A Simulation of the Future Economic Impact of Pension Rate Reductions

Alan I. Blankley, Philip G. Cottell and Richard H. McClure
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Alan I. Blankley: University of North Carolina, Charlotte
Philip G. Cottell: Miami University
Richard H. McClure: Miami University

American Journal of Business, 2004, vol. 19, issue 2, pages 31-40

Abstract: Pension rate estimates are important because they provide information to the market, and because they are useful in estimating future cash ßows or for other analytical purposes. This is especially true now, because the economic environment has deteriorated to a point that many investors perceive increased uncertainty with respect to pension plans and the effect they have on future income. In fact, several authors in the popular Þnancial press have speculated on the impact of such fundamental changes in pension assets, liabilities, and estimates. Often, however, these articles are sensational, and do not appear to appreciate fully the complexities of pension accounting. In order to model the economic impact of pension rate declines, we develop a two-period analytical model of pension cost, which allows us to simulate future pension expense and its associated earnings impact using a triangular distribution of rate estimates. In addition, we model the incremental cash contributions required under these estimates in order to maintain the ratio of pension assets to liabilities at 100 percent. Our results indicate that while the pension expense effect is large in both periods across Þrms with small, mid-sized and large pension plans, Þrms with large plans show the greatest increase in pension expense. Interestingly, however, the earnings impact is the smallest for Þrms with large plans in both periods. In addition, all Þrms face signiÞcantly increased cash funding requirements in order to prevent funding ratios (plan assets scaled by pension liabilities) from deteriorating. These results suggest not only future earnings reductions from pension rate declines, but also a potentially signiÞcant cash ßow impact as well.

Keywords: Accounting; pension rates; retirement income (search for similar items in EconPapers)
JEL-codes: R00 Z0 (search for similar items in EconPapers)

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