Countercyclical policies required to save DB: OECD

The Organization for Economic Cooperation and Development’s (OECD) latest report The Impact of the Financial Crisis on Defined Benefit Plans and the Need for Counter-Cyclical Funding Regulations, argues that countercyclical funding policies—such as better tax ceilings for over-funded pension plans—should be promoted by regulators in order to shore up the DB market. These policies should be internationally coordinated, it adds.

“Three essential goals of pension plan funding are the long-term viability, stability and security of member benefits,” write the report’s authors. “Reform of funding regulations for DB pension plans to make them more counter-cyclical in nature can help achieve these goals as well as make DB schemes more attractive to plan sponsors that are increasingly moving away from DB towards defined contribution plans.”

The paper offers the following measures regulators should take to make DB plans more counter-cyclical:

• avoid excessive reliance on current market values for purposes of determining contributions;
• set minimum funding levels or targets that are consistent with the goal of benefit security;
• allow appropriate levels of over-funding in good economic times via more flexible tax ceilings;
• limit contribution holidays and plan sponsor access to surplus;
• encourage stability of long-term contribution patterns via appropriate actuarial methods;
• incorporate flexibility into funding rules to reflect the overall volatility of funding valuations; and
• avoid over-regulation and maintain a stable regulatory environment.

One possibility explored in the report is for maximum contributions or funding ceilings to span a multi-year period, as opposed to an annual basis, to allow greater management of cash-flows by the plan sponsor. Also, it recommends that governments consider raising the maximum level of surplus before contributions must be suspended.

“Actuarial funding methods should be transparent,” says the report. “The actuarial funding methods that lead to smoother contribution patterns could be encouraged by regulators”.

The OECD recommends that funding principles should be harmonized on an international scale, but warns against mandatory international standardization that might be “ill-fitting across jurisdictions”.

Principles could instead be developed and “complemented by general international best-practices and guidelines on how to determine minimum funding contributions and assets and liabilities and by further developing the OECD Guidelines on Funding and Benefit Security”.

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