How to verify if your defined benefit plan is properly funded

In a defined benefit (DB) pension plan, the employer guarantees a retirement benefit. These plans became less popular over time as the employer bears the financial risk of the plan.

For DB pension plans which have been closed, the employer still has to guarantee the accrued benefits at the date of closing. Due to the 28 April 2003 law regarding occupational pensions, the benefits have to be revalued for salary increases up to the date of leaving (referred to as the “dynamic guarantee”).

In order to protect the pension rights of the plan participants against a bankruptcy of the employer, pension plans must be funded externally through a group insurance or a pension fund. Furthermore, DB pension plans are subject to a minimum funding requirement (MFR).

For DB plans funded through a group insurance, the MFR  basically equals the vested reserves to which the plan participant is entitled in case of leaving. The vested reserves, which have to be defined in the plan regulations, should be at least equal to the discounted value of the accrued retirement benefits based on a 6% discount rate. Because, the latter significantly exceeds the expected rate of return on insurance reserves, the MFR can be considered as too weak.

In a study published in January 2020, the Financial Services and Markets Authority (FSMA) strongly recommends to select funding methods and assumptions which are more prudent than the MFR:

De FSMA dringt er dan ook bij de verzekeringsondernemingen en inrichters op aan om te kiezen voor prudente financieringsmethodes- en hypothesen en in elk geval af te zien van methodes die uitsluitend een minimaal financieringsniveau nastreven. In afwezigheid van wettelijke regels kunnen die aanbevelingen vandaag echter niet worden afgedwongen.”

La FSMA insiste auprès des entreprises d’assurance et des organisateurs, pour opter pour des méthodes et des hypothèses de financement prudentes et pour éviter d’utiliser des hypothèses visant uniquement à atteindre le niveau minimum de financement. Toutefois, en l’absence de règles légales, ces recommandations ne peuvent être actuellement imposées.”

To properly assess the funded status of your defined benefit pension plan, the insurance company should not just confirm that the MFR is respected but also provide a relevant funding ratio (assets / accrued liabilities). The accrued liabilities should be based on a discount rate which reflects a prudent estimate of the expected rate of return on the insurance reserves.

For plans funded through a pension fund, the MFR is defined as the higher of the vested reserves and a prudent calculation of the accrued liabilities. The 2020 financial survey carried out by PensioPlus (the Belgian association of pension funds) shows that the accrued liabilities were usually calculated using discount rates up to 3.5%.