Pension Funding and the Actuarial Assumption Concerning Investment Returns

An assumption concerning the long-term rate of return on assets is made by actuaries when they value defined-benefit pension plans. There is a distinction between this assumption and the discount rate used to value pension liabilities, as the value placed on liabilities does not depend on asset allocation in the pension fund. The more conservative the investment return assumption is, the larger planned initial contributions are, and the faster benefits are funded. A conservative investment return assumption, however, also leads to long-term surpluses in the plan, as is shown for two practical actuarial funding methods. Long-term deficits result from an optimistic assumption. Neither outcome is desirable as, in the long term, pension plan assets should be accumulated to meet the pension liabilities valued at a suitable discount rate. A third method is devised that avoids such persistent surpluses and deficits regardless of conservatism or optimism in the assumed investment return.

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Measuring Pension Liabilities: An Examination Of The Funding Levels Of Defined Benefit Pension Plans

Journal of Applied Business Research (JABR) ◽

10.19030/jabr.v11i2.5877 ◽

2011 ◽

Vol 11 (2) ◽

pp. 73 ◽

Cited By ~ 1

Author(s):

Alan I. Blankley ◽

Rober Y. W. Tang

Keyword(s):

Interest Rate ◽

Discount Rate ◽

Pension Plan ◽

Fortune 500 ◽

Pension Plans ◽

Economic Conditions ◽

Defined Benefit ◽

Discount Rates ◽

Chi Square ◽

Pension Liabilities

We examine pension funding measures and interest rate disclosures for 223 firms from the Fortune 500. Three different liability measures are used to develop funding ratios, which indicate sample firms funding condition. We then examine firms discount rate estimates and compare these estimates with their funding levels. Using chi-square tests to examine dependence between rates and funding, we determine whether over (under) funding is simply an artifact of the choice of discount rates or the result of authentic economic conditions surrounding the pension plan.

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The Potential for Inflating Earnings through the Expected Rate of Return on Defined Benefit Pension Plan Assets

Accounting Horizons ◽

10.2308/acch-10115 ◽

2011 ◽

Vol 25 (3) ◽

pp. 443-464 ◽

Cited By ~ 15

Author(s):

Brian Adams ◽

Mary Margaret Frank ◽

Tod Perry

Keyword(s):

Financial Reporting ◽

Asset Allocation ◽

Cumulative Effect ◽

Pension Plan ◽

Pension Plans ◽

Rate Of Return ◽

Defined Benefit ◽

Operating Income ◽

Defined Benefit Pension Plan ◽

Reported Earnings

SYNOPSIS Using a sample of firms over the period of 1991 through 2005, we examine the opportunity that exists for firms to inflate earnings through the expected rate of return (ERR) assumption associated with defined benefit pension plans. The evidence suggests that, on average, the ERR is not overstated relative to several benchmarks, including contemporaneous actual returns, historical cumulative actual returns, and expected future returns based on asset allocation within the pension. We also find that actual changes in the ERR are infrequent and typically have less than a 1 percent impact on annual operating income. We also estimate that a 0.5 percent change (50 bps) in the ERR will result in a cumulative effect on operating income over a five-year period of approximately 0.5 percent or less for the majority of firms. When we examine firms with the highest ERRs or with the greatest opportunity to inflate earnings, again, we find that the ERR is not overstated relative to several benchmarks. Although we do not observe pervasive inflating of reported income through the ERR during our sample period, we do find that for some firms, small increases in ERR can have a material impact on reported earnings. Our results provide evidence related to the pervasiveness, materiality, and impact of overstated earnings through the ERR, which helps regulators assess the costs and benefits of eliminating this discretion in financial reporting.

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Sustainability of the Funded Ratio and Asset Allocation Choice of State Public Pension Plans

International Journal of Accounting and Financial Reporting ◽

10.5296/ijafr.v9i1.14358 ◽

2019 ◽

Vol 9 (1) ◽

pp. 366

Author(s):

Amod Choudhary ◽

Nikolaos Papanikolaou

Keyword(s):

Asset Allocation ◽

The United States ◽

Pension Plans ◽

Public Pension ◽

Key Factors ◽

Short Term ◽

Investment Returns ◽

Current Member ◽

Public Pension Plans

The paper examines State Public Pension Plans in the United States and the sustainability of their funded ratios. The authors apply a panel logit with random effects regression model of asset allocation choice and average returns during fiscal years 2001 to 2015. There are three key factors which adequately fund State Public Pension Plans: (i) current member contributions, (ii) members’ employer contributions, and (iii) investment returns on those contributions. Returns on those contributions depend heavily on allocation choice of those funds in traditional and alternative investments. Alternatives are generally assumed to provide higher average returns with higher risk. This paper shows that in the long-term, investment in traditional assets such as bonds, equities and short-term cash have a higher likelihood of funding State Public Pension Plan’s payment obligations to beneficiaries.

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Optimal Asset Allocation of Assets in an Open Pension Plan

International Journal of Financial Management ◽

10.21863/ijfm/2015.5.1.002 ◽

2015 ◽

Vol 5 (1) ◽

Author(s):

Maneesh Sharma ◽

Tom Totten ◽

John Cierzniak

Keyword(s):

Asset Allocation ◽

Market Performance ◽

Pension Plan ◽

Pension Plans ◽

Research Committee ◽

Allocation System ◽

Time Horizons ◽

The Impact ◽

Allocation Strategies

Given the generally long term nature of pension plans, the behavior of the market plays a crucial role in making a pension plan able to meet its obligations. Regardless of the market performance, the structure of the benefits remains the same, unless they are negotiated to be at a different level. In this paper, we studied primarily the impact of market performance on a pension plans ability to meet its obligations. We studied the period from 1974 to 2010 and included asset allocation strategies that varied from allocating 25% to 100% weight assigned to equity portfolios. The goals were to determine which type of asset allocation system is the most efficient across all time horizons. Our results show that it is not necessary to have an overly aggressive posture to equities. Indeed, as assets become more exposed to equities, the efficiency of a portfolio (as measured by Sharpe ratio) declines. We found that an exposure to equity in the range of 35%-50% is sufficient to meet most pension obligations, provided that the plans are fully funded at the outset. We acknowledge and thank the support of all members of the research committee of SOA for their valuable comments.

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An Analysis of Critical Accounting Estimate Disclosures of Pension Assumptions

Accounting Horizons ◽

10.2308/acch-50823 ◽

2014 ◽

Vol 28 (4) ◽

pp. 819-845 ◽

Cited By ~ 16

Author(s):

Mark P. Bauman ◽

Kenneth W. Shaw

Keyword(s):

Discount Rate ◽

Pension Plan ◽

Pension Plans ◽

Defined Benefit ◽

Asset Return ◽

Big 4 ◽

Accounting Estimates ◽

Regulated Industries ◽

Funded Status ◽

Defined Benefit Pension Plans

SYNOPSIS Accounting for defined-benefit pension plans is complex, and reported financial statement amounts are significantly impacted by a myriad of assumptions. In its interpretative release FR-72 (SEC 2003), the SEC called for more informative and transparent Management Discussion and Analysis (MD&A) disclosure of critical accounting estimates (CAE), including those regarding pension plans. This paper uses a random sample of 147 firms with relatively large defined-benefit pension plans to analyze firms' MD&A pension-related critical accounting estimate disclosures. We find that 60 (61) percent of our sample firms quantify the effect on pension measurements—primarily pension expense—of a given change in discount rates (expected asset returns). The median effect on earnings per share of these CAE-disclosing firms is between two and three cents. Firms rarely disclose the effects of potential changes in future salary assumptions or other estimates on pension measurements. While FR-72 encourages MD&A disclosure of information to assess the past accuracy of or predict future changes in critical accounting estimates, few firms provide such information with respect to their pension plans, suggesting avenues for improvement in disclosures. Finally, we use logistic regression to analyze the determinants of firms' decisions to disclose the sensitivity of pension expense to pension discount rate or expected asset return assumptions. Results indicate that the likelihood of providing a discount rate or expected asset return CAE is positively related to firm size, having a Big 4 auditor, and the variability of pension plan funded status, and is lower for firms operating in regulated industries and for firms with better-funded pension plans.

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Corporate Pension Plans as Takeover Deterrents

Journal of Financial and Quantitative Analysis ◽

10.1017/s0022109013000355 ◽

2013 ◽

Vol 48 (4) ◽

pp. 1119-1144 ◽

Cited By ~ 24

Author(s):

João F. Cocco ◽

Paolo F. Volpin

Keyword(s):

Pension Plan ◽

Pension Plans ◽

Defined Benefit ◽

Announcement Effects ◽

Defined Benefit Pension Plan ◽

Corporate Pension ◽

Pension Liabilities

AbstractWe use UK data to show that firms that sponsor a defined-benefit pension plan are less likely to be targeted in an acquisition and, conditional on an attempted takeover, they are less likely to be acquired. Our explanation is that the uncertainty in the value of pension liabilities is a source of risk for acquirers of the firm's shares, which works as a takeover deterrent. In support of this explanation we find that these same firms are more likely to use cash when acquiring other firms, and that the announcement of a cash acquisition is associated with positive announcement effects.

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Analyzing Retirement Withdrawal Strategies

10.20944/preprints201801.0182.v1 ◽

2018 ◽

Author(s):

Robert Rietz ◽

Tim Blumenschein ◽

Spencer Crough ◽

Albert Cohen

Keyword(s):

Asset Allocation ◽

Probability Distribution Function ◽

Relative Impact ◽

Government Bonds ◽

Investment Return ◽

Lifetime Income ◽

Investment Returns ◽

Asset Classes ◽

Constant Percentage

An optimal withdrawal strategy beginning at age 65 provides a lifetime income from a portfolio, adjusted annually for inflation, while reducing the probability of living in financial ruin to an ac-ceptable level. This paper analyzes the probability of living in financial ruin, potentially for multiple years, rather than just the event of ruin. A stochastic Excel model was developed to simulate the effect of varying investment returns on a portfolio with two asset classes; large company stocks and long-term government bonds. A stochastic model is also applied to retiree mortality. The following variables were analyzed to determine their relative impact on withdrawal strategies: • Withdrawing a constant percentage of the portfolio, • Gender, • Initial asset allocation, • Asset allocation rebalancing methods, and • Low investment return environments. For both genders and most withdrawal rates, an approximately equal initial asset allocation of stocks and bonds, combined with a level rebalancing function, provided the lowest probability of living in financial ruin. Because each investment return followed its own probability distribution function, some retirees experienced financial ruin even in the most conservative simulations.

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Pension plan risk-taking: does it matter if the sponsor is publicly-traded?

Journal of Pension Economics and Finance ◽

10.1017/s1474747212000339 ◽

2012 ◽

Vol 12 (2) ◽

pp. 218-249 ◽

Cited By ~ 9

Author(s):

CHRISTINA ATANASOVA ◽

EVAN GATEV

Keyword(s):

Risk Taking ◽

Pension Plan ◽

Pension Plans ◽

Defined Benefit ◽

Publicly Traded ◽

Public And Private ◽

Publicly Traded Firms ◽

Main Determinants ◽

Funded Status ◽

Pension Liabilities

AbstractWe use a large sample of defined benefit (DB) pension plans to document economically significant differences in the risk-taking of plans sponsored by privately-held versus publicly-traded firms. The magnitude and the main determinants of pension plan risk-taking are different for public and private firms. The effect of pension liabilities’ funded status on risk-taking is two and a half times higher for plans with publicly-traded sponsors than for plans with private sponsors. In contrast, changing sponsor contributions has more than four times higher effect on risk-taking for plans with private sponsors. The results suggest that the alignment of incentives for the stakeholders in a pension contract is different for plans sponsored by private versus publicly-traded firms.

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The strategic use of pensions by not-for-profit organizations

Journal of Pension Economics and Finance ◽

10.1017/s1474747218000021 ◽

2018 ◽

Vol 18 (3) ◽

pp. 388-414

Author(s):

THAD DANIEL CALABRESE ◽

ELIZABETH A. M. SEARING

Keyword(s):

Financial Management ◽

Pension Plan ◽

Pension Plans ◽

Defined Benefit ◽

For Profit ◽

Management Objectives ◽

Not For Profit ◽

Net Assets ◽

Earnings Targets ◽

Pension Liabilities

AbstractDefined benefit pension plans are an important and unexplored aspect of not-for-profit compensation, covering between 15% and 21% of the estimated national not-for-profit workforce. Here we consider whether pension contributions and actuarial assumptions are mechanisms for achieving not-for-profit financial management objectives such as smoothing consumption, managing reported net earnings, and minimizing pension liabilities. The empirical results indicate a variety of these behaviors. Not-for-profit pension plan sponsors use accumulated net assets to smooth consumption. Further, not-for-profits manage reported profits downwards when they exceed expectations by increasing pension contributions, but both minimize contributions and liberalize actuarial assumptions when they underperform relative to their desired earnings targets.

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