This section examines whether the funding ratio of defined benefit plans continued to improve in 2023 and whether this has had implications on the long-term shift away from these plans.
Pension Markets in Focus 2024
Abstract
While assets have been growing over the long-term, liabilities of defined benefit (DB) plans have been growing too and faster than assets in some countries, putting pressure on the sponsors of these plans. The deterioration of the funding ratio – i.e. the ratio of assets over liabilities – has led some employers to shift away from these plans towards defined contribution (DC) plans. However, the funding ratio of DB plans improved in a number of countries in 2022 following the rise in interest rates.
This section looks at whether the funding ratio of DB plans continued to improve in 2023 and whether this had had implications on the long-term shift away from DB plans.1 This section shows that the liabilities of DB plans also grew in 2023. However, assets grew at a faster pace than liabilities, leading to an improvement in the funding ratio. Despite this, the shift from DB to DC continued.
After a decline in 2022 in most jurisdictions, the liabilities of DB plans grew again in 2023. Liabilities have been increasing over the last decades, driven by years of falling interest rates and improving life expectancy.2 The increase in interest rates in 2022 temporarily reversed this trend for pension providers using market-based discount rates (e.g. Netherlands, United Kingdom). For these providers, higher interest rates translated into higher discount rates to calculate the present value of the liabilities, leading to a decline in the liabilities of pension providers. Yet, liabilities rose again for pension providers in all reporting jurisdictions in 2023 except in Ireland, Luxembourg and the United Kingdom (Figure 4.1).3 The discount rates that the largest private pension funds used in the United States fluctuated in 2023 but ended up at a lower level at end-2023 than at end-2022 (Milliman, 2024[17]). As a result, the liabilities of these funds were higher at end-2023 than the year before. Liabilities increased in Finland and Iceland where pension providers value liabilities using a fixed discount rate (at 3% and 3.5% respectively). The liabilities shown in Figure 4.1 are aggregated at the national level and reflect the evolution of funds. The evolution of the liabilities may therefore reflect the population of DB plans.
Base: 2021 = 100
Note: For more details, please see the methodological notes in Annex C.
Source: OECD Global Pension Statistics.
Assets outpaced liabilities in 2023, leading to an improvement in the funding ratio, which is the ratio of assets over liabilities. The funding ratio of DB plans improved in 2023 in Finland, Germany, Ireland, Liechtenstein, Norway, Switzerland, the United Kingdom and the United States. It reached a record high in the United Kingdom and the United States, although the funding ratio remained below 100% in the United States. A ratio below 100% means that the assets would be insufficient to meet all the liabilities of a plan (Table 4.1).
In per cent
Note: For more details, please see the methodological notes in Annex C.
Source: OECD Global Pension Statistics.
Rising equity valuations in 2023 contributed to the improvement of the funding position of DB plans. The gains that pension providers achieved on their equity holdings drove asset growth. These gains offset the negative impact of decreasing discount rates on the funding ratio, such as in the United States. By contrast, in Hong Kong (China) where pension providers achieved moderate investment gains in nominal terms in 2022, the actuarial position of DB plans worsened.
The indexation policy of benefits could have an impact on the evolution of the funding ratio of DB plans. For example, the funding ratio of DB plans in the Netherlands remained relatively stable in 2023, after improvements in 2021 and 2022. The improvement of the funding ratio slowed down as pension funds to some extent granted higher benefits indexed to inflation to some pensioners.4
Any entry or exit from the sample of DB plans can also influence the evolution of the funding ratio calculated at the aggregated level. For example, a large decline in the aggregated funding ratio happened in Iceland between 2016 and 2017 due to the conversion of a public-sector scheme for state and municipal employees (one with the highest funding ratio) into a DC plan, therefore leaving the sample of DB plans on which the aggregated funding ratio is calculated.
The shift away from DB plans continued despite the improvement of the funding ratio in 2022 and 2023 in most jurisdictions. The share of assets in DB plans declined in all reporting jurisdictions in 2023 except Finland where DB plans continued to account for around 90% or more of assets (Figure 4.2).
As a percentage of total assets earmarked for retirement (excluding reserves of unfunded/PAYG plans)
Source: OECD Global Pension Statistics.
The long-term shift away from DB plans has several reasons. Employers are usually responsible for covering any funding shortfall in the case of traditional DB plans. The fall in interest rates over the years has made the promise of DB plans harder to meet (OECD, 2015[18]) and has led some employers to close their DB plans and offer DC plans instead (OECD, 2016[19]). The move to DC plans also makes contributions to the plan more predictable, which is one of the reasons employers moved away from DB plans in the United States, for example.5 In some other cases, countries legislated the closure of some DB schemes to new entrants. For example, a 1993 legislative decree in Italy closed existing DB plans for specific sectors (e.g. banking sector) to new members and introduced supplementary DC pension plans for all. Israel also closed access to DB plans and granted access to DC plans to the whole population in 1995.
The shift away from DB plans continues as sponsors seek the opportunity to transfer their liabilities while the solvency of DB plans improves. The improvement of the funding ratio of DB plans alleviated some pressure on the plan sponsors to make deficit repair contributions. Some employers are taking advantage of the improvement in the funding ratio to wind up schemes and offload the risks and liabilities. For example, the amount transferred away to insurance companies through buy-out contracts reached a record level in 2023 in the United Kingdom.6 The amount transferred in the United States fell in 2023 compared to 2022, but the number of buy-out contracts increased.7
← 1. This section focuses on pension providers. Public pension reserve funds have no specific obligation to a specific group of people.
← 2. COVID-19 has had a significant short-term impact on mortality rates and life expectancy (OECD, 2023[21]).
← 3. Data for the United Kingdom are at end-March 2023.