Smoothing the Waves of the Perfect Storm: Changes in Pension Funding Rules Could Reduce Cyclical Underfunding

Abstract

Defined-benefit plans experienced difficulties after interest rates and asset prices fell after 2000. Interest rate and asset price declines are typical for a recession, when earnings are low. Current funding rules exacerbate this regularity by directly linking the valuation of liabilities and assets to short-term fluctuations, requiring greater contributions when times are bad. We design three funding rule changes and evaluate these changes for the period 1952–2002. The results indicate that our changes would have constituted an improvement over current rules. Contributions would have been smaller and their volatility lower, required contributions during bad economic times would tend to be less, and the funding adequacy levels would generally be higher.