Are Pension Fund Status Assumptions Consistent? Mid-American Journal of Business (11/01/02) Vol. 17, No. 2 p.23; Newell, Gale E.; Kreuze, Jerry G.; Hurtt, David
Three professors at Western Michigan University conducted a study of the relationship between pension plan assumptions and the funding status of a pension plan. The study revealed that defined benefit plans require companies to make assumptions about discount rates, projected salary increases, and expected long-term return on plan assets, which determines the funding status of the pension plan and the annual pension expense. The professors found that when companies assume higher discount rates, the pension obligation is reduced, along with lump-sum payments, and the funding status of the plan is enhanced. These results are in response to the lower calculated liability that goes along with the higher assumed rate, which requires smaller contributions to the pension plan. Companies have incentives to use higher discount rates, because the smaller required contributions help plans with fewer plan assets compared to its projected benefit obligation. Discount rate assumptions are important, according to the professors, because of diminished actual returns on pension plan assets in the current financial climate. The study concluded that higher discount rate assumptions result in better funding status, while their expense impacts on pensions are offset by higher expected long-term rates of return on assets.