This Working Party has considered the pensions implications of a prolonged period of low inflation. Experience in the United States of America suggests weaker correlation between equity and bond returns and greater overall volatility of returns. Without a further significant increase in the valuation of equities relative to their underlying economic activity, the cost of pensions will rise, possibly as much as doubling within the next 15 years. It follows that for defined contribution schemes and personal pensions, current contribution levels are likely to produce disappointing and generally inadequate results. Similarly, the costs of defined benefit promises will increase. Future defined benefit provision is also vulnerable to the mismatch of mainly equity assets with mainly fixed liabilities and is therefore difficult to control. Many practical issues of scheme design still reflect past inflation and need to be addressed.

This paper has been written to provoke discussion and will be used as background to the debate on 18 November 2002. An earlier version was produced by the Faculty of Actuaries Pension Research Group and presented as a paper to the Faculty of Actuaries Students' Society.

We investigate the pension choices made by over 700 firms between 1981 and 1998 when DC plans expanded and overtook DB plans. Their average pension contribution per employee dropped in real terms from $2,140 in 1981 to $1,404 in 1998. At the same time, the share of their pension contributions attributed to defined contribution plans was 23% in 1981 and increased to 68% in 1998. By analyzing pension plan data from the IRS Form 5500 and finances of the plan's sponsoring employer from COMPUSTAT with a fixed-effects ordinary least squares model and a simultaneous model, we find that a 10% increase in the use of defined contribution plans (including 401(k) plans) reduces employer pension costs per worker by 1.7–3.5%. This suggests firms use DCs and 401(k)s to lower pension costs. Lower administrative expenses may also explain the popularity of DC plans. Although measuring a firm's pension cost per worker may be a crude way to judge a firm's commitment to pensions, this study suggests that firms that provide both a traditional defined benefit and a defined contribution plan are the most committed because they spend the most on pensions. Further research, especially case studies, is vital to understand employers' commitment to employment-based pension plans.