Pension Funding and the Actuarial Assumption Concerning Investment Returns

Abstract

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.