Corporate Pension Plan Funding Levels and the Expected Return Assumption

Abstract

We use the 2008 crisis as an exogenous shock to the annual pension funding ratios of U.S. corporate defined benefit (DB) pension plans to examine the causal impact on the assumption of expected return on pension assets (EROA). Contrary to prior literature, we find that DB pension plans transitioning from fully funded to underfunded status make significant expense-reducing assumptions for corporate plan sponsors by increasing their EROA. 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 9% to 13%. Our results are robust to controlling for the shock induced by the global financial crisis on corporate performance.

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

JEL Classification: G11, G32, J32