Four Issues in Funding

Introduction

Employer-provided pension plans – traditional, hybrid, or defined contribution – all have balance sheets, and the aim of plan funding (at least in the case of traditional and hybrid plans) is to ensure that a plan will always have enough assets to honor its pension promises. A successful funding strategy will prevent a shortfall, or at least an excessive shortfall, of plan assets from liabilities and will require that a plan's sponsor take steps to close any gap that emerges between liabilities and assets in an appropriately short period of time. As Whittington (2006) points out, the adoption of the balance-sheet method of pension fund accounting, which is a necessary but not a sufficient condition for adequate funding, is relatively recent. He dates it from the issue by the Financial Accounting Standards Board (FASB) of Statement No. 87 in 1985.

With the balance-sheet approach, the net cost that the plan incurs in a particular period is the increase in the plan's net liabilities. Net cost in period t (NCt) can be represented by the following expression [equation (3.1)]:

NCt = Lt-1 • rt + Bt + BPSt - At-1 • rt + EXADJt

The variable r stands again for the rate of interest, L stands for the stock of plan liabilities, B for benefits earned by plan members during the current period, BPS for the benefits earned from past service, A for assets, and EXADJ for what are called experience adjustments.