Working Paper: CEPR ID: DP13591
Authors: Alexander Michaelides; Panayiotis Papakyriakou; Andreas Milidonis
Abstract: 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.
Keywords: Defined Benefit Pension Plans; Pension Assumptions; EROA; Underfunded
JEL Codes: G11; G32; J32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Funding ratios of US corporate defined benefit pension plans (G32) | EROA assumptions (C51) |
| Transition from fully funded to underfunded status (G33) | EROA assumption revision (F12) |
| Upward revision of EROA assumption (C51) | Reduction in pension contributions (J32) |
| Decrease in funding level (H69) | Increase in EROA (O40) |
| Decrease in funding level (H69) | Reduction in pension contributions (J32) |
| Underfunded DB pension plans (G23) | Higher EROAs in subsequent years (I23) |