from both employees and employers to build a corpus during the employee's service period. Upon retirement, employees use the corpus fund to sustain their livelihood. A critical concern for individuals is whether the corpus will grow sufficiently to be sustainable or if it will deplete, leaving them financially vulnerable at an advanced age. We explore the impact of market risks on the performance of the corpus resulting from the NPS. To address this, we quantify market risks using Monte Carlo simulations with historical data to model their impact on NPS. We quantify the risk of pension corpus being insufficient and the cost to the Government to hedge the risk arising from guaranteeing the pension.