Corporate Pension Plans: How Consistent are the Assumptions in Determining Pension Funding Status?

With the bankruptcy of Enron and the accompanying loss of pension benefits of its employees, pensions have recently received significant press. Accounting for pension plan obligations, for defined benefit plans in particular, requires companies to make assumptions regarding discount rates, projected salary increases, and expected long‐term return on plan assets. Such assumptions, in turn, determine the funding status of the pension plan and the annual pension expense. Higher assumed discount rates reduce the pension obligation, enhance the funding status of the plan, and reduce any lump‐sum payments. Higher expected return on assets reduces the current pension expense. This study investigates the relationship between pension plan assumptions and the funding status of a pension plan. The results reveal that companies with pension plans that are more fully funded assume higher discount rates and expected long‐term return on assets than do companies with less funded plans. The effect of these assumptions is that higher discount rate assumptions lead to better funding status, and higher expected long‐term rates of return on assets partially offset the pension expense impacts of these higher discount rate assumptions. We are doubtful that more funded plans collectively should be assuming higher discount rates and expected long‐term return on plan assets, especially since the actual return on plan assets investigated did not correlate with these assumptions.