Observations on Input and Output Smoothing Methods: How do they affect the funding of defined benefit plans?

Following the release of our first Rapid Retirement Research report, The Rising Tide of Pension Contributions, the SOA decided to begin an investigation of ways to address the volatility of statutory funding requirements for U.S. private sector defined benefit plans. The Rising Tide report discussed perceptions of volatility in the funding rules and identified potential stress to the single-employer system in the form of cash contributions that would be required of plan sponsors. Consequently, we believed there would be demand for greater smoothing of contribution requirements and we saw an opportunity to provide insight into discussions about a topic with clear actuarial implications.

Our most recent report, Observations on Input and Output Smoothing Methods: How do they affect the funding of defined benefit plans?, provides a high-level comparison of input and output smoothing methods in the context of U.S. statutory requirements for private single-employer DB plans. The report offers several observations about how these two general categories of smoothing methods operate, including:

  • Input and output smoothing methodologies can have similar effects on plan solvency and the predictability of statutory requirements, because any rate of experience recognition can be determined under either form.
  • Input methods smooth specific sources of volatility and may affect multiple statutory requirements. In contrast, output methods smooth the effects of multiple sources of volatility for specific statutory requirements.
  • Input smoothing methodologies change the relationship between market-based and reported values of assets and liabilities, but output methods do not. In order to use this information appropriately, we believe users need to understand the relationship.

It is important to note that this report is intended to provide objective, actuarial illustrations of the basic differences between input and output smoothing methodologies. It is not intended to provide a full analysis of the illustrative smoothing methods. The illustrations in the report were designed to highlight our observations and, in order to do so, control a number of factors that deserve consideration in the analysis of a smoothing method. Nor is the report intended to advocate a position for or against the use of any particular smoothing methodology. The SOA does not take any position on the merits of using the methodologies illustrated in this report.
Smoothing is a topic that actuaries have unparalleled expertise in. What do you consider as the desirable characteristics of a smoothing method?

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