DP13591 Corporate Pension Plan Funding Levels and Pension Assumptions

Author(s): Alexander Michaelides, Andreas Milidonis, Panayiotis Papakyriakou
Publication Date: March 2019
Keyword(s): Defined benefit pension plans, EROA, pension assumptions, underfunded
JEL(s): G11, G32, J32
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13591

We use a difference-in-differences approach to examine the causal impact of the funding ratios of U.S. corporate defined benefit (DB) pension plans on the assumption of expected return on pension assets (EROA). To make the causal case, we use the 2008 global financial crisis as an exogenous shock to the funding ratio of DB pension plans, and the simultaneous implementation of the Pension Protection Act, which emphasized the accountability of underfunded pension plans. We find that DB pension plans making the transition from fully funded to underfunded status over this period significantly revise their EROA assumption upward. The upward revisions in EROA are economically significant and generate obligation-reducing outcomes for corporate plans sponsors: a switch from fully funded to underfunded status generates at least a 40 (and up to a 80) basis point increase in EROA, which, in turn, corresponds to an average annual reduction in pension contributions of $6 (to $11) million.