Sensible Funding Rules to Stabilize Pension Benefits

By Christian E. Weller | February 17, 2005

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Retirement benefits are a hot button issue. While Social Security privatization is making the daily news, the safety of traditional defined benefit (DB) pensions continues to occupy public policy debates as well. Pensions received a lot of attention recently since falling interest rates and stock prices left DB plans with fewer funds than they need to cover all promised benefits. In extreme cases, pension plans were terminated, contributing to large shortfalls at the Pension Benefit Guaranty Corporation (PBGC), which insures the promised benefits for employees. To address this issue, the Bush administration recently proposed changes to funding rules. However, the proposed changes would likely make matters worse for beneficiaries, hastening the demise of pension plans. Alternative funding rules proposed below could improve the security of benefits without increasing the burden for the PBGC, while at the same time providing more certainty and stability for employers.

A closer look at pension funding and proposed rule changes shows the following:

• Current funding rules are counter-cyclical. Employers are required to contribute more to pension plans during bad economic times than during good times.
• The administration proposal would exacerbate the counter-cyclicality of pension funding and thus increase the uncertainty associated with pension plans.
• Alternative funding rules could that provide for greater leeway in averaging fluctuations in pension funding over the course of a business cycle improve the outlook for pensions. This process is called "smoothing."
• As a result of smoothing, the burden on the PBGC would be reduced through better-funded pension plans. Employers would benefit as pension funding would become less counter-cyclical, lowering the burden during bad economic times and increasing it during good economic times, when employers are best able to contribute to their pension plans.

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Christian E. Weller is senior economist at the Center for American Progress.