Corporate Pension Plan Funding Levels and the Expected Return Assumption

Abstract

We use a difference-in-differences approach to examine the causal impact of changes in the funding ratios of U.S. corporate defined benefit (DB) pension plans on the assumption of expected return on pension assets (EROA). We use the 2008 crisis as an exogenous shock to the annual pension funding ratios and find that DB pension plans transitioning from fully funded to underfunded status over this period, make significant expense-reducing assumptions (increase EROA) for corporate plan sponsors. The funding deterioration generates a 40-80 basis points’ increase in EROA, which corresponds to an average annual reduction in the pension accounting expense of 6% to 8%.

Keywords: Defined benefit pension plans, pension assumptions, EROA, underfunded, actuaries

JEL Classification: G11, G32, J32