Continued low economic growth and interest rates could lead to a proliferation of defined contribution plans, with defined benefit funds potentially forced to cut benefits, the International Monetary Fund said.
In the most recently published chapter of its Global Financial Stability Report, the IMF said a long-term transition to DC plans from DB is likely to continue, although the pace and extent of change might vary across advanced economies.
DB plans will come under increased pressure due to lower population growth, aging demographics and stagnating interest rates. Pension funds are likely to require additional capital, with lower yield curves making cash-flow obligations over the medium term difficult to meet, the report said. Sponsoring employers of pension funds might have no choice but to “significantly reduce benefits to policyholders and plan participants over the long term.”
The IMF said the “portability” of DC plans makes them more attractive to younger employees. “Over time, as the benefit differentials between the two types of plans dissipate under a low-for-long (growth) scenario, the balance will likely tip toward a labor market equilibrium in which DC plans play a larger role in the (retirement) component of the benefits package,” the report said.
Multiemployer DB funds, such as those in the Netherlands, “will be more resilient in the face of such a scenario, since they offer built-in portability to beneficiaries within industries.”
The IMF also warned of three financial stability issues arising from increased money manager activity in retirement provision and investment, and from the rise of passive strategies in retirement plans in a low-for-long growth economy. The report said stronger oversight of, and liquidity risk management by, mutual funds are needed, “especially if investors continue to seek exposure to illiquid assets.”
The increased popularity of passive strategies might pose a risk because it reduces diversity of investments, the report said. The third issue is that “herd behavior” among portfolio managers remains a concern because it can be destabilizing. In addition, the report warned that if passive investing becomes pre-eminent, “price discovery could be hampered and markets could become more prone to swings in sentiment.”
The IMF will release further analysis on April 19. The chapter is available on the IMF's website.
Jack Lejk contributed to this story.
