Why the Deisgn of Maturing Defined Benefit Plans Needs Rethinking

Abstract

This article explains why and how maturing defined benefit pension plans become increasingly unstable if they maintain asset mix policies that embody material mismatch risk between plan assets and liabilities. An important feature of maturing defined benefit plans is that net positive cash flows (i.e. contributions exceed benefit payments) eventually turn negative as more money flows out of the plan to pay benefits to a rising number of retirees. Examples in the article demonstrate the implications of this new reality for funding ratio instability in defined benefit plans.

A consequence is that the design of defined benefit plans needs rethinking. On the one hand, traditional features such as benefit security and inflation protection remain important plan features. On the other, new elements such as pension contract fairness and completeness, as well as fair-value valuation disciplines for plan assets and liabilities must also become part of plan design.

Keywords: Complete Contracts, Defined Benefit Plans, Fair-Value, Pension Plan Design, Risk-Sharing