The main reasons for requiring that a pension plan be funded are (1) to provide benefit security, (2) to increase saving/capital formation, (3) to avoid intergenerational transfers and (4) to force sponsors to recognize the costs of their programs. But funding is needed to accomplish these objectives only when informational inefficiencies and imperfections exist in the marketplace.

When sufficient disclosure takes place, funding will probably have little, if any, effect on saving/capital formation, so long as all participants understand the effect of funding on their own economic positions; funding will result only in a series of paper transactions. Furthermore, there will be no intergenerational transfers among stockholders if pensions aren’t funded; the market price of the company’s stock will reflect funding status. And disclosure directly cleans up the problem of cost recognition.

The only remaining reason to have funded pensions is to provide benefit security. The current system of funding is far from perfect, however. Adverse experience and benefit liberalization can put a pension plan far off its funding track for long periods of time. The disadvantages of funded pension systems must be weighed against the benefits. Probably the largest negative is that funding adds a layer of management (the plan sponsor) between individual savers and the capital market.

Current trends in the regulation and disclosure of private pensions are strengthening the link between pension finances and corporate finances. This will probably lead to a break in funding and to the adoption (at least in part) of a “book reserve” approach to meeting pension obligations, with significant implications for the investment community. Under such an approach, pension liabilities will have a stronger claim on corporate assets than they have now. In this scheme, the credit markets will be relied upon to provide much of the discipline needed to achieve a high degree of benefit security.