Setting the discount rate for valuing pension liabilities
By Javier Sanabria
Two key actuarial assumptions that drive costs are the rate at which liabilities are discounted and the expected longevity of members who are receiving or are expected to receive benefits.
Our two-part PERiScope series explores recent trends and theories pertaining to the setting of these assumptions. The first part, Setting the discount rate for valuing pension liabilities, discusses the fundamental approaches to discount rate setting, recent changes in such rates among public pension plans, and how these rates comply with Governmental Accounting Standards Board (GASB) regulations.
Here’s an excerpt:
In compliance with GASB standards, the overwhelming majority of public pension funds base their discount rate on the expected investment returns of the fund. These rates are set through a combination of a model based on the capital market assumptions of investment advisors and a desire to take a long-term view. Assumptions have been declining in recent years and we expect this trend to continue as the rates implied by the capital market assumptions have dropped substantially. This will result in higher contributions in the short term. However, if the investment return assumption is not being reduced in accordance with the capital market assumptions, contributions in future years are likely to be higher than otherwise.
Download and read the entire article here.