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OECD’s Take on Changes to Pension Funding Rules Needed to Promote DB Plans

Posted by on Jul 26, 2010 in Retirement | 0 comments

A July 2010 report by  Juan Yermo and Clara Severinson for the OECD discusses the impact of the crisis on DB pension schemes and the temporary responses taken by regulators to help ease financially strained plan sponsors.

Furthermore, the paper presents suggestions to governments and policy-makers for making funding regulations more counter-cyclical in nature. Such measures could strengthen the security of DB benefits and help to maintain DB plans for future workers.

The policy measures suggested include the following:

  • Avoid excessive reliance on current market values for purposes of determining contributions. Disclosure to plan stakeholders based on current market values of pension assets and liabilities may be appropriate to increase transparency, and the use of current market values could improve risk management. However, regulators should operate flexibly when reviewing ascheme’s funding position or regulators should enable pension funds and plan sponsors to dampen somewhat the volatility of market prices when determining contributions.
  • Set minimum funding levels or targets that are consistent with the goal of benefit security. In particular, the level of funding needed by pension funds in a particular country depends on what other type of security mechanisms are in place – such as pension guarantee or insurance schemes – to protect scheme assets and members from the pension fund’s or plan sponsor’s insolvency.
  • Allow appropriate levels of over-funding in good economic times via more flexible tax ceilings. One possibility that could be explored in the wider context of country-specific regulation, is for maximum contribution or funding ceilings to span a multi-year period rather than be set on an annual basis to allow greater management of cash-flows by the plan sponsor. Governments should also consider raising the maximum level of surplus before contributions must be suspended.
  • Limit Contribution Holidays and Plan Sponsor Access to Surplus. Regulators should consider restricting the extent to which plan sponsors can take contribution holidays, offer additional benefits or withdraw a portion of pension fund surplus, for example, only allowing them when a certain level of funding above the minimum level is reached.
  • Encourage Stability of Long-Term Contribution Patterns via Appropriate Actuarial Methods. Actuarial funding methods should be transparent. The actuarial funding methods that lead to smoother contribution patterns could be encouraged by regulators.
  • Incorporate flexibility into funding rules to reflect the overall volatility of funding valuations. While the primary goal of a pension plan is to provide secure benefits to plan members, funding regulations should aim at avoiding undue pressure on plan sponsors at times when their own profitability or even continuity is under pressure. For instance, regulators could take into account the overall volatility of funding levels when setting the recovery periods required for pension funds to eliminate funding deficits. The level of flexibility of funding rules will also depend on other factors such as the extent to which the fund can rely on additional plan sponsor contributions.
  • Avoid over-regulation and maintain a stable regulatory environment. The regulatory framework needs to be robust in order to provide a high degree of benefit protection. It is also important to strike the right balance between stability and flexibility in funding rules. Changing rules too frequently can lead to additional volatility in pension funding. Policymakers should therefore avoid continuously changing and excessively complex regulation as this could discourage plan sponsors from making long-term pension promises.

The paper also considers the question of convergence in pension funding regulations. It considers that the international standardization of funding regulations is unlikely and that in any case it would risk being ill-fitting across jurisdictions. However, some convergence of over-arching funding principles to promote counter-cyclical features as discussed in this paper could strengthen DB systems. This could be 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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