A Longitudinal Study of SFAS 87 Pension Rate Assumptions.

Abstract In response to allegations of widespread abuse in the business press, we investigate the reliability of the three rate estimates required under SFAS 87—the discount rate, expected rate of return on plan assets, and expected rate of future compensation—over the seven-year period, 1987-1993. We find that, while average discount rates have decreased substantially in recent years, discount rate declines have lagged behind declining yields of high-quality corporate bonds, PBGC rates, or the 30-year (benchmark) government bond. As a result, the SEC found it necessary to set a guideline of 7 percent for 1993 and firms responded with an average rate of 7.43%. We also find that expected rates of return are changed infrequently—consistent with the SFAS 87 requirement that they reflect long-run investment expectations. Although expected rates of return exceed discount rates in every year, they tend to match actual rates of return over time. Further, in 1992 and 1993, a definite pattern of decreases in expected returns emerged among those firms whose actual returns had been less than they expected. While the accuracy of future salary rates is difficult to assess, salary rate changes correlate positively with discount rate changes. Since the two rates have offsetting effects on pension cost, this reduces the income impact of lower discount rates. The positive correlation is, however, consistent with SPAS 87 requirements since both rates should incorporate expectations about future inflation. Finally, we find no support for press allegations of a relationship between employer pension contributions and SFAS 87 rate choices.