PENSION PLAN 

VALUATION

Views on Using 

Multiple Measures to 

Offer a More 

Complete Financial 

Picture

Report to the Chairman, Committee on 

Health, Education, Labor, and Pensions, 

United States Senate

September 2014

GAO-14-264

United States Government Accountability Office
United States Government Accountability Office

Highlights of GAO-14-264, a report to the 

Chairman, Committee on Health, Education, 

Labor, and Pensions, United States Senate

September 2014 

PENSION PLAN VALUATION 

Views on Using Multiple Measures to Offer a More 

Complete Financial Picture 

Why GAO Did This Study

Defined benefit plans use interest rates 

to “discount,” or determine the current 

value, of estimated future benefits. 

Experts in the United States have 

disagreed on both the approach that 

should be taken by plans to determine 

a discount rate and the appropriate 

rate to be used. Different discount 

rates can create large differences in 

the valuation of a plan’s obligations, 

which in turn can lead various 

stakeholders to draw different 

conclusions about a plan’s health, the 

value of a plan’s benefits, and the 

contributions required to fund them. 

As requested, GAO examined different 

approaches used to determine the 

discount rate. This report addresses 

(1) the significance of differences in 

approaches used to determine 

discount rates among public and 

private plans; (2) purposes for 

measuring the value of a plan’s future 

benefits and key considerations for 

determining discount rate policy; and 

(3) approaches selected countries 

have taken to choose discount rates.

For this review, GAO analyzed 

provisions in relevant federal laws and 

regulations, as well as financial 

reporting and actuarial standards. GAO 

also reviewed relevant literature and 

interviewed experts, including experts 

in Canada, the Netherlands, and the 

United Kingdom—countries with 

significant defined benefit systems. In 

addition, GAO modeled hypothetical 

pension investment portfolios and cash 

flows to calculate average investment 

returns using available historical data. 

What GAO Recommends

GAO is not making any 

recommendations in this report.

What GAO Found

Public and private sector defined benefit pension plans are subject to different 

rules and guidance regarding discount rates—interest rates used to determine 

the current value of estimated future benefit payments. These differences can 

result in significant implications: 

• Sponsors of public sector plans generally use discount rates using a longterm assumed average rate of return on plan assets. This approach results in

reported obligations that generally appear lower than those of comparable 

private sector single-employer plans. Some experts believe this approach 

may encourage public plans to invest in riskier assets, which can increase 

the assumed return and thereby lower estimated obligations and plan 

contributions. Other experts believe this approach helps to maintain more 

predictable and lower costs. Private sector multiemployer plans generally use 

an assumed rate of return for funding purposes. 

• Sponsors of private sector single-employer pension plans use bond-based 

discount rates, which are generally lower than assumed rates of return, for 

financial reporting of their plans’ liabilities. Experts believe this approach may

encourage plans to invest in less risky assets, particularly high-quality bonds, 

to make pension costs less volatile, but it may increase current reported 

costs. Funding requirements for these plans are tied to historical interest 

rates, which can reduce funding compared to measures based on more 

recent interest rates. 

Experts identified at least five purposes for measuring the value of future benefits

where discount rates are used, including determining sponsor contributions, 

reporting plan liabilities to stakeholders, determining the amount needed to 

secure benefits, measuring the value of employee benefits, and determining 

lump sum settlement amounts. They also identified a variety of considerations in 

setting discount rate policy, including cost, risk, fairness, sustainability, 

transparency, and comparability. To address trade-offs among these varied and 

sometimes competing purposes and considerations, many experts saw value in 

reporting multiple measures of plan obligations, using different discount rates. 

Some experts also regarded assumed returns used by U.S. public plans as too 

high under current market conditions. 

Selected countries we examined reported that they apply a variety of approaches 

to discounting. Canada requires determination of multiple measures of plan 

obligations, based on both assumed returns and high-quality bond rates and

annuity prices. The Netherlands requires that plan obligations be measured 

based on market interest rates, but allows the use of assumed returns for 

determining plan contributions or developing recovery plans. In the United 

Kingdom, discount rates are determined on a plan-specific basis and can include 

some allowance for assumed returns in excess of high-quality bond rates, 

depending on plan characteristics and the strength of the sponsor. To the extent 

that plans in these countries use long-term assumed rates of return, they are 

generally lower than the 7.5 to 8 percent used by many U.S. public plans under 

recent market conditions. Experts GAO interviewed in these countries described

a greater degree of government oversight which might help explain their use of

lower assumed returns. 

View GAO-14-264. For more information, 

contact Charles Jeszeck at (202) 512-7215 or 

jeszeckc@gao.gov or Frank Todisco at (202) 

512-2700 or todiscof@gao.gov. 
Page i GAO-14-264 Pension Plan Valuation 

Letter 1 

Background 4

Discount Rates for Sponsors of Public Sector Plans and Private 

Sector Multiemployer Plans Differ from Those of Private Sector 

Single-Employer Plans, Resulting in Different Incentives for 

Both and, for the Former, Higher Reported Funded Ratios and 

Lower Reported Costs 23

Experts Identified a Variety of Considerations for Setting Discount 

Rate Policy and Many Saw Value in Plan Sponsors Reporting 

Multiple Measures 33

Selected Countries Apply a Variety of Approaches to Discounting 

and Use Lower Assumed Returns Than U.S. Public Plans 50

Concluding Observations 63

Agency Comments 64

Appendix I Objectives, Scope, and Methodology 66

Appendix II Additional Information on Laws, Standards, and Practices 

for Determining Discount Rates for U.S. Defined Benefit Plans 68

Appendix III Historical Returns and the Discount Rate 74

Appendix IV Key Features of Discount Rate Practices in Canada, the 

Netherlands, and the United Kingdom 81

Appendix V GAO Contact and Staff Acknowledgments 88

Related GAO Products 89

Contents
Page ii GAO-14-264 Pension Plan Valuation 

Tables

Table 1: Laws, Standards, Practices, and Discounting Premises 

for U.S. Defined Benefit Plan Sponsors and Participating 

Employers, by Plan Type 24

Table 2: Some Available Discount Rate Information for U.S. 

Defined Benefit Pension Plans as of December 2013 29

Table 3: Some Key Considerations Identified by Experts for 

Selecting Discount Rates 39

Table 4: Summary of Discounting Practices for Funding in 

Canada, the Netherlands, and the United Kingdom, as 

Described by Foreign Experts 52

Table 5: Laws, Standards, Practices, and Discounting Premises 

for U.S. Defined Benefit Plan Sponsors and Participating 

Employers, By Plan Type 70

Figures

Figure 1: Effect of Different Discount Rates on Measuring the 

Liability for a Future Payment 13

Figure 2: 10-Year and 30-Year Treasury Interest Rates from 1962 

to 2012 19

Figure 3: Many Experts Said There Was Value to Multiple Liability 

Measures at Different Discount Rates 48

Figure 4: Annualized Historical Returns for Different Trailing 

Periods 76

Figure 5: Return Differential between Hypothetical Plans and 

Time-weighted Averages 78

Figure 6: Arithmetic Means Are Higher Than Geometric Means 80
Page iii GAO-14-264 Pension Plan Valuation 

Abbreviations

DB defined benefit

DC defined contribution

DNB De Nederlandsche Bank

ERISA Employee Retirement Income Security Act

FASB Financial Accounting Standards Board

FRC Financial Reporting Council

GASB Governmental Accounting Standards Board

IASB International Accounting Standards Board

MAP-21 Moving Ahead for Progress in the 21st Century Act

OSFI Office of the Superintendent of Financial Institutions

PBGC Pension Benefit Guaranty Corporation

PPF Pension Protection Fund

SEC Securities and Exchange Commission

Treasury Department of the Treasury

U.K. United Kingdom

This is a work of the U.S. government and is not subject to copyright protection in the 

United States. The published product may be reproduced and distributed in its entirety 

without further permission from GAO. However, because this work may contain 

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Page 1 GAO-14-264 Pension Plan Valuation 

441 G St. N.W.

Washington, DC 20548

September 30, 2014

The Honorable Tom Harkin

Chairman

Committee on Health, Education, Labor, and Pensions

United States Senate

Dear Mr. Chairman:

Traditional defined benefit (DB) plans remain an essential source of 

retirement income, with tens of millions of Americans relying on them for 

retirement security. As of 2011, state and local government sector DB 

plans covered over 28 million participants, many of whom were not 

eligible for Social Security, and private sector DB plans covered more 

than 40 million Americans.1 However, DB plans have faced a number of 

challenges, including the lingering effects from the 2008 stock market 

downturn; the implications of lower interest rates for the cost of financing 

retirement benefits; increased longevity of plan participants; and the 

possibility of a need for higher contributions to these plans. For some 

public plans, these challenges have been compounded by some plan 

sponsors not making recommended plan contributions or granting benefit 

increases during more favorable economic environments in the past.2

 

1

Coverage refers to all active, inactive, and retired plan participants, as well as 

beneficiaries. State and local government DB plan sector participation data are based on 

fiscal years that ended between July 1, 2010 and June 30, 2011 (fiscal year 2011), with 

some exceptions. Private sector DB plan sector participation data is based on Form 5500 

filings for plan years ending in 2011. See U.S. Census Bureau, Annual Survey of Public 

Pensions: State- and Locally-Administered Defined Benefit Data Summary Report: 2011

and the U.S. Department of Labor, Private Pension Plan Bulletin. Table A1. Number of 

Pension Plans, Total Participants, Active Participants, Assets, Contributions, and Benefits, 

2011. 

For 

private plans, these challenges have occurred in the context of a long 

decline in the portion of private sector workers covered by such plans.

While many plans have weathered these challenges, they have raised 

questions about the ability of some DB plans to provide adequate benefits 

to current workers and retirees in the future.

2

See GAO, State and Local Government Pension Plans: Economic Downturn Spurs 

Efforts to Address Costs and Sustainability, GAO-12-322 (Washington, D.C.: Mar. 2, 

2012). 
 

Page 2 GAO-14-264 Pension Plan Valuation 

At the same time, experts sharply disagree on which approach should be 

taken to calculate these plans’ estimated obligations for benefits promised 

to workers and retirees, referred to in this report as liabilities regardless of 

the purpose of the measurement (e.g., funding, financial reporting, or 

Employee Retirement Income Security Act (ERISA) reporting).3 More 

specifically, a major source of disagreement relates to how projected 

future benefit payments should be discounted—or valued—in today’s 

dollars. Discounting is based on the concept that $1 payable in the future 

(e.g., in 1 year) is worth less than $1 payable today because the dollar 

payable today can be invested and grow with interest over that year. One 

approach to discounting future benefits—the “assumed-return 

approach”—uses a discount rate based on a long-term assumed average 

rate of return on the pension plan’s assets, typically a mix that includes 

substantial portions of stocks and bonds. A second approach—the “bondbased approach”—uses a discount rate based on market prices for 

bonds, annuities, or other alternatives that are deemed to have certain 

characteristics that are similar to pension promises. In many instances, a 

bond-based approach produces a lower discount rate, and therefore 

higher estimates of pension liabilities, than the assumed-return approach, 

particularly given recent bond market conditions and current U.S. practice 

in setting assumed-return discount rates.4

The discounting approach used can have a significant effect on the 

calculated pension obligations. For example, for a typical pension plan, 

the liability calculated using a 4 percent discount rate (a rate close to what 

would be produced in recent years under certain bond-based 

approaches, with little or no averaging or “smoothing”) could be more 

 

3

Pension liabilities can variously be referred to as “liabilities,” “accrued liabilities,” “funding 

targets,” “obligations,” or other terms, depending on the user of the term (e.g., actuaries, 

economists, accountants, lawyers) and the context and purpose of the measurement, as 

discussed later. Generally, such liabilities are reduced by the value of plan assets in 

evaluating the plans. 

4

A bond-based approach produces higher estimates of pension obligations because 

discount rates under this approach are generally lower than discount rates under the 

assumed-return approach. U.S. plans that use the assumed-return approach currently 

often use discount rates between 7 and 8 percent, based in part on historical returns or 

historical interest rates (these rates are nominal and not adjusted for inflation). See 

appendix III for GAO analysis of historical returns. Based on historical interest rates, there 

have been instances where discount rates under a bond-based approach, if used at the 

time, would likely have been higher than the assumed-return assumptions then in use. For 

example, from 1980 to 1985 the 30-year Treasury interest rate exceeded 10 percent. (See 

fig. 2 later in this report). 
 

Page 3 GAO-14-264 Pension Plan Valuation 

than 80 percent higher than the liability calculated using an 8 percent 

discount rate (a rate commonly used under the assumed-return approach 

in recent years).5,6

As requested, GAO examined the differences of opinion concerning 

discount rates for pension plan valuations and funding. This report 

addresses the following three questions:

In addition, the appropriate discount rate can vary 

depending on the purpose of the measurement (see later discussion). 

These differences in approach to the valuations of a plan’s liabilities can 

lead stakeholders and sponsors to draw very different conclusions about 

an individual plan’s financial health, the value of the plan’s promised 

benefits, the contributions required to fund those benefits, the appropriate 

investment strategy, and perceptions about the health of the defined 

benefit “system” as a whole.

1. What is the significance of the differences in discounting approaches 

used by public versus private pension plans?

2. What are the purposes for measuring the value of a plan’s future 

benefits and key considerations for determining plan discount rate 

policy?

3. What approaches have select countries taken to choose discount 

rates?

To address our objectives, we interviewed experts, including actuaries, 

economists, and other pension experts, who represent diverse points of 

view and a variety of organizations and constituencies. We also reviewed 

relevant literature on pension discount rates. In addition, we also 

reviewed relevant provisions in the Internal Revenue Code, the Employee 

 

5

By a “typical” plan, we mean a plan with a more or less average mix of workers and 

retirees. For example, one consulting firm publishes a bond yield curve and applies it to 

sample pension plans that it characterizes as “Retiree,” “Mature,” “Average,”, and 

“Young.” It describes the Average plan as having a typical mix of active workers and 

retirees. See, Mercer, Mercer Pension Discount Yield Curve and Index Rates in the U.S., 

accessed on 9/8/14, http://www.mercer.com/insights/point/2014/mercer-pension-discountyield-curve-an-index-rates-in-us.html. Pension plans that have projected benefit payout 

cash flows of long “duration” (e.g., closer to “Young” than to “Retiree”) have liabilities that 

are more sensitive to changes in discount rates. Duration is a measure of the sensitivity of 

the present value of a series of cash flows to a change in the discount rate. It is related to 

the present-value-weighted average length of the cash flows. 

6

The “smoothing” of discount rates generally refers to the averaging of bond-based 

interest rates over multiple current and historical years.
 

Page 4 GAO-14-264 Pension Plan Valuation 

Retirement Income Security Act (ERISA) as amended, relevant federal 

regulations, and relevant accounting standards, specifically the 

Governmental Accounting Standards issued by the Governmental 

Accounting Standards Board (GASB), the Financial Accounting 

Standards issued by the Financial Accounting Standards Board (FASB), 

the International Financial Reporting Standards issued by the 

International Accounting Standards Board (IASB), and relevant actuarial 

standards of practices issued by the Actuarial Standards Board. We also 

modeled different hypothetical pension investment portfolios and cash 

flows and calculated average investment returns using available historical 

data. Lastly, we reviewed approaches used in other countries by selecting 

three countries with relatively substantial DB coverage and ongoing 

discount rate discussions—Canada, the Netherlands, and the United 

Kingdom (U.K.)—and spoke to experts from these countries.7

We conducted this performance audit from December 2012 to September

2014 in accordance with generally accepted government auditing 

standards. Those standards require that we plan and perform the audit to 

obtain sufficient, appropriate evidence to provide a reasonable basis for 

our findings and conclusions based on our audit objectives. We believe 

that the evidence obtained provides a reasonable basis for our findings 

and conclusions based on our audit objectives.

We did not 

conduct an independent legal analysis to verify the information these 

international experts provided about the laws, regulations, or policies of 

the foreign countries selected for this study. Instead, we relied on 

appropriate secondary sources, interviews with relevant experts, and 

other sources to support our work.

Employers sponsor two broad categories of pension plans: (1) defined 

benefit plans (DB)—in which employers generally maintain a fund to 

provide a specified level of monthly retirement income based on a formula 

specified in the plan—or (2) defined contribution plans (DC)—in which 

 

7

Please see appendix IV for a summary of each of these countries’ DB systems and 

discounting practices.

Background

The U.S. Retirement 

System and Defined 

Benefit Plans
 

Page 5 GAO-14-264 Pension Plan Valuation 

retirement income is based on employer and employee contributions and 

the performance of investments in individual employee accounts.8

Historically, DB benefits have typically been paid as a lifetime annuity 

(although lump sum options have increased in prevalence). Properlyfunded DB plans can shield participants from numerous risks that 

participants face in DC plans, including eligible employees not enrolling in 

the plan; employees enrolling but contributing amounts likely to be 

insufficient, together with other sources of retirement income, to provide 

adequate overall retirement income; “leakage” of plan assets through 

withdrawals for purposes other than retirement; investment risks; and the 

“longevity risk” of outliving one’s savings. Participants in DC plans must 

save a sufficient amount through contributions and investment returns to 

meet future retirement needs, and must adequately manage both the 

“accumulation phase” of building up assets prior to retirement and the 

“decumulation phase” of spending down assets during retirement. On the 

other hand, while DB plans can shield participants from numerous risks, 

they can sometimes be less advantageous than DC plans for workers 

who change employers one or more times before retirement.9

There are several major DB-plan sectors in the United States: (1) “public 

plans,” which cover state and local government employees; (2) private 

sector single-employer plans; (3) private sector multiemployer plans, 

which generally cover union employees who work for participating 

employers in a particular trade or industry; and (4) nonqualified plans, 

which do not meet the applicable requirements for tax-qualification under 

the Internal Revenue Code and are typically maintained by employers 

primarily for the purpose of providing deferred compensation for select 

 

8

There are also some DB plans that are “cash balance” plans, which are a type of “hybrid” 

DB plan that expresses accrued benefits as hypothetical account balances, with benefits 

accruing annually based on a specified percentage of salary and interest earnings. 

Discount rate issues for “cash balance” plans, as well as other types of DB plans under 

which plan benefits are based in some part on the investment performance of plan assets, 

include additional considerations that are outside the scope of this report. 

9

However, previous GAO work suggests that separating participants in DC plans can also 

experience challenges. See GAO, 401(K) Plans: Labor and IRS Could Improve the 

Rollover Process for Participants, GAO-13-30 (Washington, D.C.: Mar. 7, 2013). 
 

Page 6 GAO-14-264 Pension Plan Valuation 

groups of management or highly-compensated employees.10,11 We will 

not discuss nonqualified plans in this report because sponsors of such 

plans typically do not have to satisfy laws and regulations requiring a 

minimum level of benefits or contributions.12

For most private sector single-employer and multiemployer pension 

plans, the Pension Benefit Guaranty Corporation (PBGC) insures plan 

benefits, up to certain statutory limits, under separate insurance programs 

for these two types of plans.13

 

10Single-employer plans include a category of plans known as multiple-employer plans, 

which should not be confused with multiemployer plans. Multiple-employer plans are 

typically established without collective bargaining agreements and can be either DB or 

DC. Multiple-employer DB plans must be funded as if each participating employer is 

funding a separate plan, and plan assets have to be allocated among separate accounts 

maintained for each employer-sponsor. In contrast, multiemployer plans are established 

through collective bargaining agreements between labor unions and two or more 

employers, and plan assets are maintained in a single account. For Internal Revenue 

Service purposes, multiple-employer plans are treated the same as single-employer plans. 

Relative to other single-employer plans, multiple-employer plans may provide advantages, 

such as pooling assets for investment purposes and reducing the cost of plan 

administration, to employers in certain trades or professions. See GAO, Private Sector 

Pensions, Federal Agencies Should Collect Data and Coordinate of Multiple Employer 

Plans, 

PBGC was established under ERISA to 

insure the pension benefits of participants in qualified DB plans and pay 

participants up to the statutory limits, should their plans be terminated 

GAO-12-665 (Washington D.C.: Sept. 13, 2012). 

11Our discussion about multiemployer plans will not cover the structure of the current 

multiemployer system and the challenges that it poses to many plans as it is outside the 

scope of this report. We discussed many of these issues in a prior report. See GAO, 

Private Pensions: Timely Action Needed to Address Impending Multiemployer Plan 

Insolvencies, GAO-13-240 (Washington D.C.: Mar. 28, 2013).

12For the rest of this report, “pension plan” or “plan” means, in the U.S. context, a “taxqualified” DB plan. While the federal government sponsors DB plans for federal civilian 

and military employees, these plans were not within the scope of our work. 

13Some types of plans are typically not insured by PBGC, such as those offered by 

professional service employers (such as doctors and lawyers) that have never had more 

than 25 active participants since the enactment date of ERISA, and those offered by 

church groups (unless the plan has elected to be covered), or plans of federal, state, or 

local governments. 
 

Page 7 GAO-14-264 Pension Plan Valuation 

with insufficient funds or become insolvent.14 The statutory limits on 

insured benefits are much lower for multiemployer plans than for singleemployer plans.15 In recent years, PBGC has faced large net 

accumulated deficits coupled with future risks posed by plan sponsors 

and their plans that have threatened its solvency.16 PBGC recently 

reported that while its single-employer program is likely to remain in net 

deficit over the next 10 years, some improvement is projected. However, 

there is significant variation in projected results under PBGC’s singleemployer Pension Insurance Modeling System, with a worsening of the 

financial position of the single-employer program also possible.17

 

14PBGC’s single-employer and multiemployer insurance programs are maintained 

separately, each with a separate fund. In the multiemployer program, PBGC provides 

financial assistance in the form of loans to plans that become insolvent, that is, plans that 

do not have sufficient assets to pay pension benefits at PBGC’s guaranteed level for a full 

plan year. Although such financial assistance is referred to as a “loan,” and is by law 

required to be repaid, in practice such loans have almost never been repaid, as plans 

generally do not emerge from insolvency. Before PBGC will provide the loans, 

participants’ retirement benefits must be reduced to a level specified in law. Even after 

insolvency, the plan remains an independent entity managed by its board of trustees. This 

contrasts with the agency’s single-employer program under which PBGC does not provide 

financial assistance to ongoing plans, but instead takes over terminated underfunded 

plans as a trustee, and pays benefits directly to participants.

In 

contrast, the financial status of some multiemployer plans is deteriorating. 

PBGC reports that the insurance fund for its multiemployer program is 

15The guaranteed benefit limits for participants in single-employer plans cannot exceed 

the statutory maximum, adjusted annually, at the time the plan terminates. For 2014, the 

maximum is about $59,320 per year for a person retiring at age 65 with no survivor benefit

(that is, a single-life annuity); the maximum is indexed for inflation. The maximum is lower 

for those retiring under age 65, higher for those retiring over age 65, and lower for those 

with a survivor benefit. In addition, for any benefit increase implemented through a plan 

amendment that has been in effect for less than 5 years, only a pro-rata portion can be 

guaranteed. In contrast, the guaranteed benefit limits for participants in multiemployer 

plans are not indexed for inflation and do not vary with age at retirement, but do vary with 

a participant’s years of service, For a participant with 30 years of service, PBGC fully 

insures the first $3,960 of a participant’s annual benefit, plus three quarters of the next 

$11,880 of annual benefit, for a maximum annual payout of $12,870. For a participant with 

10 years of service, this maximum annual payout is reduced to $4,290. If PBGC’s 

multiemployer fund were to run out of money, PBGC would be unable to pay even these 

lower insured amounts. See GAO-13-240 and PBGC, FY 2013 PBGC Projections Report. 

16See GAO-13-240 and GAO, Pension Benefit Guaranty Corporation: Redesigned 

Premium Structure Could Better Align Rates with Risk from Plan Sponsors, GAO-13-58 

(Washington D.C.: Nov. 7, 2012).

17PBGC runs its single-employer simulation model under 5,000 possible future scenarios. 

A majority of the simulations project decreases in PBGC’s single-employer deficit. PBGC, 

FY 2013 PBGC Projections Report.
 

Page 8 GAO-14-264 Pension Plan Valuation 

more likely than not to be exhausted within the next 8 years, and 90 

percent likely to be exhausted by 2025, which would result in benefits for 

participants in insolvent plans being cut to a small fraction of current 

guarantees.18,19

In the public sector, DB plans still provide primary pension benefits for 

most state and local government workers. In contrast, DB plan coverage 

in the private sector has declined as these employers continued to shift 

away from sponsoring DB plans toward sponsoring DC plans. About 78 

percent of state and local government employees participated in DB plans 

in 2013, compared with only 16 percent of private sector employees.

PBGC uses a discount rate assumption, discussed later,

to determine the present value of projected future pension benefits to be 

paid to the participants of single-employer plans it has taken over, and the 

present value of projected financial assistance payments to multiemployer 

plans.

20 A 

few states offer DC or other types of plans as the primary retirement 

plan.21

Unlike in the private sector, many state and local government employees 

are not covered by Social Security. About 6.4 million, or over one-fourth, 

of state and local government employees are not eligible to receive Social 

Security benefits based on their government earnings and do not pay 

 

18These projections are based on 500 simulations of the economy and plan sponsor 

behavior. See PBGC, FY 2013 PBGC Projections Report.

19According to PBGC, in the event that the multiemployer insurance fund is exhausted, 

affected participants then relying on the PBGC pension guarantee would receive an 

extremely small fraction of what PBGC guarantees or, potentially, nothing. According to 

PBGC officials, once the insurance fund’s cash balance is depleted, the agency would 

have to rely solely on the annual insurance premium receipts. The precise effect that the 

insolvency of the multiemployer insurance fund would have on retirees receiving the 

PBGC guaranteed benefit depends on a number of factors—primarily the number of 

guaranteed benefit recipients and PBGC’s annual premium income at that 

time. GAO-13-240. 

20For the same period, there were about 19 million state and local government employees 

and over 106 million private sector employees. See U.S. Department of Labor, U.S. 

Bureau of Labor Statistics, National Compensation Survey: Employee Benefits in the 

United States, March 2013 (Washington, D.C.: Sept. 2013). 

21See GAO, State and Local Government Retiree Benefits: Current Status of Benefit 

Structures, Protections, and Fiscal Outlook for Funding Future Costs, GAO-07-1156 

(Washington D.C.: Sept. 24, 2007).
 

Page 9 GAO-14-264 Pension Plan Valuation 

Social Security taxes on these earnings.22

ERISA established minimum standards for pension plans in the private 

sector and, through the Internal Revenue Code, provides extensive rules 

on the 

As a result, employer-provided 

pension benefits for such noncovered employees are generally higher 

than for employees covered by Social Security, and employee and 

employer contributions are generally higher as well. Also, unlike private 

sector employees with DB plans, state and local government employees 

generally contribute to their DB plans.

federal tax effects of transactions associated with employee 

benefit plans. ERISA protects the interests of employee benefit plan 

participants and their beneficiaries by requiring the disclosure of financial 

and other information concerning the plan, establishing standards of 

conduct for plan fiduciaries, and providing for appropriate remedies and 

access to the federal courts, among other things. Since its enactment in 

1974, ERISA has been amended many times, including by the Pension 

Protection Act of 2006 (PPA), which changed minimum funding standards 

for private sector single-employer defined benefit pension plans by, 

among other things, changing the measurement of a plan’s funding target 

(including the discount rate used) and shortening the period of time over 

which the funding target should be attained. Minimum funding standard 

provisions have since been further revised by subsequent legislation.

PPA also included provisions requiring private sector multiemployer plans 

in poor financial shape to take action to improve their financial condition 

over the long term.23

 

22See 42 U.S.C. § 410(a)(7). Historically, Social Security did not require coverage of state 

and local government employment. As a result, some state and local government workers 

who were not covered by a retirement system were left without benefits when they retired. 

To help these employees, in 1950 section 218 was added to the Social Security Act 

allowing states to enter into voluntary agreements to provide Social Security coverage to 

certain state and local government employees not covered by public pension plans. Social 

Security Act Amendments of 1950, Pub. L. No. 81-734, § 106, 64 Stat. 477, 514 (codified 

at 42 U.S.C. § 218). In 1954, voluntary coverage was extended to those already covered 

by plans as well. Social Security Amendments of 1954, Pub. L. No. 83-761, § 101(h)(2), 

68 Stat. 1052, 1056 (codified at 42 U.S.C. § 218(d)(3)). Starting in 1991, the Social 

Security Act generally required all state and local government employees to be covered by 

Social Security if they were not already covered by a state or local retirement system. 

Revenue Reconciliation Act of 1990, Pub. L. No. 101-508, § 11332, 104 Stat. 1388-469. 

See GAO, Social Security Administration: Management Oversight Needed to Ensure 

Accurate Treatment of State and Local Government Employees, GAO-10-938 

(Washington, D.C.: Sept. 29, 2010) and GAO-12-322. 

23GAO-13-240. 
 

Page 10 GAO-14-264 Pension Plan Valuation 

The federal government has not imposed the same funding and reporting 

requirements on state and local government pension plans as it has on 

private sector pension plans.24 State and local government plans are 

specifically exempted from ERISA funding requirements, in part, because 

of the presumption that state and local governments can rely on their 

taxing power to pay for DB plan benefits.25 These plans are also not 

insured by the PBGC as private DB plans are. However, in order for 

participants to receive preferential tax treatment (that is, for contributions 

and investment earnings to be tax-deferred), state and local government

pension plans must comply with certain requirements of the Internal 

Revenue Code.26

State and local governments also follow different standards than the 

private sector for financial reporting.27

 

24To further clarify the difference between government and private sector pension plans, 

the Internal Revenue Service issued an advance notice of proposed rulemaking in 

November 2011 relating to the definition of the term “governmental plan.” The regulation 

under consideration is intended to establish coordinated criteria for determining whether a 

plan is a governmental plan and address current uncertainty regarding entities with 

organizational, regulatory, and contractual connections with states or political subdivisions 

of states. Determination of Governmental Plan Status, 76 Fed. Reg. 69,172 (Nov. 8, 2011) 

(to be codified at 26 C.F.R. pt. 1). The rule has not been finalized. 

The accounting standards for 

financial reporting by public and private sector pension plan sponsors are 

promulgated by two independent organizations. For the public sector, the 

GASB has been designated by the American Institute of Certified Public 

Accountants as the accounting standard-setter to establish generally 

accepted accounting principles for U.S. state and local governmental 

entities. GASB’s standards are not federal laws or regulations and GASB 

does not have enforcement authority. However, compliance with its 

25Committee on Ways and Means, Private Pension Tax Reform, H.R. Rep. No. 12855 

(1974).

26Employer contributions to qualified pension plans that meet certain requirements—

whether defined benefit or defined contribution—are generally not counted as taxable 

income to employees when the contributions are made. However, when pension benefits 

are paid, amounts not previously taxed are subject to federal and perhaps state tax. This 

also applies to the interest income such contributions generate. As an alternative, some 

state and local government qualified DC pension plans provide an option for designated 

contributions to Roth accounts, and such contributions to Roth accounts are made after 

taxation. The interest income earned on such contributions is generally not subject to tax 

upon distribution, provided that the requirements and restrictions applicable to such 

accounts under the Internal Revenue Code have been satisfied. 

27Financial reporting standards are also sometimes referred to as accounting standards.
 

Page 11 GAO-14-264 Pension Plan Valuation 

standards is required through laws of some individual states and is 

integrated into the audit process, whereby auditors render opinions on the 

fair presentation of state and local governments’ financial statements in 

accordance with generally accepted accounting principles. For the private 

sector, the FASB has been designated by the American Institute of 

Certified Public Accountants as the accounting standard-setter to 

establish generally accepted accounting principles for nongovernmental 

entities. Those standards are officially recognized as “generally accepted” 

for the purposes of federal securities laws by the Securities and 

Exchange Commission (SEC), and companies registered with the SEC 

are required to comply with those standards in preparing financial 

statements filed with the SEC.

In addition to the standards above, actuarial standards of practice are 

promulgated by the Actuarial Standards Board, whose mission is to 

identify what an actuary should consider, document, and disclose when 

performing an actuarial assignment. Actuaries work with plans to develop 

economic and demographic assumptions.28

For DB pension plans, the discount rate is used in converting projected 

future benefits into their “present value” and is an integral part of 

estimating a plan’s liabilities. A pension liability generally includes two 

pieces: (1) the present value of all projected future benefits for current 

retirees, as well as for former employees not yet retired but who have a 

vested right to a future pension, plus (2) the present value of a portion of 

 

28Actuarial assumptions are needed to project the amount, likelihood, and timing of future 

benefits and to determine their present value, and include both economic and 

demographic assumptions. Economic assumptions typically include those for inflation, 

future salary increases, and the discount rate. Demographic assumptions typically include 

those for the likelihood of termination of employment, age of retirement, form of benefit 

elected, and longevity. Developing actuarial assumptions typically involves both the 

analysis of data and the application of professional judgment, and different actuaries might 

reach different conclusions as to appropriate assumptions. In addition, depending on the 

type of assumption, the type of plan, and other circumstances, particular actuarial 

assumptions might be selected by the actuary, selected by the plan sponsor, or prescribed 

by statute or regulation. As a result of these factors (as well as the differences among 

conceptual approaches in the case of discount rates), actuarial assumptions can 

sometimes vary considerably among plans. Actuarial standards of practice include 

guidance on factors an actuary should consider when selecting an assumption or 

providing advice on selecting an assumption, as well as guidance on disclosures an 

actuary should make when assumptions are selected by others, including disclosures 

regarding the reasonableness of such assumptions. 

The Discount Rate and 

Liability Calculations
 

Page 12 GAO-14-264 Pension Plan Valuation 

the projected future benefits for current employees, based on their service 

to date (with each additional year of service adding to the liability, such 

that approximately the full cost of benefits is accrued when employees 

reach retirement).29 The increase in the liability that arises from an 

additional year of employee service is called the “normal cost,” which can 

also be thought of as the pension cost attributable to employees’ work in 

a single year.30

 

29The pattern by which the liability builds up over an employee’s career varies according 

to the “actuarial cost method,” discussed later. 

Both the liability and the normal cost depend on the 

discount rate, as they both represent the present value of some portion of 

future benefits. The higher the discount rate, the lower the plan’s estimate 

of its liability and normal cost (see fig. 1). In addition, the further into the 

future that the projected benefit payments occur, the more pronounced is 

the effect of the discount rate, because it is applied over a greater number 

of years. As a result, a pension liability for current workers is typically 

more sensitive to changes in the discount rate than is a pension liability 

for retirees.

30“Normal cost” is also sometimes referred to as “service cost.” 
 

Page 13 GAO-14-264 Pension Plan Valuation 

Figure 1: Effect of Different Discount Rates on Measuring the Liability for a Future 

Payment

Notes: The figure above illustrates the effect of different discount rates on measuring the liability for a 

future payment independent of an actuarial cost method.

Corresponding liabilities for a $1,000 benefit payable 7 years from today are $760 at a 4 percent 

discount rate and $583 at an 8 percent discount rate. For a benefit payable 7 years from today, the 

liability measured at 4 percent is therefore 30 percent higher than the liability measured at 8 percent. 

In contrast, for the benefit payable 15 years from today, the liability measured at a 4 percent discount 

rate is 76 percent higher than the liability measured at an 8 percent discount rate.

Methods for determining a plan’s discount rate can be categorized into 

two primary approaches—the assumed-return and bond-based 

approaches.31

 

31These primary approaches in turn can have different variations, such as the use of 

“smoothing” with bond-based approaches, as is used by private sector single-employer 

plan sponsors under ERISA, where bond interest rates are averaged over multiple current 

and historical years. 

The first approach—the “assumed-return approach”—

bases the discount rate on a long-term assumed average rate of return on 

the pension plan’s assets (which includes expected long-term stock 

market returns to the extent plan assets are so invested, and which, in 

Approaches to 

Determining the Discount 

Rate
 

Page 14 GAO-14-264 Pension Plan Valuation 

recent years, and as employed by U.S. public plan sponsors, often would 

produce discount rates between 7 and 8 percent).32,33,34 Under this 

approach, the discount rate depends on the allocation of plan assets. For 

example, a reallocation of plan assets into fewer bonds and more stocks 

can increase the discount rate and reduce the measurement of plan 

liabilities. Under this approach, the discount rate also depends on 

estimates of what future investment returns the plan will earn on its 

assets; more optimistic estimates produce higher discount rates and 

lower plan liabilities. The assumed-return approach is based in part on 

the premise that pension plans are long-term enterprises that can 

weather fluctuations in financial markets, and that the estimated long-term 

average cost of financing plan benefits, based on the plan’s asset 

allocation, provides the most relevant measure of plan costs.35

The second approach—the “bond-based approach”—uses a discount rate 

based on market prices for bonds, annuities, or other alternatives that are 

deemed to have certain characteristics similar to pension promises, 

instead of estimates of future returns.36

 

32See GAO, State and Local Government Pension Plans: Governance Practices and 

Long-term Investment Strategies Have Evolved Gradually as Plans Take On Increased 

Investment Risk, 

The bond-based approach is 

premised on the theory that pension benefits are “bond-like,” in that they 

constitute promises to make specific payments in the future, and should 

be similarly valued. Under this approach, the discount rate is independent 

of the allocation of plan assets. The relevant bond “quality” (e.g., AAArated, AA-rated, etc.) can depend on the specific purpose of the liability 

measurement, which can result in rates that vary considerably. There are 

GAO-10-754 (Washington, D.C.: Aug. 24, 2010). Discount rates as high 

as 8.5 percent have become less common in the interval since the publication of this 

report.

33Unless otherwise noted, discount rates and other interest rates cited in this report are 

nominal and not adjusted for the effects of inflation. 

34This discount rate approach is also used in determining minimum funding requirements 

for multiemployer plans. 

35We use the term “plan costs” generically, which can refer, depending on the context, to 

a plan’s liability or normal cost, and to funding or financial reporting calculations, among 

other measures and purposes. 

36The discount rate under this approach often will not be a single rate, but rather a “yield 

curve” of fixed income rates at multiple maturities.
 

Page 15 GAO-14-264 Pension Plan Valuation 

at least five variations of bond-based approaches that are in use or have 

been proposed.37

• Interest Rates on High-Quality Corporate Bonds: This method is 

typically used by private sector single-employer plan sponsors for 

financial reporting under FASB standards.38

• Historical Averages of High-Quality Corporate Bond Interest 

Rates: This “smoothing” approach is allowed for funding purposes for 

private sector single-employer plan sponsors under amendments to 

ERISA and PPA, which allowed discount rates based on a 2-year 

average of high-quality corporate bond rates. This 2-year smoothing 

was lengthened to 25-year smoothing by the Moving Ahead for 

Progress in the 21st Century Act (MAP-21), tying discount rates to a 

25-year historical average (see table 1 in the next section). The use of 

a 25-year historical average results in current discount rates that are 

 

37See later discussion for details on recent rates under some variations of the bond-based 

approach outlined here.

38The FASB accounting standards referenced throughout this report refer to requirements 

for plan sponsor, and not individual plan, financial reporting.
 

Page 16 GAO-14-264 Pension Plan Valuation 

significantly in excess of current or recent interest rates on high 

quality bonds.39

• Risk-Free Interest Rates: Another variation is to use risk-free interest 

rates (e.g., Treasury rates). A panel commissioned by the Society of 

Actuaries recommended that public plans disclose an additional 

liability measurement using this method, and at least one public plan 

currently discloses such a supplemental measure.40

 

39Under ERISA, private sector single-employer sponsors are required to use a bondbased approach to determine the minimum required contribution. Within this framework, 

these sponsors have two options. Plan sponsors are given the option of using a full yield 

curve approach, which matches projected benefit payments to high-quality corporate bond 

interest rates as of a current or very recent month, so that under this option, the 

measurement of plan liabilities would be tied to current or very recent market conditions. A 

plan sponsor choosing this approach would discount a benefit payment due in 10 years at 

the yield curve rate as published by Treasury for year 10. However, single-employer plan 

sponsors may also elect to discount using a simplified three-segment yield curve 

published by Treasury, with the three different segment interest rates applicable to benefit 

payments due in less than 5 years, 5 to 20 years, and 20 years or more. Under the 

segment rate approach, the interest rates are based on a 2-year average of high-quality 

corporate bond rates but also cannot be higher or lower than maximum and minimum 

segment rates as set in law in 2012 as part of the Moving Ahead for Progress in the 21st 

Century Act (MAP-21).The MAP-21 maximum and minimum apply to plans that use the 

segment rate approach, and are based on long-term (25-year) historical bond averages. 

MAP-21’s effect on discount rates is designed to be temporary. Because average interest 

rates over the past 25 years are significantly higher than more recent market rates, the 

MAP-21 changes have had the effect of significantly increasing ERISA discount rates over 

what they would otherwise have been, thereby lowering measurements of plan liabilities 

and reducing minimum funding requirements. Legislation was signed in August 2014 that 

further extends the use of 25-year averaging of interest rates for determining minimum 

funding standards for private sector single-employer plans. Pub. L. No. 113-159, 128 Stat. 

1839. Under either option, the market interest rates for any month, prior to any historical 

averaging, are based on an average of daily rates over the course of the month. Further, 

plan sponsors can elect to use rates as of an “applicable month,” consistently applied from 

year to year, which can be the month containing the plan’s annual valuation date or any of 

the preceding four months.

A liability based 

on risk-free interest rates can be thought of as approximating the 

amount of money that would be needed to come close to protecting 

the payment of future benefits from investment risk. Demographic risk 

40Report of the Blue Ribbon Panel on Public Pension Plan Funding: An Independent 

Panel Commission by the Society of Actuaries (February 2014). 
 

Page 17 GAO-14-264 Pension Plan Valuation 

would still remain, such as the risk of life expectancy improving faster 

than expected.

41

• Matching Bond Credit Quality with Estimated Riskiness of the 

Pension Promise: Under this variation, as advocated by some

financial economists for certain purposes, as discussed later, the 

bond credit quality could be chosen to match the estimated riskiness 

of the pension promise.42

• Annuity Settlement Rates: This fifth variation is the method used by 

PBGC for its financial reporting of its deficit.43

 

41A variation currently in use involves historical averaging of Treasury rates over recent 

years to determine a “current liability,” an additional liability measure calculated for 

multiemployer plans. The discount rate for this purpose must be between 90 percent and 

105 percent of a weighted average of interest rates on 30-year Treasury bonds over the 

prior 4 years. In the weighted average calculation, the most recent year is given a weight 

of 4, the next most recent year a weight of 3, the year before that a weight of 2, and the 

first year a weight of 1. The weighted average is calculated and published by Treasury.

This method can also 

be considered a bond-based approach as it is based on estimated 

market prices for annuities, which are influenced by, and will vary 

42The “quality” of a bond refers to an assessment of its credit risk, or the ability of the bond 

issuer to fulfill its future contractual obligations. Typically, nationally recognized rating 

companies perform credit analysis on the issuing entity and issue their conclusions in the 

form of ratings. Bond issues are assigned a rating commensurate with their credit risk. 

Among corporate bonds, AAA/Aaa rated bonds are said to be “prime,” or of the lowest 

credit risk, followed next by AA/Aa rated bonds which are of “high quality,” and so on, with 

high yield, or “junk bonds,” being the lowest quality or of the highest credit risk. Generally, 

the yield, or return on a bond, is inversely related to its credit risk, with risk-free Treasury 

bonds bearing the lowest yields and “junk bonds” the highest. 

43PBGC’s discount rate is based on interest rate factors that are specifically developed 

such that, when combined with PBGC’s longevity assumptions, will approximate singlepremium nonparticipating group annuity purchase rates. PBGC obtains information about 

the prices charged by private life insurers from quarterly surveys conducted for PBGC by 

the American Council of Life Insurers (ACLI). The ACLI surveys gather group annuity 

pricing information as of March 31, June 30, September 30, and December 31 of each 

year. The surveys collect information on private-sector group annuity prices for immediate 

and deferred annuities at a range of ages. These prices are net of administrative 

expenses: that is, the prices exclude costs for record-keeping, communication with 

annuitants, related corporate overhead, etc., but include profit and taxes. Using data from 

the annuity survey, PBGC determines two interest factors to compute estimates of the 

present value of its liabilities — a “select” factor to discount projected payouts for an initial 

period of years and an “ultimate” factor to discount projected payouts thereafter. 
 

Page 18 GAO-14-264 Pension Plan Valuation 

with, market interest rates.44 A liability based on an annuity settlement 

rate is the estimated market value of the amount of money that is 

required to fully insure the payment of future benefits against both 

economic and demographic risks.45 As a result, a settlement liability 

can be significantly greater than a liability calculated using high-quality 

bond rates.46 PBGC officials stated that this often leads to unpleasant 

surprises when a plan terminates, whereby a plan that was thought by 

plan participants to be overfunded turns out to be underfunded.47

Because bond interest rates are currently at historic lows (see fig. 2), and 

because plans’ assumed returns have not declined commensurately, 

bond-based approaches today that use little or no smoothing are likely to 

The 

remainder of this report focuses mainly on the discount rates used by 

plan sponsors and trustees.

 

44Bonds are generally priced based upon the present value of their expected cash flows 

and the yield, or interest rate, which is commensurate with other bonds of comparable 

maturity and credit quality. Annuities, generally offered by life insurance companies that 

would typically guarantee lifetime streams of benefit payments to beneficiaries, are priced 

with regard to current market or bond-based interest rates but also typically include the 

addition of various fees, which include the insurer’s administrative and marketing 

expenses, the cost of capital and surplus, and profit to the insurer. Additionally, annuity 

pricing typically includes allowance for longevity and other demographic risks. These 

differences generally result in annuity prices being higher than pension liabilities 

calculated based on high-quality bond rates (i.e., in implied annuity interest rates that are 

lower than high-quality bond interest rates). In addition, the spreads between implied 

annuity interest rates and high-quality bond interest rates will vary over time, just as the 

spreads among various classes of corporate bonds and Treasury bonds will vary over 

time. The actual market price of an annuity can depend on many factors, including the 

duration of the liabilities expected to be settled, the size of the purchase, the average 

pension amount for the pensions being purchased, capital market conditions, and 

competitive pressures in the group annuity market at the time of purchase. 

45The only risk that would remain would be the solvency of the insurance company itself. 

The U.S. insurance industry is generally regulated at the state level. Solvency protections 

include capital standards and state guaranty funds. See GAO, Insurance Markets: Impacts 

of and Regulatory Response to the 2007-2009 Financial Crisis, GAO-13-583 (Washington 

D.C.: June 27, 2013). 

46As a result, it is often the case that a private sector single-employer plan sponsor’s 

valuation of its pension liabilities under FASB or ERISA requirements is lower than 

PBGC’s valuation of that same plan. 

47For a discussion of different perspectives on PBGC’s discount rate and the 

measurement of its liabilities and deficit, see American Academy of Actuaries Issue Brief: 

Perspectives on the PBGC Single-Employer Deficit (August 2013).
 

Page 19 GAO-14-264 Pension Plan Valuation 

produce discount rates that are much lower than current assumed 

returns.48,49

Figure 2: 10-Year and 30-Year Treasury Interest Rates from 1962 to 2012

Note: The yields represent average rates from business days for the year.

a

 

48As discussed, a variation on the bond-based approach is to use an historical average of 

bond interest rates over some period preceding the measurement date. Because of 

declines in interest rates over recent years and decades, use of an historical average of 

interest rates can, depending on the averaging period, result in discount rates that are 

significantly in excess of current market interest rates. Experts who supported a bondbased approach to setting discount rates typically disagreed with the use of extended 

historical averages, and sometimes with any averaging at all. 

30-year Treasury interest rates were not available before 1977 and from 2002 to 2006.

49Our categorization of discount rates into two broad categories, “assumed-return” and 

“bond-based,” along with the subcategories of variations under “bond-based,” is 

constructed for the purpose of illustrating certain key characteristics of different 

approaches. It is not the only way to group the various approaches, and other experts 

might do so differently. For example, one expert felt that annuity settlement rates should 

be placed into a separate third category rather than grouping it with bond-based 

approaches. This expert also viewed the ERISA / PPA / MAP-21 approach of relying on a 

25-year historical average of bond rates as not being “bond-based” because of its 

remoteness from current or recent bond rates. The key factor underlying our 

categorization is that under the assumed-return approach, the discount rate depends on 

the allocation of plan assets; this is not the case for any of the bond-based variations that 

we identified, which depend on characteristics of a plan’s liabilities but not on the assets 

set aside to finance them. 
 

Page 20 GAO-14-264 Pension Plan Valuation 

The discount rate approaches and regulatory structure governing pension 

plans in Canada, the Netherlands, and the United Kingdom differ in

various ways from those in the United States. As in the United States, 

most Canadian defined benefit plans—both public and private—are 

prefunded, according to Canadian experts with whom we spoke.50

Additionally, they noted that most plans are regulated at the provincial 

level, although some plans, such as those of federally regulated 

employers such as banks, telecommunications companies, and interprovincial transportation companies, are regulated by a separate federal 

regulator.51 Nonetheless, the regulatory principles are generally similar 

across all regulators, according to experts.52 There is no national pension 

insurance program in Canada.53 In the Netherlands, De Nederlandsche 

Bank (DNB) regulates pension discount rates.54

 

50In a prefunded plan, a sponsor makes contributions that go into a trust fund, grow with 

investment returns, and eventually are paid out as benefits at a later date. 

An official told us that 

there are no regulatory distinctions among public, private, or 

multiemployer defined benefit plans in the Netherlands. They also noted 

that pension plans in the Netherlands are separate legal entities from plan 

sponsors, and there is no pension insurance program in place. Benefit 

amounts can vary with plan investment performance and plan funded 

51According to Canadian experts with whom with spoke, each province has its own 

regulatory body for pension plans under its jurisdiction (with the exception of Prince 

Edward Island). At the federal level, the Office of the Superintendent of Financial 

Institutions (OSFI) regulates and supervises private pension plans in federally regulated 

areas of employment and certain enumerated public plans. One expert added that there 

are many national companies in provincially regulated businesses such as retail, 

manufacturing, and oil. In these plans, benefit standards are dictated by the rules of the 

province of employment, while other considerations that are of a plan-wide nature, such 

as the funding rules, are governed by the rules of the province with the plurality of plan 

members. 

52However, experts told us that funding relief measures provided in recent years have 

varied across provinces. Experts also told us that Quebec has many differences in 

pension regulation compared to the rest of Canada.

53With the exception of Ontario province, which has pension insurance that insures a 

nominal benefit of up to one thousand Canadian dollars per month, experts noted that 

there is no pension insurance program in Canada.

54The DNB examines the financial position of pension funds and regulates the discount 

rates. The Netherlands Authority for the Financial Markets (AFM) monitors market conduct 

relating to pension funds’ obligations to provide information to members. 

Defined Benefit Systems 

in Selected Other 

Countries
 

Page 21 GAO-14-264 Pension Plan Valuation 

status.55,56 In the United Kingdom, private sector defined benefit plans are 

prefunded and public sector plans generally are not.57 The Pensions 

Regulator is the regulating entity for private pension plans and a national 

pension insurance program is administered by the Pension Protection 

Fund.58 Plans have trustees who are autonomous from the sponsoring 

employers. The trustees and employers negotiate in setting plan policies, 

with assumptions and approaches subject to a risk-based process of 

review by the Pensions Regulator. According to experts, the Pensions 

Regulator uses what it calls a Scheme Specific Funding framework for 

evaluating funding requirements.59 Discounting practices for DB pension 

plans in Canada, the Netherlands, and the United Kingdom are discussed 

later in this report, and a summary of these countries’ DB regulatory 

requirements and discounting approaches can be found in appendix IV.

 

55Funded status is a comparison of plan assets to plan liabilities. One measure of funded 

status is the “funded ratio,” which is calculated by dividing plan assets by plan liabilities. 

Another measure of funded status is the difference between plan assets and plan 

liabilities, that is, the dollar amount of surplus or deficit. For example, if assets are greater 

than liabilities, the funded ratio is greater than 100 percent and the plan has a surplus 

(overfunding) equal to the excess of assets over liabilities; if liabilities are greater than 

assets, the funded ratio is less than 100 percent and the plan has a deficit (underfunding, 

or unfunded liability) equal to the excess of liabilities over assets. 

56In the Netherlands, pension plan trustees can decide to increase benefits for wage or 

price inflation (“indexation”) if the funded ratio is sufficiently high. If the funded ratio stays 

below a minimum funded ratio of 105 percent, accrued benefits can be reduced.

57For most public sector plans in the United Kingdom, benefits are paid out of general 

revenue. The discussion in this report about discount rate practices in the United Kingdom 

will be related primarily to private sector plans. Beginning in 2015, the U.K. Pensions 

Regulator will assume additional responsibility for regulating the governance and 

administration of public service pension plans. 

58Participants of plans that become insolvent may be eligible for benefits from the Pension 

Protection Fund (PPF). The PPF is the U.K. equivalent to the U.S. Pension Benefit 

Guaranty Corporation. The main function of the PPF is to provide compensation to 

members of eligible defined benefit pension schemes when there is a qualifying 

insolvency event in relation to the employer, and where there are insufficient assets in the 

pension plan to cover the PPF level of compensation.

59In the United Kingdom, the term pension “scheme” is used rather than pension “plan,” 

with no pejorative connotation.
 

Page 22 GAO-14-264 Pension Plan Valuation 

For financial reporting purposes, private sector plan sponsors in these 

countries often follow the accounting standards promulgated by the IASB. 

Plan sponsors in the United Kingdom will often follow the local U.K. 

accounting standards promulgated by the Financial Reporting Council 

(FRC) or the IASB standards. IASB and FRC standards take an approach 

to the discount rate that is broadly similar to that in FASB standards.
 

Page 23 GAO-14-264 Pension Plan Valuation 

Public and private sector DB pension plans are subject to different rules 

and guidance regarding discount rates. For purposes of both funding and 

financial reporting, public plan sponsors generally use an assumed-return 

approach, while private sector single-employer plan sponsors use a bondbased approach for financial reporting purposes, but currently are allowed 

a 25-year smoothing option that is generally in use for funding 

purposes.60 Private sector multiemployer plans generally use an 

assumed-return approach for funding purposes, but also calculate an 

additional liability measure under ERISA based on an average of 

Treasury bond rates, while standards related to discounting for 

accounting purposes are typically not applicable to participating 

employers in these plans.61,62

Table 1 summarizes these laws, standards, and rules for different plan 

types. Different laws and standards also specify different actuarial cost 

methods and give different names to the resulting liability measures. See 

appendix II for more details. In addition, both FASB and GASB have 

These various rules and guidance result in 

considerable variation in the discount rates that are currently in use. The 

result is discount rates that are generally highest for public plans and for 

funding private sector multiemployer plans, followed by discount rates for 

funding private sector single-employer plans (under the interest rate path 

of the past 25 years). The lowest discount rates among U.S. plans are for 

financial reporting by sponsors of private sector single-employer plans 

and for the additional liability calculated by multiemployer plans. 

 

60For public sector plans, one exception to the typical use of assumed return discount 

rates is that some plans use a fixed discount rate set by its jurisdiction, which might not 

necessarily be tied to how plan assets are invested. 

61The minimum required contribution for multiemployer plans is generally based on a 

funding target using an assumed return discount rate. A second measure of liability, called

the “current liability” and based on a 4-year weighted average of 30-year Treasury rates, is 

also reported by plans on Schedule MB of Form 5500. However, experts viewed 

multiemployer plans as operating primarily on an assumed return basis, although they had 

differing views of the significance of the current liability calculation (see footnote 109 later). 

The “current liability” can affect the minimum required contribution in certain years, and is 

used in determining the maximum tax-deductible contribution, but the minimum funding 

target remains the liability measured using an assumed return discount rate. 

62FASB accounting standards for discounting are typically not applicable for participating 

employers in a multiemployer plan, in part because of presumed difficulties in reliably 

measuring an employer’s share of the plan’s total liability. However, the accounting 

requirements are applicable for individual plan reporting, which for a multiemployer plan 

are the same as those for private single-employer plans for individual plan reporting, noted 

below. 

Discount Rates for 

Sponsors of Public 

Sector Plans and 

Private Sector 

Multiemployer Plans 

Differ from Those of 

Private Sector SingleEmployer Plans, 

Resulting in Different 

Incentives for Both 

and, for the Former, 

Higher Reported 

Funded Ratios and 

Lower Reported 

Costs 
 

Page 24 GAO-14-264 Pension Plan Valuation 

differences in their requirements applicable to financial reporting by 

pension plan sponsors (and participating employers in the case of

multiemployer plans) and financial reporting by the pension plans 

themselves. Under GASB standards, the discount rate requirements are 

the same for both plan sponsor and plan financial reporting. Under FASB 

standards, plan sponsors are required to discount using “settlement 

rates,”---which can be based on the discount rates implicit in the current 

prices of annuity contracts, such as PBGC’s rates, but can also be based 

on current high quality bond rates, which plan sponsors generally do---

while plans are required to discount using best-estimate assumed rates of 

return. With regard to U.S. financial reporting requirements, the focus of 

this report is on requirements applicable to plan sponsors and 

participating employers, not financial reporting by the plans themselves.

Table 1: Laws, Standards, Practices, and Discounting Premises for U.S. Defined 

Benefit Plan Sponsors and Participating Employers, by Plan Type

Type of plan Financial reporting 

Applicable funding 

law 

Discounting 

premise

Applicable 

accounting 

standards 

Discounting 

premise

Private sector 

single-employera ERISA High-quality corporate bond 

yields, which may 

be averaged over 

25 years

FASB

b

Current 

high-quality 

corporate 

bond yields

c

Private sector 

multiemployera ERISA Assumed-return FASB d Typically not 

applicable

c

Public sector

e

No federal 

standards; each 

jurisdiction makes 

its own, if any

Generally assumed 

return 

GASB Assumedreturn 

approach to 

extent plan 

is projected 

to be 

funded; 

bond-based 

approach 

for shortfall

Source: GAO analysis of relevant ERISA provisions, FASB standards, and GASB standards. | GAO-14-264

f

a

Funding

Not shown in this table is the discount rate basis used by PBGC. PBGC uses annuity settlement 

rates to determine the present value of future pension benefit payments to be paid to the participants 

of eligible private sector single-employer plans that PBGC has trusteed, and to determine the present 

value of financial assistance that it projects it will have to provide to multiemployer plans. PBGC uses 

recent prices of group annuities determined based on a confidential survey of private life insurers to 

derive the interest factors, or implied discount rates. A liability based on an annuity settlement rate is 

the estimated market value of the amount of money that is required to assure the payment of future 

benefits via contracts with the insurance industry.
 

Page 25 GAO-14-264 Pension Plan Valuation 

b The 25-year averaging of high-quality corporate bond rates is designed to be temporary, though 

legislation enacted in August 2014 extends its effect.

c

d Minimum required contributions for multiemployer plans are determined at the plan level. 

Contribution rates for participating employers are determined by collective bargaining, but rates will 

typically be negotiated that are estimated to conform with minimum funding requirements. The 

minimum required contribution is generally based on a funding target using an assumed return

discount rate. A second measure of liability, called the “current liability” and based on a 4-year 

weighted average of 30-year Treasury rates, is also reported by plans on Schedule MB of Form 5500. 

The “current liability” can affect the minimum required contribution in certain years, and is used in 

determining the maximum tax-deductible contribution, but the minimum funding target remains the 

liability measured using an assumed return discount rate.

The FASB accounting standards referenced here refer to requirements for plan sponsor, and not 

individual plan, financial reporting.

e

f

Under current GASB standards, public plan sponsors use an assumed-return approach. Under a 

new GASB standard, with implementation required by fiscal years beginning after June 15, 2014, plan 

sponsors would use an assumed-return approach to the extent they project that current assets, 

assumed returns, and future contributions for current members will be sufficient to provide for 

benefits; for any projected shortfalls, public plan sponsors would use a 20-year municipal bond rate 

as the discount rate. GASB encourages earlier application of the new standard.

Participating employers in private sector multiemployer plans typically do not have to calculate a 

liability for financial reporting purposes.

Public plans and private sector multiemployer plans generally report 

higher funded ratios, and their liabilities generally appear lower, than 

those of comparable private sector single-employer plans because these 

plans currently use very different discount rate approaches, leading to 

potentially large differences in funded ratios and reported liabilities. This 

difference is because public plan sponsors’ and multiemployer plans’ 

discount rates are determined largely using an assumed-return approach, 

which generally produces higher discount rates.

63,64

 

63Under current GASB standards, plan sponsors use an assumed-return approach. Under 

a new GASB standard with implementation required by fiscal years beginning after June 

15, 2014, plan sponsors would use a blended approach which industry experts have 

indicated is likely to be closer to an assumed-return approach in most instances. See 

appendix II for more information. 

As such, this 

approach generally produces lower liabilities than variations of bondbased approaches with little or no smoothing (which often produces lower 

discount rates), as used by private sector single-employer plan sponsors 

64As noted, multiemployer plans calculate an additional liability measure under ERISA, 

called the current liability, based on a 4-year weighted average of 30-year Treasury rates.

However, experts viewed multiemployer plans as operating primarily on an assumed 

return basis, although they had differing views of the significance of the current liability 

calculation (see footnote 109 later). 
 

Page 26 GAO-14-264 Pension Plan Valuation 

for financial reporting purposes.65 For example, Mercer, a retirement 

industry consultant, estimated that at the end of 2013 an average private 

sector single-employer plan sponsor would have a discount rate of 4.88 

percent for FASB reporting. According to the National Association of 

State Retirement Administrators, however, public plan sponsors assumed 

a return of 7.72 percent on average as of December 2013.66,67 At this 

difference in discount rates, the present value of a benefit payment due in 

15 years for a private sector single-employer plan sponsor for financial 

reporting would be almost 50 percent higher than for a comparable public 

sector plan sponsor.68

 

65For current workers, the effects of different actuarial cost methods also have to be taken 

into account in comparing the size of different liability measurements, as discussed later in 

this section and in appendix II. 

Some experts (including those on the GASB) view 

differences between public sector and private sector single-employer 

discounting approaches as appropriate because they see public plans as 

going concerns that can best estimate their pension costs using very 

long-term assumed returns as their discount rate. There are other 

experts, however, who disagree with this viewpoint or see value in both 

types of measures. See the next section for a discussion of various 

considerations underlying different views on discount rate policy.

66National Association of State Retirement Administrators, NASRA Issue Brief: Public 

Pension Plan Investment Return Assumptions (December 2013). Historically, private 

sector multiemployer plans have often used assumed return assumptions of 7.5 percent or 

higher. Between 1995 and 2007, large multiemployer plans used an average assumed 

return, weighted by plan liabilities, of 7.57 percent. For the 2010 plan year, multiemployer 

plans used an average assumed return, weighted by plan liabilities, of 7.52 percent. See 

Department of Labor, Department of the Treasury, and Pension Benefit Guaranty 

Corporation, Multiemployer Pension Plans: Report to Congress Required by the Pension 

Protection Act of 2006 (Washington, D.C.: Jan. 22, 2013).

67As shown in table 1, private sector multiemployer plans also generally discount using 

the assumed-return approach for funding purposes under ERISA. All other assumptions 

and factors held constant, a private sector multiemployer plan discounting using an 

assumed-return approach would generally result in lower reported liabilities than a private 

sector single-employer plan with the same pension obligations discounting using a bondbased approach with little or no smoothing. For current workers, the difference may 

sometimes be lessened somewhat by differences in actuarial cost method.

68For current workers, this difference will typically be lessened somewhat by differences in 

actuarial cost method, discussed later in this section.
 

Page 27 GAO-14-264 Pension Plan Valuation 

Bond-based discount rates can vary considerably, and may not always 

result in significantly lower discount rates than assumed-returns.69 In 

practice, there are variations of the bond-based approach that can result 

in discount rates that do not, to varying degrees, reflect current or recent 

market rates. These approaches have been implemented or proposed in 

order to provide stability for funding or financial reporting purposes but 

can have the effect of obscuring any measure of a market value of the 

liability (i.e., a connection to current market prices).70 For funding 

purposes under ERISA as amended by the PPA, but prior to the MAP-21 

amendments, private sector single-employer plan sponsors who elected 

to use 2-year smoothing of interest rates based on high-quality corporate 

bonds would have used, in December 2013, Treasury-prescribed 

discount rates of 1.28 percent for benefit payments due in less than 5 

years, 4.05 percent for payments due between 5 and 20 years, and 5.07 

percent for payments due in 20 years or more.71

 

69As discussed, under a variation of the bond-based approach, as advocated by some 

financial economists for certain purposes, the bond quality could be chosen to match the 

estimated riskiness of the pension promise. Under this approach, for example, a pension 

promise deemed highly risky might be discounted using interest rates on high-yield lowrated bonds, rates that could be closer to assumed returns used by public and private 

sector multiemployer plans than to high-quality corporate bond or Treasury rates. For 

some of the reasoning for and against this approach, see Financial Accounting Standards 

Board, Statement of Financial Accounting Standards No. 157: Fair Value Measurements, 

paragraphs C47 to C49. 

This simplified threesegment yield curve was adjusted up by MAP-21, with its boundaries tied 

to 25-year smoothing, to minimum rates of 4.94 percent, 6.15 percent, 

70For example, historical averages of interest rates can be significantly different than 

current interest rates.

71Under ERISA standards, plan sponsors have two options—-whether to use historically 

averaged rates or more current market rates—-and within each option the specific rates 

are defined by law and published by Treasury. For private sector single-employer plan 

sponsors who elect to use historically averaged rates, under a simplified three-segment 

yield curve, the interest rates as prescribed by Treasury with respect to any month reflect 

the average, for the 24 month period ending with the month preceding such month, of 

monthly yields on investment grade corporate bonds with varying maturities and that are 

in the top 3 quality levels available (i.e., AAA, AA, and A). For private sector singleemployer plan sponsors who elect to use more current market interest rates without 

historical averaging, the interest rates prescribed by Treasury, using a full yield curve 

approach, are determined in the same way as the rates used for the segment rate 

approach but without 24-month averaging. Under either option, the market interest rates 

for any month, prior to any historical averaging, are based on an average of daily rates 

over the course of the month. Further, plan sponsors can elect to use rates as of an 

“applicable month,” consistently applied from year to year, which can be the month 

containing the plan’s annual valuation date or any of the preceding four months. 
 

Page 28 GAO-14-264 Pension Plan Valuation 

and 6.76 percent respectively, for the same month (see app. II for more 

details). In contrast, PBGC interest rate factors at December 30, 2013 

were 3.00 percent for benefit payments within the first 20 years and 3.31 

percent for payments beyond 20 years.72

Table 2 summarizes the preceding findings with regard to public and 

private sector discount rates.

At these discount rates, the 

present value of a benefit payment due in 15 years for a private sector

single-employer plan under ERISA (MAP-21) segment rates would be 

closer to the value determined under the average 7.72 percent assumed 

return used by public plans than to the annuity settlement rate used by 

PBGC.

 

72PBGC updates their interest rate factors on a quarterly basis based on surveys on 

annuity pricing information as of March 31, June 30, September 30, and December 31st of 

each year. Comparisons among market-based (i.e., without smoothing) interest rate 

factors, such as between PBGC discount rates and rates that might be used for private 

sector single-employer sponsor financial reporting, will vary at different points in time and 

could change based on market conditions affecting interest rate spreads and other factors. 

Additionally, discount rates based on annuity pricing will account for mortality and other 

risks that are not incorporated into a corporate bond index. For example, the American 

Academy of Actuaries reported that, based on the annuity quotes obtained for the federal 

fiscal year ended September 30, 2012, the PBGC discount rate was 3.28 percent, based 

on a liability duration of approximately 11 years, while the Citigroup Pension Liability index 

as of the same date, which reflects high-quality corporate bond yields (rated no lower than 

AA), was 3.9 percent based on a liability duration of approximately 20 years. Adjusting the 

Citigroup index to a duration comparable to PBGC’s would reduce the interest rate to 

about 3.5 percent, much closer to PBGC’s rate. For details, see American Academy of 

Actuaries Issue Brief: Perspectives on the PBGC Single-Employer Deficit (August 2013).
 

Page 29 GAO-14-264 Pension Plan Valuation 

Table 2: Some Available Discount Rate Information for U.S. Defined Benefit Pension Plans as of December 2013

Applicability Discounting premise Discount rate (as of December 2013)

Public sector plan sponsors

a

Assumed return 7.72 percent average rate

Private sector multiemployer 

plans

b

Assumed return 7.52 percent average rate (for the 2010 plan year)

Private sector single-employer 

plan sponsors: minimum funding 

under ERISA/PPA, as modified by 

MAP-21

c

High-quality corporate bond yields 

averaged over 25 years

Varies by timing of future benefits: d

4.94 percent for less than 5 years;

6.15 percent between 5 and 20 years;

6.76 percent beyond 20 years

Private sector single-employer 

plan sponsors: minimum funding 

under ERISA/PPA, prior to MAP21 modifications

High-quality corporate bond yields 

averaged over 2 years

Varies by timing of future benefits:

1.28 percent for less than 5 years;

4.05 percent between 5 and 20 years;

5.07 percent beyond 20 years

Private sector single-employer 

plan sponsors: financial reporting 

under FASB

High-quality corporate bond yields, on 

the measurement date

4.88 percent average rate

PBGC Group annuity prices charged by life 

insurance companies, surveyed quarterly

Varies by timing of future benefits:

3.00 percent within 20 years;

3.31 percent beyond 20 years

Source: GAO analysis of relevant ERISA provisions, FASB standards, GASB standards and NASRA, Treasury, Mercer, and PBGC published rates | GAO-14-264

a

See text for sources. 

b

c

Historically, private sector multiemployer plans have often used assumed return assumptions of 7.5 

percent or higher. Between 1995 and 2007, large multiemployer plans used an average assumed 

return, weighted by plan liabilities, of 7.57 percent. For the 2010 plan year, multiemployer plans used 

an average assumed return, weighted by plan liabilities, of 7.52 percent. See Department of Labor, 

Department of the Treasury, and Pension Benefit Guaranty Corporation, Multiemployer Pension 

Plans: Report to Congress Required by the Pension Protection Act of 2006 (Washington, D.C.: Jan. 

22 2013). As noted earlier, multiemployer plans also calculate a “current liability” based on a discount 

rate that must be between 90 percent and 105 percent of a 4-year weighted average of 30-year 

Treasury rates. For December 2013, this permissible range, as published by Treasury, was from 

3.11 percent to 3.63 percent.

National Association of State Retirement Administrators, NASRA Issue Brief: Public Pension Plan 

Investment Return Assumptions (December 2013).

d

For plan sponsors who use this option. The segment rates in 2013 could not be less than 85 percent 

of the 25-year averages.
 

Page 30 GAO-14-264 Pension Plan Valuation 

In addition to the discount rate, the actuarial cost method used to allocate 

retirement costs among employees’ work years can affect the size of a 

pension plan’s liability.73 Public sector plan sponsors typically use 

actuarial cost methods that assign higher liabilities to younger workers as 

compared to the cost methods private sector single-employer plan 

sponsors use. As discussed in appendix II, the cost methods typically 

used by public plan sponsors tend to somewhat increase the liability 

relative to the cost methods used by private sector single-employer plan 

sponsors. However, this effect is often greatly offset by the effect of the 

differences in discount rates determined between the bond-based and 

assumed-return approaches.74

These different funding and financial reporting requirements for setting 

discount rates for different types of plans also result in differing amounts 

of discretion that plan sponsors can use in setting their discount rates. Of 

the GASB, ERISA, and FASB requirements with respect to discount 

rates, GASB standards and ERISA’s multiemployer funding standards 

leave the most room for judgment, because, for example, estimated longterm average rates of return on pension plan investments in equities are 

judgments rather than observable data, and such estimates can vary 

significantly even among experts. This stands in contrast to ERISA’s 

single-employer standards and FASB standards (for plan sponsors) which 

allow less discretion.75,76

 

73An actuarial cost method is a method for allocating retirement costs among employees’ 

working years. Those costs allocated to past service become part of the accrued liability; 

those costs allocated to future service become part of future normal costs. Prescribed 

actuarial cost methods vary among GASB, ERISA, and FASB. In appendix II, we discuss 

cost methods allowed under GASB, ERISA, and FASB. 

74The differences in liabilities resulting from the use of differing actuarial cost methods 

between public sector and private sector single-employer plan sponsors only apply to the 

liability for current employees. For retired annuitants and separated deferred annuitants, 

most actuarial cost methods result in the same level of liability. Thus, if a plan has a large 

proportion of retirees and/or separated deferred annuitants, it becomes even more likely 

that the differences among actuarial cost methods are less significant than the differences 

in discount rates.

75Under ERISA’s single-employer standards, while plan sponsors may elect from two 

options (for example, whether to use historically averaged rates or more current market 

rates), within each option the specific rates are defined by law and published by Treasury. 
 

Page 31 GAO-14-264 Pension Plan Valuation 

Some experts said that the assumed-return approach could incentivize 

public plan sponsors to invest in riskier assets because doing so can 

increase the assumed-return discount rate, thereby lowering reported 

liabilities and reducing funding requirements.77 In addition, some experts 

said that some public plan sponsors have sometimes inverted the 

recommended practice of first determining plan asset allocation—based 

on an assessment of investment goals and the amount of risk that can be 

taken on—and then deriving a discount rate based on an assumed longterm average return for that mix of assets. Instead, these experts said 

that some plan sponsors have set a target discount rate and then asked 

the plan’s investment team to develop an asset allocation to support it. 

Other experts stated that this practice does not occur. In a related way, 

some experts said that the assumed-return approach has led some public 

plan sponsors to issue pension obligation bonds.78

 

76FASB standards require discount rates to reflect the rate at which pension benefits 

could be effectively settled. In estimating these “settlement rates,” plan sponsors have 

discretion in interpreting and applying this requirement. They can look either at available 

information about rates implicit in the pricing of current annuity contracts or interest rates 

on high-quality bonds that are currently and expected to be available that match the 

duration of the pension benefits; in practice, discount rates derived from high-quality 

bonds are typically used. Because current bond rates are observable in the market, there 

are fairly narrow limits to how much a FASB discount rate can vary and still be considered 

reasonable. Jon Waite, Pension Accounting Research Series. 2013: An Update for 

Disclosures for 2012 (SEI Institutional Group, 2012).

While issuing such 

bonds could help state and local governments improve plan funding, the 

increased capital into the pension fund is derived from the apparent 

arbitrage opportunity created for the plan sponsor by taking on more debt 

outside the plan. The use of an assumed-return discount rate allows the 

plan sponsor to capitalize on the difference between the assumed return 

on the invested assets and the interest rate on the pension obligation 

bonds, essentially taking credit for the assumed returns before actually 

achieving them. The use of pension obligation bonds effectively allows 

plan sponsors to invest on “margin,” or borrow money to invest in risky 

77The incentive to invest in riskier assets could also apply to private sector multiemployer 

plans because they generally use the assumed-return approach for minimum funding 

purposes. 

78Pension obligation bonds are taxable general obligation bonds issued by the public plan 

sponsor. The money received for these bonds is designated for investment in the pension 

trust. As a result, a pension obligation is replaced by a long-term fixed obligation of the 

government issuing the bond. As GAO has previously reported, some states have issued 

pension obligation bonds to address severe plan underfunding. Pension obligation bonds 

had been an attractive option for some governments because interest rates and borrowing 

costs were considered low and pension assets invested in equities allowed plan sponsors 

to assume future returns that were higher than the cost of borrowing. See GAO-10-754. 
 

Page 32 GAO-14-264 Pension Plan Valuation 

assets. This strategy comes with increased risk and is only successful if 

the sponsor’s pension assets actually do appreciate at a higher rate than 

the rate at which the plan sponsor borrowed.

Some experts told us that it is also possible that a plan’s discount rate 

approach could influence future benefit levels. At the most basic level, the 

cost of benefits typically will appear lower using an assumed-return 

discount rate than using a bond-based discount rate, perhaps leading to 

compensation packages that are weighted toward more retirement 

benefits or to larger overall compensation packages. Further, some 

experts expressed concern that sponsors of plans that have earned more 

than the assumed return, such as in a bull market, have given this extra 

return to participants as a benefit increase, but that benefits would not be 

cut at the same rate during periods of low returns.79 To the extent this 

occurs, it would mean that an assumed-return discount rate would need 

to be lowered, or the plan liability increased in some other manner, to 

reflect the fact that future bull-market gains would not be fully available to 

offset future bear market losses. On the other hand, many public plans 

have reduced some aspect of their benefit structure in recent years in 

response to low returns on assets.80

In contrast to the investment incentives that public plan sponsors (and 

multiemployer plans) may face, the use of a bond-based discount rate for 

private sector single-employer plan sponsors can create an incentive to 

invest in bonds to make pension contributions more predictable or 

financial reporting results less volatile.81

 

79There are various legal constraints on the ability of plan sponsors to reduce future or 

current benefit accruals, which vary further for public and private sector plans.

For plans using bond-based 

discount rates (with little or no smoothing), liability values will fluctuate 

with changes in market interest rates. A bond-based investment policy 

can be used so that plan asset values will move in tandem with liability 

values as interest rates fluctuate. The greater the match between a plan’s 

investment assets and the amount and timing of its projected benefit 

payments, the more stable the plan’s funded status will be. However, 

80GAO-12-322. 

81The bond-based discount rate for funding purposes under ERISA includes the option to 

use rates that are based on a 24-month average of interest rates, further bounded by 

rates tied to a very long (25-year) smoothing period that would be less likely to create an 

incentive to invest in bonds. The bond-based discount rate for financial reporting purposes 

under FASB is based on current market interest rates.
 

Page 33 GAO-14-264 Pension Plan Valuation 

holding bonds means forgoing potentially higher returns from equities. 

Thus, the more that a plan matches assets to liabilities by purchasing 

similar-duration low-risk bonds, the more expensive the plan may become

to fund, which may provide a countervailing disincentive to invest more in 

bonds.82

For many of the experts we interviewed, the appropriate discount rate to 

use depends on the purpose of the measurement. Regardless of whether 

they believed the appropriate discount rate to use depends on the 

purpose of the measurement, all experts we interviewed pointed to 

various considerations that influenced their views on discount rate policy. 

Many of these experts supported reporting multiple liability measures and 

some said assumed-return rates may be too high.

Additional incentive effects are discussed in the next section.

The discount rate used can vary depending on the purpose of the 

measurement. There are at least five key purposes for which one might 

determine a discounted value of future benefits: (1) determining the 

required or recommended amount that the plan sponsor should contribute 

into the plan; (2) reporting plan liabilities to shareholders, taxpayers, plan 

participants, or other stakeholders, such as for financial reporting; (3) 

determining the amount needed to terminate a plan, settle a portion of 

plan liabilities, or to guarantee or minimize risk on pensions earned to 

date; (4) expressing the value of participants’ benefits (for example, in 

putting a value on their total compensation); and (5) determining optional 

lump sum amounts payable to participants in lieu of an annuity.83

 

82However, from the standpoint of financial economics theory, the “risk-adjusted cost” 

would be the same under both the low-risk and high-risk financing approaches. The riskadjusted cost takes into account the market price for bearing risk.

Several 

experts with whom we spoke also indicated that their views on the 

83For example, Actuarial Standard of Practice No. 4 cites the following examples of 

measurement purposes: periodic costs, actuarially determined contribution requirements, 

benefit provision pricing, comparability assessments, withdrawal liabilities, benefit plan 

settlements, funded status assessments, market value assessments, and plan sponsor 

mergers and acquisitions. 

Experts Identified a 

Variety of 

Considerations for 

Setting Discount Rate 

Policy and Many Saw 

Value in Plan 

Sponsors Reporting 

Multiple Measures

For Many Experts, the 

Appropriate Discount Rate 

to Use Depends on the 

Purpose of the 

Measurement
 

Page 34 GAO-14-264 Pension Plan Valuation 

appropriateness of different rates for different purposes of the 

measurement vary between public and private plans. The discussions 

with these experts were focused on setting future policy and not 

necessarily related to laws, standards, and practices that currently apply 

to plans in the United States.

As a plan will ultimately pay benefits out of contributions into the plan and 

investment earnings on those contributions, some experts said a measure 

of a plan’s liability based on an assumed return can be thought of as a 

best estimate of the assets a plan believes it needs to have on hand to 

fulfill its promises. Experts told us that an assumed-return approach can 

be useful in determining this amount, as well as for estimating a plan 

sponsor’s most likely stream of future contributions into the plan. Some 

experts referred to this measurement purpose as “funding” or “budgeting,” 

as distinct from “accounting” or “financial reporting.”84 For funding 

purposes, public plan sponsors typically calculate a liability using an 

assumed-return discount rate, but there are no federal laws that require 

them to do so.85 In contrast, for funding purposes, private sector singleemployer plan sponsors must follow ERISA standards for discounting to 

determine their minimum required contribution.86 Under ERISA, private 

sector single-employer plan sponsors use a bond-based discount rate to 

determine a minimum required contribution, while private sector 

multiemployer plans generally employ an assumed-return approach to 

determine this required contribution.87 Private sector single-employer 

plans include most private sector plans and about three-quarters of 

private sector plan participants.88

 

84Two experts suggested that a liability measurement using an assumed-return approach 

for this purpose would be better labeled a “funding target” rather than a “liability.” 

85Public sector plan sponsors do not always make the full contributions determined by 

their funding calculations. See GAO-12-322. 

86As noted earlier, this only applies to tax qualified plans. 

87However, ERISA’s bond-based approach is currently bounded by 25-year historical 

averages. See appendix II for more information. In general, multiemployer plan liability 

calculations are more similar to public plan liability calculations than to private sector 

single-employer plan calculations because the first two generally use an assumed-return 

approach and the last generally uses a bond-based approach, albeit with significant 

smoothing.

88U.S. Department of Labor, Employee Benefits Security Administration, Private Pension 

Plan Bulletin: Abstract of 2011 Form 5500 Annual Reports (June 2013). 

Determining Sponsor

Contributions into a Plan 

(Funding)
 

Page 35 GAO-14-264 Pension Plan Valuation 

Another purpose for using a discount rate is in calculating and then 

reporting liabilities to shareholders, taxpayers, plan participants, 

regulators, or other stakeholders, such as in annual funding notices, or 

financial or actuarial reports.89 For example, participants in private sector

plans receive information on the health of their plan through the Annual 

Funding Notice, which reports plan funded status based on funding 

measures under ERISA. For single-employer plans, MAP-21 requires that 

this Annual Funding Notice report the plan’s funded status both before 

and after MAP-21’s 25-year smoothing of interest rates. The Annual 

Funding Notice can show a funded status that is higher than it would be 

on a PBGC basis under current market conditions. All publicly-traded 

companies follow FASB accounting standards for reporting pension 

liabilities to shareholders and other users, which allows investors to 

compare different companies’ pension liabilities along with other financial 

data. For this purpose, most private sector sponsors of single-employer 

plans use bond-based discount rates based on high-quality (AA-rated) 

bonds.90 In contrast, for public plans, the discount rate approach 

prescribed in GASB standards requires discounting that is closer to an 

assumed-return basis in most cases.91

 

89Reporting plan liabilities to different stakeholders can be done via other venues besides 

financial reports, such as in a published actuarial report. Actuarial reports are prepared by 

the plan actuary and are typically submitted on an annual basis to the plan sponsor or 

regulating entity. An independent panel commissioned by the Society of Actuaries recently 

recommended that actuarial reports for public pension plans provide expanded 

disclosures, including additional risk analysis and multiple liability measures, and that plan 

sponsors share these reports in a timely manner with elected and civil service officials as 

well as other parties of interest, including taxpayers and service recipients, plan member 

and union officials, other stakeholders, and the media. Report of the Blue Ribbon Panel on 

Public Pension Plan Funding: An Independent Panel Commission by the Society of 

Actuaries (February 2014). 

 Some proponents of bond-based 

approaches for financial reporting suggested that the bond quality should 

90Jon Waite, Pension Accounting Research Series 2013: An Update for Disclosures for 

2012 (SEI Institutional Group, 2012).

91Under GASB standards governmental entities are generally considered “goingconcerns.” Under current GASB standards, plan sponsors use an assumed-return 

approach. Under a new GASB standard with implementation required by fiscal years 

beginning after June 15, 2014, plan sponsors would use a blended approach, which 

industry experts have indicated is likely to be closer to an assumed-return approach in 

most instances. See appendix II for more detailed information about new GASB pension 

accounting standards going into effect. Due to differences in actuarial cost methods 

between FASB and GASB standards, the difference in the value of liabilities under GASB 

standards compared to the bond-based approach under FASB standards may be 

somewhat less than the differences in discount rates may otherwise suggest. 

Reporting Liabilities to 

Stakeholders (Financial 

Reporting or Other Reports)
 

Page 36 GAO-14-264 Pension Plan Valuation 

vary with the riskiness of the benefit promise. For example, a pension 

benefit promise that was deemed to be at risk—perhaps because of some 

combination of an underfunded plan and a weak plan sponsor—might be 

discounted at a B-rated bond rate, to reflect the risk of non-payment of 

the benefit promise, whereas a strong, well funded pension promise by a 

financially strong sponsor might be discounted at a AAA-rated bond rate. 

This would result in a weaker sponsor reporting a lower liability than a 

strong sponsor with a comparable plan.92

To determine the amount needed to terminate a plan or to guarantee 

pensions to date—a “solvency measure”—the discount rate, such as the 

interest rate factors used by PBGC, would typically be based on the price 

an insurance company would charge to take over the obligation. In a 

standard ERISA plan termination, the plan would purchase annuities from 

an insurance company and transfer the liability to it.93 This measure can 

also be used to determine how much it would cost to guarantee pensions 

at any given moment, even if the plan was not terminated. Solvency 

measures typically exceed the liability measure disclosed under financial 

reporting standards.94 As a result, a plan could be insolvent if it needed to 

terminate, even if it appeared fully funded on a financial reporting basis 

(or on an ERISA basis). For an ongoing plan, a liability could also be 

calculated using Treasury bond rates, as a measure of the plan assets 

that would be needed to minimize investment risk in the ongoing plan, 

while retaining demographic risk, without transferring the obligations to an 

insurance company.95

 

92As noted earlier, for some of the reasoning for and against this approach, see Financial 

Accounting Standards Board, Statement of Financial Accounting Standards No. 157: Fair 

Value Measurements, paragraphs C47 to C49. 

93Plans can also offer participants lump sums that are based on IRS-published rates for 

high-quality corporate bonds.

94This is often the case even though the measure disclosed under FASB standards, 

known as the projected benefit obligation, or PBO, includes a projection of future salary 

increases, whereas a solvency measure generally does not. 

95For the investment risk to actually be minimized, the plan assets would actually have to 

be invested in such Treasury bonds using a portfolio of Treasury bonds that matched the 

expected timing of benefit payments. As noted, a panel commissioned by the Society of 

Actuaries recommended that public plans disclose an additional liability measurement 

using this method, and at least one public plan currently discloses such a supplemental 

measure. Report of the Blue Ribbon Panel on Public Pension Plan Funding: An 

Independent Panel Commission by the Society of Actuaries (February 2014). 

Determining Funding Amount 

Needed to Terminate Plan or 

Guarantee or Minimize Risk on 

Pensions Earned to Date 

(Solvency)
 

Page 37 GAO-14-264 Pension Plan Valuation 

A plan sponsor, or both management and labor in a collective bargaining 

process, that wants to assess the value of retirement benefits as part of 

employees’ total compensation must decide how to discount future 

benefits to today’s dollars, among other assumptions. All proponents of a 

bond-based approach with whom we spoke advocated that approach for 

this purpose, so that pension benefits would be valued in a manner 

consistent with similar future financial promises (i.e., based on bonds with 

a similar level of risk of nonpayment). In contrast, most proponents of an 

assumed-return approach with whom we spoke advocate that approach 

for this purpose so that pension benefits would be valued in a manner 

consistent with a plan sponsor’s long-term budgeting estimates.

Some plans offer a lump sum as an optional form of payment at 

retirement or termination of employment, as an ongoing plan feature. 

Some sponsors of plans that did not previously provide for a lump sum 

option have recently amended their plans to offer one-time lump sum 

payout options to retirees and other former employees as a settlement of 

the plan’s remaining pension obligation to those plan participants.96

Converting monthly annuity or lifetime benefit streams into a lump sum 

amount requires a discount rate, among other assumptions. The Internal 

Revenue Code requires that a lump sum offer be at least as large as that 

determined using bond-based discount rates (in particular, prescribed 

high-quality corporate bond yields, along with other prescribed 

assumptions).97

Regardless of whether they believed the appropriate discount rate to use 

depends on the purpose of the measurement, all experts we interviewed 

pointed to at least one among six considerations that influenced their 

views on discount rate policy. These considerations can present tradeoffs in setting discount rate policy and can be grouped into issues related 

to cost and risks, fairness and sustainability, and transparency. (See table 

3 for a summary of these considerations). In terms of costs and risks, 

 

96GAO is engaged in a review of “risk transfer” strategies, such as offering lump sums to 

participants, employed by private pension plan sponsors to reduce the risks associated 

with sponsoring defined benefit plans. A report is expected to be issued in late 2014. 

97ERISA minimum lump sum calculations are determined based on 26 U.S.C. § 417(e)(3), 

which specifies the interest rate and mortality assumptions plan sponsors must use in 

calculating the minimum amount of any lump-sum offers for tax-qualified pension plans. 

These minimum lump sum amounts vary depending on the form and amount of a 

participant’s promised benefit and age. 

Expressing Value of Benefits 

as Part of Compensation 

(Valuing Benefits)

Determining Lump Sum 

Amounts in Plans That Offer a 

Lump Sum Option in Lieu of an 

Annuity

Various Considerations 

Influenced Experts’ Views

on Discount Rate Policy
 

Page 38 GAO-14-264 Pension Plan Valuation 

some experts identify tradeoffs between two competing goals: having 

level and predictable costs versus being certain that plans will ultimately 

have sufficient funds to ensure benefit security for plan participants and 

minimizing risks to other stakeholders, including the entity sponsoring the 

plan, shareholders and PBGC in the case of a private sector plan, and 

taxpayers and beneficiaries of public services in the case of a public plan. 

Some experts also said that it could be useful to account for plan and 

sponsor characteristics in setting discount rates for funding purposes. 

Plan and sponsor characteristics could include the size of the plan 

relative to the size of the plan sponsor, the maturity of the plan, and the 

strength of the plan sponsor. In terms of issues of fairness and 

sustainability, experts disagreed on whether an assumed-return or bondbased approach to discounting would best ensure intergenerational equity 

for bearing the cost of these plans, and would best promote system 

sustainability. Additionally, experts who support the use of only the bondbased approach or both approaches identified transparency and 

comparability as important considerations for setting discount rate policy, 

but they disagreed as to whether these considerations suggested using 

an assumed-return or bond-based discount rate. Lastly, many experts 

cited financial economic theory as an important consideration in setting 

discount rate policy based on market valuation principles.98 Other experts 

argued that this theory is not relevant to public plans because as “goingconcerns” with very long time horizons, they do not have significant risk of 

plan termination; according to these experts, discounting based on longterm assumed-return expectations is a best estimate of long-term plan 

costs for public plans. 

 

98Financial economic theory (or financial economics) is a subset of microeconomics, 

largely devoted to the study of capital markets. Financial economic theory informs the 

premise of certain bond-based approaches: that the promise to make a future payment of 

benefits is similar to a promise to pay off any other kind of debt (such as a bond) and 

should be valued in a similar way. The theory also says that the discount rate should not

be related to a plan’s asset allocation, but that it should be based on an external market 

measure of the value of future dollars today.
 

Page 39 GAO-14-264 Pension Plan Valuation 

Table 3: Some Key Considerations Identified by Experts for Selecting Discount Rates

Consideration Summary

Cost and risk considerations

Level and predictability of cost Bond-based discount rates can lead to costs that are too high (depending on 

market conditions), or too volatile from year to year for sponsors to bear. On the 

other hand, an emphasis on ensuring predictable and level costs from year to 

year may mean plan sponsors are not contributing enough to adapt to changing 

market conditions. 

Benefit security and risks to stakeholders Basing funding on assumed returns increases the risk that insufficient assets 

could be on hand when needed, or that contributions will have to be increased, 

or promised benefits reduced, in the future. 

Plan and sponsor characteristics Key risk factors include the size of the plan relative to the size of the plan 

sponsor, the maturity of the plan, and the strength of the plan sponsor. 

Fairness and sustainability considerations

Intergenerational equity Experts agreed that each generation should pay its fair share for pension costs, 

but disagreed about what this meant in practice. One viewpoint is that using 

assumed returns passes uncompensated risk to future generations. The other 

viewpoint is that using bond rates charges current generations an amount 

greater than the expected long-term cost.

System sustainability One viewpoint is that the use of bond-based rates pushes plan sponsors to 

abandon sponsoring DB plans. The other viewpoint is that use of assumed 

returns leads to poor risk management practices (for both investment and benefit 

policy) and to crises of poorly-funded or failing DB plans that cause sponsors, or 

create pressures, to abandon these plans. 

Transparency considerations

Transparency and comparability Providing a bond-based measure in addition to an assumed-return measure may 

help outside parties get a transparent, comparable view of plan liabilities, based 

on market measures. However, some experts argued that multiple measures 

might not enhance transparency because such information could be confusing or 

misleading about the likely cost to fund a plan.

Source: GAO analysis of expert views. | GAO-14-264
 

Page 40 GAO-14-264 Pension Plan Valuation 

• Level and predictability of costs refers to the level of certainty a 

sponsor has that its pension costs will be affordable and stable from 

year to year.99 Reported costs based on bond rates will typically be 

higher than reported costs based on assumed rates of return, but 

depending on asset allocation and amortization periods.100 Experts 

also noted that liabilities based on point-in-time bond-market rates will 

fluctuate as interest rates rise and fall, causing costs to be 

unpredictable compared to costs based on assumed long-term 

returns, which tend to be more stable than bond interest rates 

because they are based on very long-term expectations.101 Some of 

these experts suggested smoothing discount rates by averaging bond 

rates over a number of years in order to make costs more predictable, 

as used by most private single-employer plan sponsors under ERISA 

provisions. Other experts preferred that, if smoothing were to be done, 

that costs be smoothed directly rather than smoothing discount 

rates.102

 

99“Costs” can refer to funding costs or financial reporting costs, either of which could be 

important to a plan sponsor. Conceptually, either type of cost will typically consist of a 

normal cost and an amortization of any unfunded liability, so that the cost will also depend 

on the length of the amortization period. Further, some “smoothing” could be used, either 

by smoothing the measurements of plan assets or liabilities (smoothing the inputs into the 

cost calculation) or by smoothing the output of the cost calculation. ERISA, FASB, and 

GASB have different rules for determining annual costs, which are outside the scope of 

this report. Sponsors will also be concerned about the volatility of the unfunded liability, 

not just the volatility of annual cost.

For funding purposes, private sector single-employer plan

100As discussed, based on historical interest rates, there have been instances where 

discount rates under the bond-based approach may have been higher than the assumed 

long-term average rate of return. For example, from 1980 to 1985 the 30-year Treasury 

interest rate exceeded 10 percent. (See fig. 2 earlier.)

101The costs determined by the bond-based approach are more volatile than the 

assumed-return approach because for the bond-based approach (without smoothing) the 

practitioner is using market interest rates as of the measurement date of the calculation. 

Conversely, the costs determined by the assumed-returned approach, as practiced in the 

United States, have been more stable because the practitioner uses the rate of return that 

they believe can be returned on assets invested over the long term, informed at least in 

part by long-term historical averages. Long-term return assumptions used for U.S. plans 

have shown much more stability from year to year than market interest rates. 

102This approach was proposed by the American Academy of Actuaries Pension Practice 

Council in a letter to conferees in May 2012 regarding the Pension Funding Stabilization 

provisions in the Moving Ahead for Progress in the 21st Century Act (MAP-21). The 

Academy suggested that directly smoothing contribution requirements (rather than 

smoothing discount rates) would preserve reported funded status and provide a clear and 

transparent measurement of contribution reductions. 

Cost and Risk Considerations
 

Page 41 GAO-14-264 Pension Plan Valuation 

sponsors generally use a smoothing approach to discount rates, but 

for financial reporting, they do not.103

• Benefit security and risks to stakeholders are the risks that a plan will 

be unable to pay promised benefits to plan participants or will present 

serious financial challenges to other stakeholders, including the entity 

sponsoring the plan, shareholders and PBGC, and PBGC premium 

payers in the case of a private sector plan, and taxpayers and 

beneficiaries of public services in the case of a public plan. In the 

private sector, some companies fail and sometimes entire industries 

decline. While participants in single-employer plans have PBGC 

protection, it is limited, and participants sometimes lose a portion of 

their benefits. Participants in multiemployer plans face greater risks: 

as noted earlier, their PBGC benefit limits are much lower, and PBGC 

projects that its multiemployer insurance program is itself likely to 

become insolvent within the next decade without further action. While 

states cannot and local governments usually do not go out of 

business and have the option to raise tax revenue or reduce services 

to pay for underfunded benefits, some local governments have 

entered into bankruptcy and some participants in public plans have 

lost some current benefits or anticipated future growth in benefits.104

 

103ERISA allows private sector plans to smooth their discount rates by allowing private 

sector single-employer plan sponsors to choose a 2-year average of bond rates. Since 

2012, as part of MAP-21, this average is now based on long-term (25-year) bond 

averages. MAP-21’s effect on discount rates is designed to be temporary, though 

legislation signed in August 2014 extends its effect. Because average interest rates over 

the past 25 years are significantly higher than more recent market rates, the MAP-21 

changes had the effect of significantly increasing ERISA discount rates over what they 

would otherwise have been, thereby lowering measurements of plan liabilities and 

reducing minimum funding requirements and potentially putting plan participants and 

PBGC at greater risk. 

Benefit losses can be particularly challenging for those public sector 

participants who are not covered by Social Security. Some experts 

told us that using an assumed-return discount rate could obscure the 

risk that a plan could ultimately be unable to pay for benefits, and/or a 

sponsor may be unable or unwilling to make necessary additional 

contributions, even though the plan might appear fully funded on a 

given date using an assumed return discount rate. For example, a 

plan could be insolvent if it needed to terminate, even if it was fully 

funded using an assumed-return discount rate or a bond-based rate 

with significant smoothing, because the cost to actually buy out the 

104GAO-12-322. 
 

Page 42 GAO-14-264 Pension Plan Valuation 

pension benefits or transfer them to another party could be much 

higher than the liability using an assumed return.105 Another risk to 

using the assumed-return approach cited by some experts is that a 

plan’s assets could fail to grow at the assumed return, which would 

require higher-than-expected contributions or future reductions in 

benefits. The associated risks to participants would depend on how 

well the sponsor could use other financial resources to make up 

funding shortfalls and pay benefits. Due to these risks, according to 

some experts, using a discount rate that is lower than an assumedreturn rate—whether a bond-based rate (with little or no smoothing) or 

something in between an assumed-return rate and a bond-based 

rate—can be viewed as a lower-risk approach than a pure assumedreturn approach. Specifically, because the discount rates would be 

more conservative, sponsors would have to put more money into the 

plan to be fully funded, which would provide a cushion against the 

possibility of actual returns falling short of those assumed and being 

inadequate to pay for future benefits.

• Plan and plan sponsor characteristics, such as the size of the plan 

relative to the size of the plan sponsor, the maturity of the plan, and 

the strength of the plan sponsor may be key factors in determining an 

appropriate discount rate, particularly for funding purposes. Two 

supporters of the assumed-return approach for some purposes said 

that weak plan sponsors with uncertain futures might need to be more 

conservative in setting a discount rate because the sponsor might not 

be able to make up the difference (through higher future contributions) 

if plan investments perform poorly.106

 

105One viewpoint is that a termination or solvency measurement for public plans is 

irrelevant because these plans are going-concerns, and the need for them to transfer their 

pension obligations to a third party (such as an insurance company) is remote, especially 

for plans that are fully-funded. An alternative viewpoint is that a solvency or low-risk 

measurement is useful for identifying the full cost of benefits without passing on risk to 

future taxpayers, users of public services, and plan participants.

Based on interviews with 

106This perspective that a weak sponsor needs to use a lower discount rate is most 

applicable for funding purposes. (See later discussion of the use of this perspective in the 

United Kingdom.) In contrast, as noted earlier, for financial reporting and certain other 

purposes, some supporters of the bond-based approach argue that the bond quality used 

to discount liabilities should vary with the riskiness of the benefit promise, such that a 

weak plan sponsor of an underfunded plan would use a higher rate than a strong sponsor 

of the same plan, to reflect the risk of non-payment of the benefit promise. This would 

result in a weak sponsor reporting a lower liability than a stronger sponsor with a 

comparable plan. For some of the reasoning for and against this approach, see Financial 

Accounting Standards Board, Statement of Financial Accounting Standards No. 157: Fair 

Value Measurements, paragraphs C47 to C49. 
 

Page 43 GAO-14-264 Pension Plan Valuation 

experts, we identified the following key plan and sponsor 

characteristics to consider in setting the discount rate:

1. The size of the plan relative to the size of the plan sponsor, since a 

small sponsor with a large plan may be less able to cope with 

assumed returns that fail to materialize. The size of a plan sponsor 

could be measured by metrics such as revenue or market 

capitalization for a corporation or revenue or tax base for a state or 

local government.

2. The maturity of the plan, since an aging plan with few new participants 

will wind down over a shorter time horizon. Such a plan will have less 

time to recover if it does not meet investment expectations.107

3. The strength of the plan sponsor, since a sponsor with strong revenue 

projections is better positioned to take risks with funding or investment 

policy or with its discount rate approach.

These characteristics can change over time. Indeed, it is not uncommon 

for a plan’s demographics to mature over time, for a plan to grow in size 

relative to the size of the plan sponsor over time, or for once-healthy plan 

sponsors to become financially strained. Related to this is that risks to 

plans and plan sponsors are “correlated,” meaning that a market 

downturn may both decrease the value of plan assets and weaken the 

financial health of the plan sponsor at the same time. These risks are also 

considerations in setting a discount rate.

• Intergenerational equity is the issue of whether current and future 

generations bear fair amounts of cost and risk. In general, a principle 

of public finance is that each generation should pay for the services it 

receives, and that borrowing should be for capital projects that benefit

people over a long period of time. Experts disagreed on how to best 

 

107For example, an aging or maturing plan, such as a frozen plan over time, may be more 

vulnerable to “sequence of return risk” than a growing plan. This risk refers to the 

variability of investment performance over time, rather than a uniform average rate of 

return for the same period. Due to net cash outflows from benefit payments to retirees, a 

maturing plan has a diminishing asset base that can be particularly at risk if the plan 

encounters periods of low returns, as it will have less time to recover from the downturn, 

and less money to benefit from a future market upturn. The extent of the sequence of 

return risk depends on several factors, including the variability of returns, investment time 

horizon, and amount of money available for investment. See appendix III for the results of 

modeling the cash flows of hypothetical pension plans that illustrate the effects of plan 

characteristics on actual investment returns. 

Fairness and Sustainability 

Considerations
 

Page 44 GAO-14-264 Pension Plan Valuation 

design the discount rate to achieve the goal of intergenerational 

equity. Some experts stated that using an assumed-return approach 

passes uncompensated risk to future generations. Others had an 

opposing view that using a bond-based approach charges current 

generations in excess of a best estimate of the funds that would 

ultimately be needed for future pension benefits, which would pass 

surplus assets to future generations.

• System sustainability refers to whether public or private sponsors will 

want to continue to provide DB pension plans under one or the other 

discount rate regime. Several experts attributed historical declines in 

private sector DB coverage to bond-based discount rate policies that 

created too much volatility in reported DB liabilities, along with 

increases in reported costs. These experts noted that DB plans are 

often replaced by DC plans that shift risks onto participants, who, in 

the view of two experts, are less equipped to bear them than are plan 

sponsors. Another expert noted an incongruity between the fact that 

bond-based discount rates create an incentive for DB plans to move 

out of the stock market and into bonds, whereas the standard 

recommendation for DC participants is to invest in a mix of stocks and 

bonds (with the particular mix varying by age). Some experts argued 

that DB plans, particularly public plans, can and should take on some 

amount of investment risk, which could reduce long-term costs. 

Others said that the discount rate should be an assumed return to be 

consistent with plan investment practices. Other experts argued the 

opposite, that assumed-return discount rates lead to poor risk 

management practices—such as taking on too much investment risk 

or increasing benefits when plans appear overfunded. In this view, 

such practices could lead to funding shortfalls and crises that 

undermine system sustainability. One such expert argued that DB 

pension plans should be operated more like insurance companies in 

their risk management practices.

• Transparency and comparability refers to providing sufficient 

information for users of financial data to understand a pension plan’s 

financial position and to make comparisons across plans. A number of 

experts emphasized transparency or comparability considerations in 

setting the discount rate and many supported the reporting of multiple 

measures of liability using different discount rates. While some 

proponents of an assumed-return approach stated that multiple 

measures of liability would be confusing for stakeholders in the public 

plan environment, other experts were often concerned that one 

measure of liability reported at a single discount rate could not provide 

enough information for pension plan stakeholders to make informed 

Transparency and 

Comparability
 

Page 45 GAO-14-264 Pension Plan Valuation 

decisions. For example, one expert compared using a single discount 

rate to driving across the country with only a single gauge—fuel, 

speed, or temperature.

Nearly half of the experts we interviewed supported the use of multiple 

measures for valuing pension plan obligations. Some experts saw value 

in reporting a bond-based liability in addition to an assumed-return liability 

because of various concerns about asset allocation. To the extent the 

same actuarial cost method is used, the difference between the two 

liabilities would represent: (1) a measure of the long-term reduction in 

cost that a plan thinks it can achieve through investments that outperform 

a low-risk rate and (2) the amount of investment risk a plan takes on 

relative to a low-risk funding target. Additionally, many experts stated that 

reporting multiple measures of liabilities would be useful in providing 

transparency. Some experts felt that more complete information for all 

key stakeholders would be an improvement over currently available 

information, while others said that reporting liabilities based on multiple 

discount rates would provide fuller transparency into a plan’s finances 

than using a single rate. Some experts also took the view that public 

plans providing liabilities at both a bond-based and assumed-return 

discount rate could provide a broader range of information to plans and 

employers to guide plan policies, and could potentially provide a useful 

check on the assumed-return measurement. At least one large public 

plan voluntarily provides multiple measures of liability using different 

discounting approaches (as well as multiple actuarial cost methods). The 

plan discloses a number of estimates of liability based on low-risk bond

rates as well as estimates of liability using assumed returns. It also 

Many Experts Supported 

Reporting Multiple Liability 

Measures; Some Said 

Assumed-Return Rates 

May Be Too High
 

Page 46 GAO-14-264 Pension Plan Valuation 

provides a narrative explaining what the different numbers represent.108

As noted earlier, while multiemployer plans generally use an assumedreturn approach for funding purposes, they also calculate an additional 

liability measure under ERISA based on a 4-year weighted average of 

Treasury bond rates. Experts had differing views on the significance of 

this “current liability” calculation.109

In contrast to experts favoring multiple measures, nearly a quarter of the 

experts we interviewed argued that only a bond-based approach should 

be used to value plan obligations while nearly a third of the experts we 

interviewed favored use of only the assumed-return approach. For 

 

 

108Under the new GASB standard required for public pension plan sponsors for fiscal 

years beginning after June 15, 2014, state and local government plan sponsors will be 

required to disclose the sensitivity of their net pension liability calculation using discount 

rates that are 1 percent higher and 1 percent lower than the discount rate actually being 

used (a similar requirement applies under GASB’s new standard for financial reporting by 

the plans themselves, for fiscal years beginning after June 15, 2013). This information 

would help interested financial report users to calculate estimates of the pension liability at 

alternative discount rates (although the accuracy of the estimate can diminish for large 

differences in discount rates). GASB cited the significance of the discount rate as 

motivating this new requirement. Some respondents to GASB’s exposure draft would have 

gone further and required direct disclosure of additional measures of pension liability. In 

addition, the panel commissioned by the Society of Actuaries to report on public pension 

plan funding recommended that additional information be provided to all interested parties, 

such as through the actuary’s report that is typically provided to plan trustees. The 

recommended additional information includes the plan liability calculated using a risk-free 

discount rate (such as with a U.S. Treasury yield curve); a projection of future annual plan 

benefit payments, which would allow a user to calculate a liability at alternative discount 

rates with precision; and the results of specific stress testing. 

109While this current liability measure could be accessed by stakeholders through the 

Department of Labor’s Form 5500 database, some experts noted that this measure is 

generally not otherwise reported in certain other important communications. For example, 

they noted that it is not required to be reported in the Annual Funding Notice to plan 

participants, nor is it used in the annual certification of a multiemployer plan’s “zone 

status,” which is based on the funded status of the plan and determines whether remedial 

measures are necessary to improve the financial health of the plan (see GAO-13-240). 

However, other experts noted that the current liability measure is generally contained in 

the actuary’s valuation report, and one expert stated that many actuarial valuation reports 

now show five or six measures of funded status, and that plan trustees are aware of these 

alternative measures. On the other hand, one expert noted that the use of a 4-year 

weighted average for the discount rate used in calculating the current liability measure, 

rather than a more current rate, limited its usefulness as a market-based liability measure. 

In addition, plans have a certain amount of discretion in selecting this current liability 

discount rate from within a range of 90 percent to 105 percent of this 4-year weighted 

average, and another expert noted that this discretion in choosing this rate limited its 

usefulness in making comparisons across plans. 
 

Page 47 GAO-14-264 Pension Plan Valuation 

example, some advocates of each of the assumed-return and bondbased approaches did not see value in the other approach, and as noted 

earlier, some even saw potential damage. Some experts who saw the 

bond-based approach as the only correct approach for all purposes, 

argued that including a liability based on an assumed-return approach is 

incorrect based on economic theory and could result in lower 

contributions, higher benefits, or riskier investment strategies. Some 

advocates of using only the assumed-return approach argued that 

including a liability based on a bond-based approach is irrelevant for 

public plans. One expert noted that requiring public plans to report a

bond-based measure could result in pressure to fund to this much higher 

measure, and two experts said requiring state and local governments to 

fund their plans using a bond-based measure could put pressure on them 

to change their pension plans from DB to DC.110 Some of these experts 

felt that more extensive risk analysis and disclosure, using techniques 

such as stochastic modeling and stress testing, would provide more 

useful and relevant information than the addition of a bond-base liability 

measure.111

Nevertheless, some of the experts who principally advocate for one 

particular approach also said that they could see value in multiple 

measures. Some experts who principally support a bond-based approach 

thought that if a plan were trying to earn returns in excess of low-risk 

bonds, reporting a funding target based on the assumed-return measure 

could be worthwhile. Some experts did not think that plans should attempt 

to earn a risk premium, and therefore, their assumed rate of return would 

be the same as the bond-based rate, since the plan would only invest in 

low-risk bonds. Some advocates of the assumed-return approach for at 

least some purposes said that reporting multiple measures could provide 

 

110This assumes recent or current market conditions where bond-based discount rates 

have generally been lower than assumed-returns. As discussed, based on historical 

interest rates, there have been instances where discount rates under the bond-based 

approach may have been higher than the assumed long-term average rate of return. For 

example, from 1980 to 1985 the 30-year Treasury interest rate exceeded 10 percent. (See 

fig. 2 earlier.)

111Some advocates of multiple measures argued that such analysis alone is insufficient. 
 

Page 48 GAO-14-264 Pension Plan Valuation 

informational value. Figure 3 illustrates some of these lines of 

argument.112

Figure 3: Many Experts Said There Was Value to Multiple Liability Measures at 

Different Discount Rates

Note: The figure above illustrates how experts who principally support one approach or another can 

also see value in multiple liability measures.

According to some experts, even within the assumed-return discount rate 

framework, the returns assumed by public plans have been too high. 

More specifically the assumed return among most public plans surveyed 

 

112Figure 3 is a simplification meant to illustrate some of the lines of argument but does 

not encompass all the views of the experts we interviewed, or capture all of the nuances 

of the various views such as the use of risk-free vs. other interest rates in the bond-based 

approach.
 

Page 49 GAO-14-264 Pension Plan Valuation 

in 2013 was between 7.5 to 8 percent.113

Some experts we spoke to cited the historical returns of assets in a 

typical pension plan portfolio as evidence for the appropriateness of 

assuming a rate of return of around 8 percent. Some experts have cited, 

for example, the average level of historical returns over particular periods 

or the distribution of returns over rolling long-term historical periods, such 

as all possible 30-year periods for which there is good return data. 

However, by themselves, historical returns have limited usefulness in 

resolving disagreements over the appropriate discount rate. We modeled 

returns on typical pension portfolios over past periods, but identified 

numerous challenges with using historical data to generate or support an 

assumed-return assumption. First, analysis of returns on overlapping 

rolling historical periods has significant statistical limitations. Second, 

historical returns vary with the time period used in the analysis. 

Furthermore, future return expectations will depend in part on current 

economic variables that may not be consistent with any particular 

historical time period. Third, actual returns for any particular plan would 

also depend on plan characteristics and cash flows. Lastly, investment 

Some experts said assumedreturn discount rates are currently too optimistic, and a few said it would 

be difficult to achieve such returns given current market conditions. 

Further, some experts cited current interest rates, which are historically 

very low, as indicative of lower expectations for future returns. In contrast, 

two experts were more optimistic about future returns, including one 

expert who cited an analysis of price-to-earnings ratios on stocks as 

indicating potential for strong long-term future returns. Two experts noted 

that public plans’ assumed returns have been declining. One of these 

experts said this decline indicates that the system is making necessary 

self-corrections. The other expert viewed the discount rate reductions as 

too small and too gradual.

 

113According to the Public Fund Survey conducted by the National Association of State 

Retirement Administrators and the National Council on Teacher Retirement in 2013, 107 

of the 126 plans surveyed used discount rates between 7.5 and 8 percent. National 

Association of State Retirement Administrators, NASRA Issue Brief: Public Pension Plan 

Investment Return Assumptions (April 2014). Historically, private sector multiemployer 

plans have often used assumed return assumptions of 7.5 percent or higher. Between 

1995 and 2007, large multiemployer plans used an average assumed return, weighted by 

plan liabilities, of 7.57 percent. For the 2010 plan year, multiemployer plans used an 

average assumed return, weighted by plan liabilities, of 7.52 percent. See Department of 

Labor, Department of the Treasury, and Pension Benefit Guaranty Corporation, 

Multiemployer Pension Plans: Report to Congress Required by the Pension Protection Act 

of 2006 (Washington, D.C.: Jan. 22, 2013).
 

Page 50 GAO-14-264 Pension Plan Valuation 

returns and plan benefit levels are not independent variables. Details of 

our analysis, and its limitations, can be found in appendix III.114

Canada requires determination of multiple measures of plan obligations, 

based on both assumed returns and high-quality bond rates and annuity 

prices. The Netherlands requires that plan obligations be measured 

based solely on market interest rates, but allows the use of assumed 

returns for determining plan contributions or developing recovery plans. In 

the United Kingdom, discount rates are plan-specific and can include 

some allowance for assumed returns in excess of high-quality bond rates, 

depending on plan characteristics and the strength of the sponsor. Table 

4 summarizes discounting practices used by plans or plan sponsors in 

Canada, the Netherlands, and the United Kingdom (see app. IV for more 

details).115 Officials in Canada told us that Canadian private sector plans 

discount using both assumed-return and bond-based approaches, and 

then determine minimum contributions based on the greater of separate 

calculations using each of these two approaches to measure the 

unfunded liability.116,117

 

114In addition, historical returns are not relevant in the context of a bond-based approach 

to discount rates, since the bond-based approach relies on observable market interest 

rates.

In some cases, assumed returns may be reduced 

115GAO did not conduct an independent legal analysis to verify the information provided 

about the laws, regulations, or policies of the foreign countries selected for this study.

116Either of the two liabilities resulting from the bond-based or assumed-return approach 

could be higher than the other because of differences in actuarial cost method regarding 

whether the effect of projected future salary increases (for salary-based benefit formulas) 

received by plans’ covered workforce is included in the liability.

Selected Countries 

Apply a Variety of 

Approaches to 

Discounting and Use 

Lower Assumed 

Returns Than U.S. 

Public Plans

Selected Countries Apply 

a Variety of Approaches to 

Discounting
 

Page 51 GAO-14-264 Pension Plan Valuation 

by a safety margin, known as a “margin for adverse deviation.”118

Canadian public plans and multiemployer plans generally are not required 

to use a bond-based approach for funding purposes, but they are 

required to calculate and provide a bond-based measure of liability to 

certain key stakeholders. According to a Dutch official with whom we 

spoke, pension plans in the Netherlands use a bond-based approach to 

value liabilities, with stringent solvency requirements that are adjusted for 

investment risk and benefit levels, so that funding targets are in excess of 

100 percent of bond-based liabilities.119,120

 

117As discussed, a plan has an unfunded liability or is underfunded when its liabilities are 

greater than assets, so that the funded ratio is less than 100 percent. The amount of the 

unfunded liability is equal to the excess of liabilities over assets. 

The official said that Dutch 

plans can use assumed returns for future projections of assets and 

liabilities, including projections to determine how underfunded plans will 

close funding deficits. This official also said that Dutch plans can use 

bond-based or assumed-return discount rates for determining minimum 

required contributions, but the funding target is still based on the bondbased liability. Further, when using assumed returns, the maximum 

expectations that can be used are regulated. In the United Kingdom, 

officials told us that under the Scheme Specific Funding framework that 

governs private plans, discount rates are plan-specific. Plans may set 

their discount rates by incorporating either or both of the bond-based and 

assumed-return approaches. Plans often use different rates to discount 

different portions of their liabilities by retirement status, with a more 

118A margin for adverse deviation is a provision that can be applied to an actuarial 

assumption in a manner that produces higher cost, or lower revenue, than a best-estimate 

assumption in order to provide a margin of safety against the risk that actual experience 

proves to be less favorable than the best-estimate assumption. For example, if the bestestimate of future investment returns is 7 percent and a margin for adverse deviation of 

0.5 percent is applied, then the assumed return net of the margin would be 6.5 percent. 

119Generally, plans in the Netherlands use the Euro rate swap curve to discount pension 

liabilities. A swap rate yield curve is a commonly used interest rate benchmark. The Euro 

swap curve is an interest rate benchmark that uses the Euro Interbank Offered Rate as 

the reference rate. The Euro Interbank Offered Rate is the rate at which bank deposits in 

countries that have adopted the Euro currency and are members of the European Union 

are offered by one prime bank to another prime bank. The actual swap rate for a given 

maturity is the fixed interest rate that is paid by the fixed rate counterparty in an interest 

rate swap transaction. In this report, the Netherlands’ use of the Euro swap curve to 

discount pension liabilities is also referred to as a bond-based approach. See later 

discussion and appendix IV for more details on discount rate practices in the Netherlands. 

120Generally, solvency requirements exist to mitigate the risk that benefits cannot be paid 

due to plan underfunding. This contrasts with going-concern risk which is the risk that a 

plan sponsor will go bankrupt. 
 

Page 52 GAO-14-264 Pension Plan Valuation 

conservative (i.e., lower) discount rate at or close to government bond 

yields often used for benefits of retired workers as compared to some 

assumed return in excess of high-quality bond yields used for current 

workers. The precise discount rate that can be reasonably justified by a 

plan depends on the strength of its sponsor. The regulator uses a riskbased approach that considers plan and sponsor characteristics to 

determine the reasonability of the discount rate and other plan 

assumptions.121,122

Table 4: Summary of Discounting Practices for Funding in Canada, the Netherlands, and the United Kingdom, as Described 

by Foreign Experts

Country Summary

Canada Private sector Canadian plans use two liability measurements to determine minimum required 

contributions: (1) a solvency-liability measurement based on bond-based discount rates, and (2) a 

going-concern liability measurement generally based on an assumed return. The minimum 

contribution requirement is based on the larger of two different “amortization” calculations, one to 

pay down the unfunded solvency liability, the other to pay down the unfunded going-concern 

liability. Most public and some multiemployer plans fund based on an assumed-return approach, 

but are required to provide a solvency liability using a bond-based approach to certain key 

stakeholders as well. 

The Netherlands Plan liabilities are measured using a bond-based approach. Funding targets exceed these liabilities 

to provide a cushion, with the required cushion increasing with the riskiness of plan assets. Plans 

that are underfunded must develop a recovery plan that can be based on an assumed return. The 

assumed return on the equity portion of the portfolio is currently capped at 7 percent by an 

independent commission.

The United Kingdom For private plans, typical discount rates currently are equivalent to using U.K. government bond 

rates plus about 1 percent. Under the Scheme Specific Funding framework, plans use a planspecific approach with many plans using government or corporate bond rates for benefits of retired 

workers, and varying levels of assumed returns above bond rates for current workers for the period 

up to retirement. The discount rates used by plans depend on plan characteristics and the strength 

of the sponsor, subject to a risk-based review by the regulator. The regulator urges plans to 

consider the ability of the sponsor to assume risks of plan underfunding resulting from their 

discount rate and other plan assumptions. The weaker the sponsor relative to the plan, the more 

prudent the plan discount rate should be.

Source: GAO interviews with foreign experts. | GAO-14-264

 

121As we previously reported, the United Kingdom established a new risk-based pensions 

regulator in 2005 after a review of the previous regulator revealed inefficiencies with the 

compliance-based approach. See GAO, Defined Contribution Plans: Approaches in Other 

Countries Offer Beneficial Strategies in Several Areas, GAO-12-328 (Washington, D.C.: 

Mar. 22, 2012).

122The regulator also uses a risk-based approach in selecting which plans to investigate in 

detail each year. Under the “risk-based” approach, the regulator allocates resources 

based on an assessment that prioritizes risks in the context of its statutory objectives and 

focuses on the areas where it determines its actions will likely have the greatest effect. 
 

Page 53 GAO-14-264 Pension Plan Valuation 

Canadian experts said that private sector Canadian plans use two liability 

measurements to determine minimum required contributions: (1) a 

solvency-liability measurement based on an assumption of plan 

termination, using bond-based discount rates, and (2) a going-concern 

liability measurement generally based on an assumed return (and 

typically with projections of future salary increases).123 The minimum 

contribution requirement is based on the larger of two different 

“amortization” calculations, one to pay down the unfunded solvency 

liability, the other to pay down the unfunded going-concern liability.124 The 

two measurements reflect the dual goals of solvency and long-term 

returns. The required solvency measure reflects, in part, the absence of a 

pension insurance program.125 The solvency measure generally consists 

of two parts: an amount for plan participants who would be assumed to 

take a lump sum upon plan termination, and an amount for plan 

participants who would be assumed to take an annuity upon plan 

termination.126

 

123The Canadian Institute of Actuaries’ standards of practice and regulators (such as 

Ontario and the Office of the Superintendent of Financial Institutions) do not prescribe a 

discount rate approach for the going-concern liability measurement. Experts told us that in 

practice, plans generally use the assumed-return approach for the going-concern liability 

measurement.

Lump sum values are calculated in accordance with 

Canadian Institute of Actuaries standards, which specify discount rates 

based on a formula tied to Canadian government bond rates plus a 

124More specifically, the required contribution is the sum of “normal cost” on a goingconcern basis plus the larger of two different amortization calculations, a going-concern 

amortization and a solvency amortization. Normal cost is the cost of future benefits 

attributable to the current year of employees’ service. The going-concern amortization is 

an amortization of the unfunded going-concern liability, with various components of the 

unfunded liability having remaining amortization periods of 15 years or less. The solvency 

amortization is an amortization of the unfunded solvency liability over 5 years.

125Although, as one expert noted, the solvency measure is also required in Ontario, which 

does have a pension insurance program that insures a nominal benefit of up to one 

thousand Canadian dollars (Can$1,000) per month.

126Upon the wind-up of a plan, retired members and retirement-eligible members will 

typically elect immediate annuities. Active members and members with deferred benefits 

may elect a lump sum , although the lump sum would have to go into an IRA-type of 

account that one expert described as “locked in,” with limited exceptions for withdrawal. 

Certain aspects of the solvency measure can vary across regulators.

Canada
 

Page 54 GAO-14-264 Pension Plan Valuation 

spread.127 For participants assumed to take an annuity, the solvency 

measure reflects the market prices insurers charge for immediate and 

deferred annuities. As noted earlier, using annuity prices can be 

considered a bond-based approach since such prices are influenced by, 

and will vary with, market interest rates. These annuity discount rates 

ranged from about 3.6 to 4.0 percent as of December 2013.128

Given the recent low interest-rate environment in Canada, private plans 

have generally had to fund to the more conservative solvency calculation. 

Experts also told us that a number of Canadian regulators have extended 

temporary solvency funding relief to some private sector single-employer 

plans following low valuations of their asset portfolios resulting from the 

2008 market decline.

In contrast, experts told us that most Canadian public plans and some 

multiemployer plans are generally exempted from the solvency 

assessment for funding or have been granted temporary solvency funding 

relief. Experts told us that because these plans are considered goingconcerns, they are allowed to make contributions based solely on an 

assumed-return discount rate. This is similar in concept to practices for 

such plans in the United States, though the actual levels of assumedreturn assumptions differ between the two countries, as discussed later in 

this section.129

 

127The formula specifies a two-tier discount rate, with one discount rate applied to 

projected benefits that would have been paid in the first 10 years after the valuation date, 

and the second discount rate applied to projected benefits that would have been paid 

beyond 10 years after the valuation date. The formula was intended to approximate the 

results that would be obtained from discounting using a full yield curve based on highly 

rated provincial bonds.

However, Canadian Institute of Actuaries standards 

require that a (bond-based) solvency liability be calculated and provided 

128The Canadian Institute of Actuaries provides guidance related to establishing 

appropriate assumptions regarding the market price of immediate and deferred annuities 

for DB plan solvency valuations. In its guidance for plans with valuation dates between 

December 31, 2013 and December 30, 2014, the Canadian Institute of Actuaries 

estimated that the cost of purchasing non-indexed annuities could range from 50 to 80 

basis points (depending on the duration of the liabilities) above Government of Canada 

bonds with maturities over 10 years. As of December 31, 2013, this would result in 

discount rates ranging from 3.63 to 3.93 percent.

129In addition, one expert noted that Canadian multiemployer plans tended to use shorter 

time periods to amortize unfunded liabilities than their U.S. counterparts, with typical 

Canadian amortization periods ranging from 8 to 12 years, depending on the province. 
 

Page 55 GAO-14-264 Pension Plan Valuation 

by all plans, including public and multiemployer plans. An expert told us 

that this Canadian Institute of Actuaries requirement is not a public 

disclosure requirement; rather the information is provided only to plan 

sponsors, plan members, and regulators. Nonetheless, it stands in 

contrast to U.S. practice, where such a bond-based measure of liability is 

generally not provided by public plans.

In the Netherlands, plan liabilities are measured using a bond-based 

approach.130 Benefits projected to be paid within the next 20 years are 

discounted using a 3-month average of a market interest rate curve.131

For benefits projected to be paid beyond 20 years, rates are extrapolated 

from the market interest rate curve to approach a predetermined rate, set 

at a fixed rate of 4.2 percent by an independent commission and 

introduced by De Nederlandsche Bank (DNB) in September 2012.132 A 

Dutch official told us that an independent commission has recently issued 

an advisory on the determination of this rate. In the future, the fixed level 

of 4.2 percent will be replaced by a 10-year moving average of the 20-

year forward rate.133

An official noted that the Netherlands bases a plan’s funding target on the 

riskiness of the plan’s asset allocation. Plans are subject to a base 

funding target of 105 percent of the plan’s liability, which protects nominal 

accrued benefits, and a risk-adjusted target based on the riskiness of a 

 

130The actuarial cost method used is unit credit (i.e., based on service and salary to date, 

with no projection of future salary increase). The liability also does not include future 

inflation-indexation of benefits.

131As mentioned, plans in the Netherlands generally use the Euro rate swap curve to 

discount pension liabilities. A DNB official told us that 3 month smoothing is a temporary 

measure to mitigate day-to-day interest rate volatility while more comprehensive changes 

to the system are contemplated. A DNB official told us that under future regulations, all 

policy decisions will be based on a 12 month moving average of the funding ratio.

132Prior to the introduction of this predetermined rate, called the Ultimate Forward Rate, 

pension plans discounted their liabilities using the full Euro rate swap curve as prescribed 

by the DNB. Before DNB introduced the use of market interest rates to discount pension 

liabilities in 2007, pension plans in the Netherlands determined the value of their liabilities 

using a maximum discount rate of 4 percent.

133A forward rate is a rate of interest for a future period that would equate the total return 

of a long-term bond with that of a strategy of rolling over shorter-term bonds. The forward 

rate is inferred from a yield curve. 

The Netherlands
 

Page 56 GAO-14-264 Pension Plan Valuation 

plan’s asset allocation.134 Plans must fund to these risk-adjusted funding 

targets, which increase as a plan’s asset allocation gets riskier in order to 

provide a buffer or provide a financial cushion to protect against 

investment risk.135

For determining minimum required contributions, plans may use either 

market interest rates, a 10-year moving average of market interest rates, 

or assumed returns. The option to use an average of market interest rates 

or assumed returns provides plans with some ability to avoid sharp 

fluctuations in minimum required contributions. However, the funding 

target would still be the risk-adjusted target based on the bond-based 

liability. For future projections of assets and liabilities, plans may use 

assumed returns. Similarly, plans that become underfunded must submit 

a recovery plan to the regulator but are allowed to use an assumed return 

to project their ability to close the funding deficit. However, in developing 

assumed returns, the maximum expectations that can be used are 

regulated. Currently, the maximum acceptable assumed return on the 

equity portion of the portfolio, as established by an independent 

commission as of December 2013, is 7 percent (the overall assumed 

return would also reflect the other asset classes in the portfolio).

This is in contrast to the dynamic in the United States 

where, under the assumed-return approach used by U.S. public plan

sponsors and private sector multiemployer plans, the funding target 

(which is the liability) decreases as a plan’s asset allocation gets riskier.

136

 

134Plans can attempt to provide inflation-indexed benefits by investing in riskier asset 

portfolios, but the benefit increases are only granted to the extent they are supported by 

investment returns.

The 

135An official told us that a common asset allocation of 50 percent equity, 40 percent 

bond, and 10 percent real estate would require a plan to be 120 percent funded, based on 

a 2.5 percent probability of shortfall in a one-year horizon. See appendix IV for more 

details on plan funding standards in the Netherlands. 

136For example, using maximum return assumptions of 7 percent for equities and 4.2 

percent for bonds (the current predetermined maximum bond-based discount rate as 

introduced by the DNB), a static portfolio allocation of 60 percent in equities and 40 

percent in bonds would result in a composite assumed return of about 5.9 percent. The 

actual composite assumed return could be even lower since the portfolio may contain 

shorter duration bonds which would likely yield less than 4.2 percent under current 

conditions.
 

Page 57 GAO-14-264 Pension Plan Valuation 

recovery plan details specific measures that will enable a plan to return to 

fully-funded status within the allotted time.137

U.K. experts told us that under the U.K.’s Scheme Specific Funding 

framework, discount rates used by private plans for funding purposes are 

plan-specific and may incorporate elements of either or both of the bondbased and assumed-return approaches. In setting their discount rate or 

rates, plans can choose to apply the bond-based, assumed-return, or a 

combination of approaches, which is then subject to a risk-based 

regulatory review by the regulator.138 The U.K.’s Pensions Regulator 

urges plans to consider the ability of the sponsor to assume risks of plan 

underfunding resulting from their discount rate and other plan 

assumptions.139

The Pensions Regulator told us that as part of its evaluations, the 

regulator places plan sponsors into one of four different categories of 

financial strength and conducts a preliminary screen of discount rates and 

The weaker the sponsor relative to the plan, the more 

prudent should be the plan’s strategy and approach to the discount rate 

(and other assumptions). A weak sponsor may find it prudent to take less 

risk than a strong sponsor and use a discount rate that assumes lower 

returns.

 

137In the Netherlands, there are two types of recovery plans based on different minimum 

funding targets that are commensurate with the riskiness of plan investments. According 

to officials we spoke with, plans with funded ratios less than the 105 percent base funding 

target must submit a recovery plan to return to this target within 3 years. Plans with funded 

ratios less than the risk-adjusted funding targets must submit a recovery plan to return to 

these targets within 15 years. In 2008, the recovery period for plans under the base 

funding threshold was extended by the government from 3 to 5 years as a vast majority of 

plans had to file recovery plans. As of July 2013, the regulator told us that there are still 70 

plans in recovery status in this, the fifth year. In response, the regulator is in the process 

of contemplating more comprehensive changes to the pension regulatory system. 

138The relevant regulation states that “the rates of interest used to discount future 

payments of benefits must be chosen prudently, taking into account either or both–(i) the 

yield on assets held by the scheme to fund future benefits and the anticipated future 

investment returns, and (ii) the market redemption yields on government or other highquality bonds.” 

139Officials indicated that the U.K. parliament has established a new objective within the 

regulatory framework: to minimize any adverse impact on the sustainable growth of an 

employer when dealing with plan funding issues. Pursuant to this objective, in all its 

regulatory actions and guidance to trustees, the Pensions Regulator must now balance 

the financial position of the employer plan sponsor, especially regarding their ability to 

grow, with plan funding considerations. 

The United Kingdom
 

Page 58 GAO-14-264 Pension Plan Valuation 

other plan assumptions to determine if any appear to be too high or 

inappropriate given plan risks and sponsor strength.140 The regulator 

cautions plan trustees in published guidance to regularly assess sponsor 

strength because it may fluctuate significantly over relatively short periods 

of time. As part of its evaluation, the regulator also compares the size of 

the plan relative to the size of the plan sponsor. The regulator then 

conducts risk-based assessments to determine which plans may require 

additional scrutiny.141

Plans are required to be fully funded or they must set up a recovery plan, 

which guides funding decisions until the deficit is eliminated and is 

overseen by the regulator. According to an official from the U.K. Pensions 

Regulator, plans operating under a recovery plan may assume a higher 

return over the recovery period than the discount rate used to calculate 

the plan’s liability, provided that the recovery plan return assumption is 

justified by the investment strategy.142 The same official also told us that 

about 75 percent of plans were in recovery status as of June 2013.143

U.K. discount rates for funding purposes frequently differ between the 

retired and current worker portions of the plan populations. The projected 

benefits of retired plan participants are frequently discounted largely with 

reference to U.K. government bond rates, known as “gilts,” and to 

corporate bond rates. The projected benefits of current workers (and 

deferred members) are frequently discounted at gilt rates plus 2 to 3 

percent for the period up to retirement. Generally, this practice 

acknowledges that the benefits of retirees should be discounted at a more 

conservative rate than the benefits of current workers, for whom more 

time is available to make up for any adverse plan experience, according 

 

140These ratings of financial strength of plan sponsor companies by the Pensions 

Regulator are not made public.

141Another important risk factor is plan asset allocation. One expert told us that the 

Pensions Regulator does not have direct jurisdiction over a plan’s asset allocation, but if a 

plan invested too aggressively, the regulator would engage the plan trustees and use the 

regulatory powers it did have, such as reviewing the reasonability of plan contribution 

determinations, to try to persuade the plan trustees to adjust the level of risk.

142Another official indicated that while discount rates for calculating liabilities must be 

chosen prudently, recovery plans could assume something closer to best estimate returns. 

The recovery plan does not change the calculation of the liability. 

143The average recovery plan length based on plans with valuation dates from September 

22, 2010, to September 21, 2011, was 7.5 years. 
 

Page 59 GAO-14-264 Pension Plan Valuation 

to officials.144 As discussed, the precise discount rate used—be it based 

on government bond yields or varying levels of assumed returns in 

excess of bond yields—is plan-specific and depends on the strength of 

the sponsor, subject to a risk-based review by the regulator. Currently, 

the net result of this plan-specific approach is discount rates of gilt rates 

plus 0.8 to 1.3 percent.145 For plans in recovery, the average overall 

discount rate has ranged in recent years from 4.3 to 5.7 percent.146

As noted earlier, public plans in the United Kingdom are generally 

financed on a pay-as-you-go basis, with plan benefits paid out of tax 

revenue. Public plan sponsors make contributions to a notional pension 

account that are calculated based on a discounted measure of the plan’s 

liabilities. The discount rate used for this purpose is 3 percent above the 

U.K. Consumer Prices Index.147

 

144In practice, an official suggested that the use of different discount rates for benefits for 

current and retired workers might reflect the different investment approaches used to

finance these different components of plan liabilities, with plan assets allocated to highquality bonds to back benefits for retired workers in pay status, and a portion of plan 

assets allocated to riskier, but potentially higher yielding investments, such as equities, to 

fund benefits for current workers not yet in pay status. In this sense, this “different rates” 

approach can be thought of as an assumed-return approach. We did not examine plan 

asset allocations across countries. The regulator also told us that, increasingly, plans are 

using a yield-curve approach to discounting. This approach discounts projected plan 

benefit payments using interest rates on the yield curve that are approximated or matched 

to the timing of those benefit payments.

145These figures were based on valuations for plans in recovery submitted to the regulator 

between 2005 and 2012. 

146Private plans are generally required to submit actuarial valuations to the regulator on a 

triennial basis with valuation dates from September 22 of one year to September 21 of the 

next year. The average discount rate for plans in deficit for the 7 valuation periods ending 

between 2006 and 2012 were: 5.2 percent in 2006, 5.5 percent in 2007, 5.7 percent in 

2008, 5.3 percent in 2009, 5.3 percent in 2010, 5.3 percent in 2011, and 4.3 percent in 

2012. 

147Many U.K. public plans used the Superannuation Contributions Adjusted for Past 

Experience discount rate to value their pension liabilities and set contributions. In 

response to concerns from an independent commission that the Superannuation 

Contributions Adjusted for Past Experience rate was higher than warranted, the U.K. 

government in 2011 announced that the discount rate used to calculate unfunded public 

pension contributions will be based on long term expectations of U.K. Gross Domestic 

Product growth, and a discount rate of 3 percent above the U.K. Consumer Prices Index 

was adopted. As of December 2013, the annual U.K. Consumer Prices Index was 2 

percent, resulting in a 5 percent discount rate.
 

Page 60 GAO-14-264 Pension Plan Valuation 

When determining their liabilities, U.S. public plans generally use higher 

discount rates than plans use in Canada, the Netherlands, and the United 

Kingdom. In the United States, it is common for public plans to use a 7.5 

to 8 percent long-term assumed rate of return.148 Experts told us that 

Canadian public plans generally use funding discount rates, using the 

assumed-return approach, of about 6 percent or lower, and that Canadian 

private plans use similar assumed-return rates for their going-concern 

valuations, and even lower rates—under current market conditions—for 

their solvency valuations.149 According to a Dutch official, the funding 

discount rates used in the Netherlands, using a bond-based approach, 

depend on the duration of plan liabilities and can fluctuate with the market 

but cannot currently exceed 4.2 percent, unless amended by the Dutch 

independent commission.150 In the United Kingdom, funding discount 

rates used by private plans in recovery have most recently been about 

4.3 percent,151

 

148According to the Public Fund Survey conducted by the National Association of State 

Retirement Administrators and the National Council on Teacher Retirement in 2013, 107 

of the 126 plans surveyed used discount rates between 7.5 and 8 percent. National 

Association of State Retirement Administrators, NASRA Issue Brief: Public Pension Plan 

Investment Return Assumptions (April 2014). Historically, private sector multiemployer 

plans have often used assumed return assumptions of 7.5 percent or higher. Between 

1995 and 2007, large multiemployer plans used an average assumed return, weighted by 

plan liabilities, of 7.57 percent. For the 2010 plan year, multiemployer plans used an 

average assumed return, weighted by plan liabilities, of 7.52 percent. See Department of 

Labor, Department of the Treasury, and Pension Benefit Guaranty Corporation, 

Multiemployer Pension Plans: Report to Congress Required by the Pension Protection Act 

of 2006 (Washington, D.C.: Jan. 22, 2013).

with the average excess return assumed over 

149An expert noted that Canadian public sector pensions are usually indexed to increases 

for inflation, and that while they typically use lower nominal assumed returns than US 

plans, their inflation assumptions are also often lower (about 2 percent to 2.5 percent, 

where U.S. plans might more typically use 3 percent), and speculated that their salary 

growth assumptions are likely lower as well. The expert said that the resulting Canadian 

funding target still ends up being more conservative (i.e., higher) than in the U.S., but the 

difference is not as great as the difference in valuation discount rates would suggest.

150As of December 2013, the maximum rate was set at 4.2 percent. See appendix IV for 

more details. 

151The regulator also pointed out that, as most pension liabilities in the U.K. are in some 

way linked to inflation, this rate is about 1.1 percent higher than the index-linked 

government bond yield. 

U.S. Public Plans 

Generally Use Higher 

Discount Rates Than 

Plans in Selected 

Countries
 

Page 61 GAO-14-264 Pension Plan Valuation 

conventional 20 year gilts at about 1 percent.152 In addition, discount rates 

for financial reporting purposes under International Accounting Standards 

Board (IASB) and Financial Reporting Council (FRC) standards (and 

FASB in the U.S.) are all bond-based and lower than U.S. public plan 

discount rates.153

Some of the differences in discount rates between the United States and 

these countries are accounted for by differing approaches to determining 

these rates.154 Bond-based discount rates generally will be lower than 

assumed-return discount rates under current and most market conditions. 

U.S. public plans use an assumed-return approach for funding and 

accounting purposes.155 In contrast, the Dutch discount rate, one of the 

two Canadian funding measures, and the IASB, FRC, and FASB discount 

rates are all bond-based.156

 

152The average excess returns are based on valuations for plans in recovery, submitted 

between September 2011 and September 2012 to the Pensions Regulator. As discussed 

earlier, plans in recovery are allowed to assume higher returns, over the recovery phase, 

than the discount rate used to calculate plan liabilities, provided that the recovery plan 

return assumption is justified by the investment strategy.

However, in those cases where these other 

countries use assumed returns, or some allowance for assumed 

returns—for example, one of the two Canadian measures, the rate for 

Dutch recovery plans, and the U.K.’s plan-specific approach—these 

assumed returns tend to be lower than assumed returns currently used by 

U.S. public plans.

153As discussed, for financial reporting purposes, private sector plan sponsors in Canada, 

the Netherlands, and the United Kingdom often follow the accounting standards 

promulgated by IASB. U.K. plan sponsors will often follow the local U.K. accounting 

standards promulgated by FRC (the standards are referred to as Financial Reporting 

Standards) or the IASB standards.

154Each country’s retirement system reflects that country’s unique historical and political 

experience, making generalizations difficult. For example, the Netherland’s adherence to 

market-interest valuation principles using strict risk-based solvency requirements may in 

part reflect the absence of a pension insurance system. Or, in the United Kingdom, the 

discretion plan sponsors have in determining their discount rate and approach under the 

Scheme Specific Funding framework may reflect the U.K.’s prior experience under a more 

rules-based regulatory regime. 

155For financial reporting purposes, the discount rate will switch to a blended approach 

once new GASB standards are fully in effect, but industry experts have indicated that in 

most cases the resulting discount rate is likely to be closer to the assumed-return 

approach.

156As discussed, the FASB bond-based discount rate referenced here refers to 

requirements for plan sponsor, and not individual plan, financial reporting. 
 

Page 62 GAO-14-264 Pension Plan Valuation 

One potential explanation for differences in the discount rates is the 

greater degree of government oversight in Canada, the Netherlands, and 

the United Kingdom, where experts said regulators routinely scrutinize 

discount rates.157 Unlike for public plans in the United States, Canadian 

pension regulators’ authority to reject an actuarial report allows them to 

implicitly set the boundaries for reasonable assumptions.158 One expert 

stated that Canadian provincial regulators’ scrutiny “sets the tone” even 

for plans that are not subject to solvency measurements. Another expert 

said that in some jurisdictions, the regulator explicitly tells plans the 

acceptable range of discount rates to use.159 In addition, another expert 

told us that while Canadian Institute of Actuaries standards state that 

assumed returns should be best estimates unless otherwise required by 

the circumstances of the calculation, many regulators have sent notices 

to plans under their jurisdiction that margins for adverse deviation are 

needed.160

 

157In the United States, funding discount rates for private sector single-employer plans are 

fixed in law and Treasury performs the necessary data gathering and calculations to arrive 

at these rates. Private sector multiemployer and public plans have greater discretion in 

setting their discount rate.

The overall acceptable net assumption tends to vary across 

provincial and federal regulators but, as discussed, is generally not higher 

than about 6 percent, under recent and current conditions. In the 

Netherlands, De Nederlandsche Bank’s use of prescribed bond-based 

discount rates obviates the need for explicit scrutiny of the discount rate 

assumption. However, plans are allowed to make assumed-return 

assumptions for recovery plans, and for this purpose an independent 

158Actuarial reports are prepared by the plan actuary and are typically submitted on a triannual basis to the regulating entity, except for federally registered plans and for plans 

registered with the Quebec regulator, where actuarial reports are generally submitted on 

an annual basis. Plans that fall below certain funding levels may also be required to file on 

an annual basis.

159For example, OSFI officials told us that a funding discount rate not to exceed 6.25 

percent applies to all federally-regulated pension plans registered under Canada’s 

Pension Benefits Standards Act of 1985. This was reduced from 6.5 percent effective April 

2013. These plans include primarily private sector plans, but also include some pension 

plans provided by certain public sector employers.

160For example, one expert indicated that a current best-estimate assumed return in 

Canada might be about 7 or 7.2 percent, but that subtracting a margin for adverse 

deviation might bring the assumption down to 6 percent. However, another expert told us 

that it is often difficult to tell if a plan is using a margin for adverse deviation, that any 

margin matters less than the actuary’s expectation of future returns, that most plans 

probably do not use a margin, and that what ultimately matters is the net assumption 

used. 
 

Page 63 GAO-14-264 Pension Plan Valuation 

commission sets a ceiling on the maximum acceptable assumed return 

on the equity portion of plan assets. In the United Kingdom, the Pensions 

Regulator has legal powers to ensure that the discount rate and other 

plan assumptions are prudent given plan risks and sponsor strength.

Differences in discount rates also arise from variations in the regulatory 

framework of each country, which reflect different views among 

governments and regulators on the most appropriate way to protect DB 

pension benefits for plans under their jurisdiction. Experts told us that 

under the Canadian two-measurement funding standard, private plans 

have less incentive to be overaggressive with their assumed-return 

assumption used for the going-concern measurement because they must 

generally fund their plan using a bond-based solvency measurement, 

which is currently the higher of the two measures. The Netherlands’ 

adherence to market interest valuation of accrued benefits through use of 

a bond-based approach to discounting for all plans is the most 

conservative among the countries we studied and, consequently, results 

in generally the lowest discount rates. As for the United Kingdom, the 

discretion to determine a discount rate approach under the Scheme 

Specific Funding framework necessitates negotiation among plan 

sponsors, trustees, and advisors, and may involve the regulator. This 

process facilitates a system of checks and balances that help to ensure 

that reasonable plan assumptions, including the discount rate, are used, 

experts said.

Although our report illustrates the differences of opinion over pension 

discount rates, we found one significant area where there is some, but not 

universal, room for agreement. Specifically, many experts supported 

providing multiple measures of liabilities for different purposes to provide 

a more complete picture of pension plan finances. The practices of 

selected foreign countries—notably, Canada, the Netherlands, and the 

United Kingdom—may provide insight into ways that other pension 

systems discount liabilities, applying a variety of approaches to 

discounting, with significant government oversight, and generally using 

lower discount rates than U.S. assumed returns.

In general, as in many aspects of pension plan finances, additional 

transparency and information about discount rates and their impact can 

be useful. There may be value in providing multiple measures of liability 

and cost, using both assumed-return and bond-based discount rates—

carefully labeled to describe their purpose (e.g., with some measures, 

such as funding targets, not even necessarily labeled “liabilities”)—and 

with explanations of what these measures do and do not represent. The 

Concluding 

Observations
 

Page 64 GAO-14-264 Pension Plan Valuation 

measurements resulting from these different discount rate approaches 

can ultimately improve the understanding, management, and governance 

of the finances of pension plans. In short, there may be value in having 

multiple liability measures to arrive at funding, benefit, and investment 

policies that will better balance risks and rewards to plan participants and 

all other stakeholders.

Despite the challenges that many plans currently face, traditional DB 

plans in the public and private sector continue to play an important role in 

American retirement security. This is especially true in the public sector 

where many current workers and retirees do not participate in Social 

Security and may rely on these pensions as their primary source of 

retirement income. Policy options to address these plans’ challenges may 

be addressed by fostering the use of appropriate liability measurements 

and discount rate assumptions and increased transparency concerning 

their financial health. However, any such options should also be sensitive 

to the crucial need to ensure that benefits remain adequate to current and 

future retirees and their families. 

We provided officials from the Department of the Treasury and the 

Pension Benefit Guaranty Corporation with a draft of this report. They 

provided technical comments that we incorporated, as appropriate. In 

addition, we provided officials from the Financial Accounting Standards 

Board and the Governmental Accounting Standards Board with a draft of 

this report. They provided technical comments that we incorporated, as 

appropriate. We also provided select experts and officials from the 

countries we reviewed with portions of the draft report that addressed 

aspects of the pension funds in their jurisdictions. We incorporated their 

technical comments, as appropriate, as well.

As arranged with your office, unless you publicly announce its contents 

earlier, we plan no further distribution of this report until 30 days from the 

date of this letter. At that time, we will send copies of this report to 

appropriate congressional committees, the Secretary of the Treasury, the 

Director of the Pension Benefit Guaranty Corporation, and other 

interested parties. In addition, this report will be available at no charge on 

GAO’s website at http://www.gao.gov. 

If you have any questions about this report, please contact Charles 

Jeszeck at (202) 512-7215 or jeszeckc@gao.gov or Frank Todisco at 

(202) 512-2700 or todiscof@gao.gov. Mr. Todisco meets the qualification 

standards of the American Academy of Actuaries to address the actuarial 

issues contained in this report. Contact points for our Offices of 

Agency Comments
 

Page 65 GAO-14-264 Pension Plan Valuation 

Congressional Relations and Public Affairs may be found on the last page 

of this report. Key contributors to this report are found in appendix V.

Sincerely,

Charles A. Jeszeck

Director

Education, Workforce, and Income Security

Frank Todisco

Chief Actuary

Applied Research and Methods
Appendix I: Objectives, Scope, and 

Methodology

Page 66 GAO-14-264 Pension Plan Valuation 

To analyze differences of opinion concerning discount rates for pension 

plan valuations and funding, GAO examined (1) the significance of the 

differences in discounting approaches used by public versus private

sector pension plans; (2) the purposes for measuring the value of a plan’s 

future benefits and key considerations for determining plan discount rate 

policy; (3) the approaches select countries have taken to choose discount 

rates. This appendix provides an account of the information and 

methodology we used to answer these questions.

To address our objectives, we spoke with experts, including actuaries, 

economists, and other pension experts, from a variety of organizations 

and constituencies who represent diverse points of views regarding 

discount rates. These experts’ opinions cover a wide range of views on 

the appropriate way to set discount rates. We examined relevant literature 

on pension discount rates. We also reviewed relevant provisions in the 

Internal Revenue Code and the Employee Retirement Income Security 

Act, as amended; relevant federal regulations; relevant pension 

accounting standards issued by the Governmental Accounting Standards 

Board, Financial Accounting Standards Board, and the International 

Accounting Standards Board; and relevant actuarial standards of practice 

issued by the Actuarial Standards Board.

For our analysis of historical returns and their implications, we spoke to 

experts and reviewed historical data on bond and stock returns as tracked 

using historical data from 1926 to 2012 in the Ibbotson Stocks, Bonds, 

Bills, and Inflation Historical Yearbook. We calculated average annual 

time-weighted geometric and arithmetic returns for various asset 

allocations and over various time periods within the 1926 to 2012 period. 

We also developed two stylized pension plans—a growing plan and a 

maturing plan—for which we calculated dollar-weighted returns over each 

of the three consecutive 29-year periods from 1926 to 2012.

A growing plan is characterized by contributions into the plan exceeding 

benefit payments out of the plan. The ratio of cash in to cash out is set at 

10 to 1 for the entire 29-year period. The ratio of contributions relative to 

total plan assets starts at about 40 percent in year 1 and declines to 

about 2 percent in year 29. A maturing plan is characterized by 

decreasing contributions relative to benefit payments, with benefit 

payments beginning to outpace contributions during the middle years of 

the 29-year period and continuing to increase relative to contributions for 

the remainder of the analysis period. The ratio of cash in to cash out 

starts at 3 to 1 in year 1 and ends at 0.65 in year 29. The cash in to cash 

out ratios for the intervening years (from 2 through 28) are determined 

Appendix I: Objectives, Scope, and 

Methodology
Appendix I: Objectives, Scope, and 

Methodology

Page 67 GAO-14-264 Pension Plan Valuation 

through linear interpolation. The ratio of contributions relative to total plan 

assets start at about 43 percent in year 1 and declines to between 6 and 

14 percent in year 29, depending on the period. These plans were 

provided as illustrative examples of how the dollar-weighted return of a 

particular plan can differ from a time-weighted return.

To examine other countries’ approaches, we asked experts to identify 

countries with significant defined benefit systems and active controversies 

with regard to discount rates. Ultimately, we chose to examine Canada, 

the Netherlands, and the United Kingdom. These countries are not meant 

to be a representative sample of international practice; rather, they 

represent countries with contrasting approaches to discounting and 

ongoing discussions about the appropriate rate of discount. We spoke to 

experts in these countries and reviewed publicly-available documents. 

We did not conduct an independent legal analysis to verify the information 

provided about the laws, regulations, or policies of the foreign countries 

selected for this study. Instead, we relied on appropriate secondary 

sources, interviews with relevant officials, and other sources to 

summarize each country’s approach to discounting pension liabilities. We 

also provided select experts and officials from the countries we reviewed 

with portions of the draft report that addressed aspects of the pension 

funds in their jurisdictions. We incorporated their technical comments, as 

appropriate, as well.
Appendix II: Additional Information on Laws, 

Standards, and Practices for Determining 

Discount Rates for U.S. Defined Benefit Plans

Page 68 GAO-14-264 Pension Plan Valuation 

As discussed in the background, discount rate guidelines and practices 

for U.S. DB pension plans and plan sponsors differ for funding and 

financial reporting purposes, and for different plan types: public sector 

plans, private sector single-employer plans, and private sector 

multiemployer plans. As discussed, for both funding and financial 

reporting, sponsors of private sector single-employer plans generally use 

a bond-based approach, while sponsors of public plans generally use an 

assumed-return approach; private sector multiemployer plans generally 

use an assumed-return approach for funding, but also calculate an 

additional liability measure under ERISA based on an average of 

Treasury bond rates, while participating employers usually do not have to 

report a liability for financial reporting. However, the different plan sectors 

have unique guidelines and practices for arriving at a final discount rate 

for different purposes.1

It is important to note that different laws and standards specify different 

actuarial cost methods as well, and give different names to the resulting 

liability measures. For determining minimum funding requirements for 

single-employer plans, ERISA specifies the unit credit actuarial cost 

method, which defines the accrued liability based on a worker’s service 

and salary to date; the resulting liability measure is called the funding 

target.2 The Financial Accounting Standards Board (FASB) specifies the 

projected unit credit actuarial cost method, which is similar to the unit 

credit method, but adds a projection for future salary increases; the 

resulting liability measure is called the projected benefit obligation, also 

frequently referred to as the PBO.3

 

1

Discounting guidelines and practices for federal pension plans are outside of the scope of 

this report. Information on PBGC’s discount rate practices was provided as background.

The recently issued Governmental 

Accounting Standards Board (GASB) revisions specify that plan sponsors 

2

Multiemployer plans have a choice of actuarial cost methods under ERISA for 

determining the accrued liability on which minimum required contributions are primarily 

based. Multiemployer plans also disclose, on Schedule MB of Form 5500, two liability 

measures based on the unit credit actuarial cost method: an accrued liability using the 

plan’s assumed return discount rate, and a measure called the current liability using a 

discount rate based on a 4-year weighted average of 30-year Treasury rates. 

3

More precisely, for pension benefit formulas based on future compensation, such as 

final-pay and career-average-pay pension formulas, the FASB method of attributing 

benefits to years of service is the same as the projected unit credit actuarial cost method. 

For flat benefit formulas (i.e., formulas that are not based on pay), a projection of future 

pay increases is irrelevant and unnecessary. 

Appendix II: Additional Information on Laws, 

Standards, and Practices for Determining 

Discount Rates for U.S. Defined Benefit 

Plans
Appendix II: Additional Information on Laws, 

Standards, and Practices for Determining 

Discount Rates for U.S. Defined Benefit Plans

Page 69 GAO-14-264 Pension Plan Valuation 

use the entry age actuarial cost method. Using this method, a worker’s 

service and salary are both projected to retirement to estimate a projected 

benefit. The cost of this benefit is allocated over the worker’s entire 

service (both past and projected future) as a level percentage of his or 

her salary (for plans whose benefit formula is tied to salary levels). The 

accrued liability is the value of these allocated costs accumulated up to 

the point of the worker’s service to date. The resulting liability measure is 

simply called the total pension liability. For active workers, holding 

actuarial assumptions constant, an entry age normal accrued liability 

(GASB method) will typically be somewhat higher than a projected unit 

credit accrued liability (FASB method), which in turn will typically be 

somewhat higher (for benefit formulas tied to salary levels) than a unit 

credit accrued liability (ERISA method). For plan participants who are 

already retired or terminated employment, these three methods produce 

the same liability.

In addition, the different funding and financial reporting requirements for 

setting discount rates for different types of plans also result in differing 

amounts of discretion that plan sponsors can use in setting their discount 

rates. Of the GASB, ERISA, and FASB requirements with respect to 

discount rates, GASB standards and ERISA’s multiemployer funding 

standards leave the most room for judgment, because, for example, 

estimated long-term average rates of return on pension plan investments 

in equities are judgments rather than observable data, and such 

estimates can vary significantly even among experts. This stands in 

contrast to ERISA’s single-employer standards and FASB standards (for 

plan sponsors) which allow less discretion.4,5

 

4

Under ERISA, while plan sponsors may elect from two options (whether to use 

historically averaged rates or more current market rates), within each option the specific 

rates are defined by law and published by Treasury. 

Table 5 summarizes 

5

FASB standards require discount rates to reflect the rate at which pension benefits could 

be effectively settled. In estimating these “settlement rates,” plan sponsors have discretion 

in interpreting and applying this requirement. They can look either at available information 

about rates implicit in the pricing of current annuity contracts or rates of return on highquality bonds that are currently and expected to be available that match the duration of the 

pension benefits; in practice, discount rates derived from high-quality bonds are typically 

used. Because current bond rates are observable in the market, there are fairly narrow 

limits to how much a FASB discount rate can vary and still be considered reasonable. Jon 

Waite, Pension Accounting Research Series. 2013: An Update for Disclosures for 2012 

(SEI Institutional Group, 2012).
Appendix II: Additional Information on Laws, 

Standards, and Practices for Determining 

Discount Rates for U.S. Defined Benefit Plans

Page 70 GAO-14-264 Pension Plan Valuation 

differences in the laws, standards, and practices that govern discount rate 

approaches across plan types in the United States.

Table 5: Laws, Standards, Practices, and Discounting Premises for U.S. Defined 

Benefit Plan Sponsors and Participating Employers, By Plan Type

Type of plan Funding Financial Reporting

Applicable 

funding law 

Discounting Premise Applicable 

accounting 

standards 

Discounting 

premise

Private sector 

single-employera ERISA High-quality corporate 

bond yields, which 

may be averaged 

over 25 years

FASB

b

Current highquality 

corporate 

bond yields

c

Private sector 

multiemployera ERISA Assumed-return FASB d Typically, not applicable

c

Public sector

e

No federal 

standards; each 

jurisdiction

makes its own, 

if any

Generally, assumed 

return 

GASB Assumedreturn 

approach to 

extent plan is 

projected to 

be funded; 

bond-based 

approach for 

shortfall

Source: GAO analysis of relevant ERISA provisions, FASB standards, and GASB standards. | GAO-14-264

f

a Not shown in this table is the discount rate basis used by PBGC. PBGC uses annuity settlement 

rates to determine the present value of future pension benefit payments to be paid to the participants 

of eligible private sector single-employer plans that PBGC has trusteed, and to determine the present 

value of financial assistance that it projects it will have to provide to multiemployer plans. PBGC uses 

recent prices of group annuities determined based on a confidential survey of private life insurers to 

derive the interest factors, or implied discount rates. A liability based on an annuity settlement rate is 

the estimated market value of the amount of money that is required to assure the payment of future 

benefits via contracts with the insurance industry.

b The 25-year averaging of high-quality corporate bond rates is designed to be temporary, though 

legislation enacted in August 2014 extends its effect.

c

d Minimum required contributions for multiemployer plans are determined at the plan level. 

Contribution rates for participating employers are determined by collective bargaining, but rates will 

typically be negotiated that are estimated to conform with minimum funding requirements. The 

minimum required contribution is generally based on a funding target using an assumed return 

discount rate. A second measure of liability, called the “current liability” and based on a 4-year 

weighted average of 30-year Treasury rates, is also reported by plans on Schedule MB of Form 5500. 

The “current liability” can affect the minimum required contribution in certain years, and is used in 

determining the maximum tax-deductible contribution, but the minimum funding target remains the 

liability measured using an assumed return discount rate.

The FASB accounting standards referenced here refer to requirements for plan sponsor, and not 

individual plan, financial reporting.

e Participating employers in private sector multiemployer plans typically do not have to calculate a 

liability for financial reporting purposes. 
Appendix II: Additional Information on Laws, 

Standards, and Practices for Determining 

Discount Rates for U.S. Defined Benefit Plans

Page 71 GAO-14-264 Pension Plan Valuation 

f Under current GASB standards, public plan sponsors use an assumed-return approach. Under a 

new GASB standard, with implementation required by fiscal years beginning after June 15, 2014, plan 

sponsors would use an assumed-return approach to the extent they project that current assets, 

assumed returns, and future contributions for current members will be sufficient to provide for 

benefits; for any projected shortfalls, public plan sponsors would use a 20-year municipal bond rate 

as the discount rate. GASB encourages earlier application of the new standard.

Recently revised GASB standards prescribe a “blended approach” to 

determining pension discount rates for financial reporting by public plan 

sponsors, with implementation required by fiscal years beginning after 

June 15, 2014. Under the new GASB standard, plan sponsors would use 

an assumed-return approach to the extent they project that current 

assets, assumed returns, and future contributions for current members 

will be sufficient to provide for benefits; for any projected shortfalls, public 

plan sponsors would use 20-year, tax-exempt general obligation 

municipal bond interest rates with an average rating of AA/Aa or higher. 

Thus, for some plans the composite discount rate will be a hybrid of the 

assumed-return approach and bond-based approach. Industry experts 

have indicated that, on average, the composite discount rate is likely to 

be closer to the assumed-return rate for two reasons: many plans have 

contribution policies which, combined with current plan assets, are likely 

to be projected to cover projected benefit payments, so that the blended 

discount rate will be the same as the assumed-return discount rate; and 

for those plans where there is a projected insufficiency, the bond-based 

approach would only apply to a portion of plan liabilities.

With regard to the rates they use to discount benefits, single-employer 

sponsors are generally required to use a bond-based approach to 

determine the minimum required contribution. However, within this 

framework, these sponsors have options which can result in 

measurements of plan liabilities that may not be closely tied to current 

market conditions. Plan sponsors are given the option of using a full yield 

curve approach, which matches projected benefit payments to highquality corporate bond interest rates averaged over a current month, so 

that under this option, the measurement of plan liabilities would be tied to 

current or recent market conditions. A plan choosing this approach would 

discount a benefit payment due in 10 years at the yield curve rate as 

published by Treasury for year 10. However, single-employer plan 

sponsors may also elect to discount using a simplified three-segment 

yield curve published by Treasury, with the three different segment 

interest rates applicable to benefit payments due in less than 5 years, 5 to 

20 years, and 20 years or more. These segment rates are based on a 2-

year average of bond rates and also cannot be higher or lower than 

maximum and minimum segment rates as set in law in 2012 as part of the 

GASB Standards

ERISA Requirements
Appendix II: Additional Information on Laws, 

Standards, and Practices for Determining 

Discount Rates for U.S. Defined Benefit Plans

Page 72 GAO-14-264 Pension Plan Valuation 

Moving Ahead for Progress in the 21st Century Act (MAP-21).6 The MAP21 maximum and minimum apply to plans that use the segment rate 

approach, and are based on long-term (25-year) bond averages. MAP21’s effect on discount rates is designed to be temporary. Because 

average interest rates over the past 25 years are significantly higher than 

more recent market rates, the MAP-21 changes had the effect of 

significantly increasing ERISA discount rates over what they would 

otherwise have been, thereby lowering measurements of plan liabilities 

and reducing minimum funding requirements.7

Under the bond-based approach used by private sector single-employer 

pension plans under ERISA (as well as common practice under FASB), a 

single pension plan will use different discount rates to calculate the 

present value of benefits that will be paid out at different points in the 

future. This means that different plans can end up with very different 

average rates of discount depending on the age of the plan’s participants. 

In contrast, a public plan using an assumed rate of return would typically 

discount all future benefit payments at the same assumed return. 

Because the assumed return is based on asset allocation, the rates will 

vary depending on how a plan allocates its assets. This is an example of 

how the bond-based approach determines discount rates based on 

characteristics of a plan’s liabilities, whereas the assumed-return 

approach determines discount rates based on characteristics of the 

assets being used to finance the liabilities. As discussed, under ERISA, 

private sector multiemployer plans generally discount using an assumed 

 

6

For private sector single-employer plan sponsors who elect to use historically averaged 

rates, under a simplified three-segment yield curve, the interest rates as prescribed by 

Treasury with respect to any month, prior to the MAP-21 adjustments, reflect the average, 

for the 24 month period ending with the month preceding such month, of monthly yields on 

investment grade corporate bonds with varying maturities and that are in the top 3 quality 

levels available (i.e., AAA, AA, and A). For private sector single-employer plan sponsors 

who elect to use more current market interest rates without historical averaging, the 

interest rates prescribed by Treasury, using a full yield curve approach, are determined in 

the same way as the rates used for the segment rate approach but without 24-month 

averaging. The market interest rates for any month, prior to any historical averaging, are 

based on an average of daily rates over the course of the month. Further, plan sponsors 

can elect to use rates as of an “applicable month,” consistently applied from year to year, 

which can be the month containing the plan’s annual valuation date or any of the 

preceding four months. 

7

Legislation was enacted in August 2014 that further extends the use of 25-year averaging 

of interest rates for determining minimum funding standards for private sector singleemployer plans. Pub. L. No. 113-159, 128 Stat. 1839.
Appendix II: Additional Information on Laws, 

Standards, and Practices for Determining 

Discount Rates for U.S. Defined Benefit Plans

Page 73 GAO-14-264 Pension Plan Valuation 

rate of return for funding purposes. However, these plans also calculate a 

liability based on a bond-based discount rate under ERISA, which can 

sometimes affect the timing of minimum required contributions and is also 

used in the calculation of the maximum deductible contribution. Experts 

had differing views of the significance of the reporting of this measure. 

FASB financial reporting standards are separate from ERISA funding 

standards but plan sponsors also typically use high-quality corporate 

bond rates to compute liabilities, with some key differences.8

 

8

Jon Waite, Pension Accounting Research Series. 2013: An Update for Disclosures for 

2012 (SEI Institutional Group, 2012).

The 

corporate bond rates that plan sponsors use to satisfy FASB standards 

are snapshots of market interest rates on the measurement date, 

producing liabilities based on current market interest rates. This approach 

is different from discount rates based on ERISA segment rates, which are 

averages of past and present rates. Also, FASB standards allow 

companies to select a hypothetical matching bond portfolio, or a yield 

curve (extrapolated for projected benefits with long durations), rather than 

rely on one particular set of published rates (such as those produced by 

Treasury for ERISA). Also, unlike the ERISA funding target, which is 

based on worker’s service and salary to date, FASB requires companies 

to report a projected benefit obligation, which for pension benefit formulas 

based on compensation includes an assumption of future benefit growth 

due to salary increases.

FASB Standards
Appendix III: Historical Returns and the 

Discount Rate

Page 74 GAO-14-264 Pension Plan Valuation 

Even though some experts we spoke to cited the historical returns of 

assets in a typical pension plan portfolio as evidence for the 

appropriateness of assuming a rate of return of around 8 percent, we 

found several challenges with using historical data to generate or support 

an assumed-return assumption. First, reliance on returns during

overlapping rolling historical periods has significant statistical limitations. 

Second, historical returns vary with the time period used in the analysis. 

Furthermore, future return expectations will depend in part on current 

economic variables that may not be consistent with any particular 

historical time period. Third, actual returns for any particular plan would 

also depend on plan characteristics and cash flows. Fourth, investment 

returns and plan benefit levels are not independent variables. Also, the 

potential use of historical returns is only relevant within the context of an 

assumed-return approach to discounting because a bond-based 

approach relies on observable market prices for bonds, annuities, or other 

alternatives.1

Using rolling period analysis based on historical returns to support an 

assumed-return discount rate presents statistical challenges that limit any 

conclusions that can be drawn. Some experts have argued that pension 

plans have a long time horizon and can bear short-term investment 

volatility because the historical record shows lower investment risk over 

long time horizons, such as 30 years.2 The historical record of reliable 

capital market returns covers 87 years, from 1926 through 2012.3 These 

87 years contain 58 full consecutive, rolling 30-year periods (i.e., 1926-

1955, 1927-1956, etc., through 1983-2012). However, the returns over 

these 58 different 30-year periods are not statistically independent, since 

they contain overlapping years. In fact, the 87 years from 1926 to 2012 

contain fewer than three independent 30-year data points.4

 

1

Some bond-based approaches smooth interest rates by averaging previous years’ 

interest rates to arrive at a discount rate, but equity returns would still not be relevant.

Further, the 

58 30-year rolling periods are heavily skewed towards the middle years of 

2

Other experts argue that, on the contrary, investment risk in risky assets such as equities 

increases in magnitude the longer the time horizon. 

3

2013 data was not yet available when we performed our analyses.

4

They contain three independent 29-year data points, from 1926-1954, 1955-1983, and 

1984-2012. 

Appendix III: Historical Returns and the 

Discount Rate

Challenges with Analysis 

of Historical Returns

Rolling Period Historical 

Returns Present Statistical 

Challenges
Appendix III: Historical Returns and the 

Discount Rate

Page 75 GAO-14-264 Pension Plan Valuation 

the 1926 to 2012 period.5

In analyzing the 1926-2012 historical period, modeled returns vary with 

particular subsets of years during this historical period and with the 

assumed allocation of plan assets. For the entirety of this 87-year 

historical period, we found that a static portfolio allocation of 60 percent in 

equities and 40 percent in corporate bonds (“60/40 portfolio”), rebalanced 

annually and with no intervening net cash flows, would have achieved an 

8.9 percent annualized nominal return.

As a result of these limitations, we cannot draw 

conclusions about investment risk over 30-year periods solely from this 

historical record.

6

 

5

For example, the years 1955-1983 are in 30 of the 58 rolling 30-year periods, while the 

years 1926 and 2012 are each in only one of the 58 periods. 

However, when “trailing returns” 

(i.e., returns for the years leading up to the current year) are used to 

examine historical capital market performance, the historical time period 

chosen can greatly affect return expectations. For example, as figure 4 

shows, for the same 60/40 portfolio, the annualized nominal returns are 

6.5 percent over the past 15 years, 10.9 percent over the past 30 years, 

9.3 percent over the past 50 years, 8.7 percent over the past 85 years, 

and again, 8.9 percent over the past 87 years. Even to the extent that 

such information can be informative as to future expectations, it is not 

clear how to assign relative credibility between the more recent and the 

more distant past.

6

Unless otherwise noted, the returns in this section are all geometric means rather than 

arithmetic means. See discussion at end of this section.

Past Returns Depend on the 

Time Period Used in the 

Analysis, and Future Returns 

Depend on Current Economic 

Variables
Appendix III: Historical Returns and the 

Discount Rate

Page 76 GAO-14-264 Pension Plan Valuation 

Figure 4: Annualized Historical Returns for Different Trailing Periods

When we analyzed returns over all 58 30-year periods within the 1926-

2012 historical period, we found that annualized nominal returns for the 

60/40 portfolio ranged from a low of 7.3 percent to a high of 12.5 percent. 

In contrast, for a 100 percent corporate bond portfolio, the annualized 

nominal returns ranged from a low of 1.8 percent to a high of 10.8 

percent. However, because the 58 periods are not statistically 

independent, these ranges understate the amount of variability in returns 

one might expect in future 30-year periods. 

In addition, experts told us that expectations about future returns also 

need to be informed by current economic variables. Experts mentioned in 

particular the current level of interest rates and the current price-toearnings ratios on equities. Any historical period may have had very 

different starting levels for these two variables.

Another challenge to drawing conclusions from historical returns is that 

any approach may not reflect the cash flow patterns of an actual pension 

plan. Historical return statistics are often “time-weighted” averages, 

meaning that they reflect average returns over some time period that are 

independent of the order in which those historical returns occurred. TimeReturns Also Depend on Plan 

Characteristics and Cash 

Flows
Appendix III: Historical Returns and the 

Discount Rate

Page 77 GAO-14-264 Pension Plan Valuation 

weighted returns do not vary across plans. Of more relevance to an 

actual pension plan is its “dollar-weighted” average return, which reflects 

the plan’s cash flow pattern. For example, consider a 10-year period in 

which returns average 10 percent annually for the first 5 years and 2 

percent annually for the second 5 years, for a 10-year average of 6 

percent annually, which is the time-weighted average return.7

To apply this concept to our historical return analysis, we developed two 

hypothetical pension plans—a growing plan and a maturing plan.

However, 

for a growing pension plan that has net cash inflows (contributions paid in 

exceeding benefits paid out) during this period, the returns in the second 

half of the period may be more important than the returns in the first half 

of the period, because there may be more money at stake in the second 

half of the period. Consequently, if a growing plan experiences

decreasing rates of return, the plan’s dollar-weighted average return may 

be less than the time-weighted average.

8 Each 

of these hypothetical plans generated a unique cash flow pattern that 

broadly reflected its plan characteristics and certain assumptions about 

the plans.9 We divided the 87-year period from 1926 to 2012 into three 

discrete 29-year periods.10

Our analysis shows that for a 60/40 investment portfolio allocation to 

stocks and corporate bonds, the dollar-weighted returns of our 

hypothetical plans can differ significantly from time-weighted returns. The 

hypothetical growing plan outperformed the time-weighted average in two 

of the three 29-year historical periods, while the maturing plan 

underperformed the time-weighted average in all three periods. As figure 

5 shows, the hypothetical growing plan would return nearly one 

percentage point above the time-weighted average return for the period 

For each hypothetical plan, we calculated 

dollar-weighted returns for each period based on plan assets invested in 

various investment portfolio allocations using historical return data.

 

7

This is a simplified “arithmetic” example, ignoring the effects of compounding. 

8

Over time, a growing plan will add new members and generally contribute increasing 

amounts of money compared to the payments it makes to beneficiaries. On the other 

hand, a maturing plan will begin to deplete its assets as it makes increasingly higher 

benefit payments against its contribution base.

9

See appendix I for more detail on our assumptions. 

10Period 1 is from 1926 to 1954; period 2 is from 1955 to 1983; period 3 is from 1984 to 

2012.
Appendix III: Historical Returns and the 

Discount Rate

Page 78 GAO-14-264 Pension Plan Valuation 

from 1926 to 1954 and almost a quarter of a percentage point above the 

time-weighted return for the period from 1955 to 1983, but the maturing 

plan would return nearly 1.25 percent below the time-weighted average 

return for the period from 1984 to 2012.

Figure 5: Return Differential between Hypothetical Plans and Time-weighted 

Averages
Appendix III: Historical Returns and the 

Discount Rate

Page 79 GAO-14-264 Pension Plan Valuation 

Many experts cited examples of pension plans for which benefit formulas 

were increased following periods of robust investment returns. We have 

also seen examples in more recent years of benefit formulas being 

decreased in financially distressed plans.11

In calculating average annual historical returns, either of two types of 

time-weighted (i.e., plan-independent) average annual returns can be 

measured—geometric average return or arithmetic average return. For 

returns that vary from year to year, the geometric average will always be 

less than an arithmetic average.

These examples indicate that 

investment returns and benefit levels have not been independent 

variables. If plan benefits have been more flexible in this way on the 

upside than the downside—an empirical question—it would mean that 

some historical investment returns effectively went towards net benefit 

increases rather than supporting previously existing benefit promises. 

This is another reason for caution in looking to historical returns to 

support a particular discount rate.

12

As a simplified but illustrative example, consider a two-year historical 

period where the return is positive 100 percent in year one and negative 

50 percent in year two. One dollar invested at the start of this period will 

grow to 2 dollars at the end of year one and then fall back to 1 dollar at 

the end of year two, for a total net return of zero over the 2-year period. 

The geometric average return is zero. The arithmetic average return is 

positive 25 percent (100 percent minus 50 percent, divided by 2).

Figure 6 shows the differences in these 

two types of average returns for a 60/40 investment portfolio allocated to 

stocks and corporate bonds calculated for various trailing periods.

Experts we spoke with disagreed about whether a forward-looking 

assumed-return assumption should reflect a geometric average 

 

11As previously reported, since 2008, the combination of fiscal pressures and increasing 

contribution requirements has spurred many states and localities to take action to 

strengthen the financial condition of their plans for the long-term, often packaging multiple 

changes together, such as reducing benefits, increasing member contributions, and 

switching to a hybrid approach. We found that 35 states have reduced pension benefits, 

mostly for future employees due to legal provisions protecting benefits for current 

employees and retirees. A few states, like Colorado, have reduced postretirement benefit 

increases for all members and beneficiaries of their pension plans. See GAO-12-322. 

12The only exception is if every annual return is the same, in which case, the geometric 

and arithmetic means will be equal.

Investment Returns and 

Benefit Levels Are Not 

Independent, Potentially 

Diminishing Effective Returns

Geometric Versus 

Arithmetic Means
Appendix III: Historical Returns and the 

Discount Rate

Page 80 GAO-14-264 Pension Plan Valuation 

expectation or an arithmetic average expectation. Conceptually, a 

geometric assumption reflects a median expectation (with a 50 percent 

chance that actual investment performance will be above or below the 

assumption) while an arithmetic assumption reflects a mean (average) 

expectation (with a greater than 50 percent chance that actual investment 

performance will fall short of the assumption).

Figure 6: Arithmetic Means Are Higher Than Geometric Means
Appendix IV: Key Features of Discount Rate 

Practices in Canada, the Netherlands, and the 

United Kingdom

Page 81 GAO-14-264 Pension Plan Valuation 

Appendix IV: Key Features of Discount Rate 

Practices in Canada, the Netherlands, and 

the United Kingdom
Page 82 GAO-14-264 Pension Plan Valuation 

Appendix IV

Funding requirements and discounting approaches 

• There are two liability assessments that determine minimum required 

contributions—a solvency valuation using bond-based discount rates 

and a going-concern valuation generally based on an assumed-return 

on plan assets. The solvency measurement typically does not include 

a projection of future salary increases while the going-concern 

measurement typically does include projections of future salary

increases. Assumed return assumptions sometimes are reduced by a 

margin for adverse deviation.2

• Generally, private sector plans discount using both the bond-based 

and the assumed-return approach, and then determine minimum 

contributions based on the greater of separate calculations using each 

of these two approaches to measure the unfunded liability. A number 

of Canadian regulators have extended temporary solvency funding 

relief to some private single-employer plans following low valuations of 

their asset portfolios resulting from the 2008 market decline.

• Generally, most public plans and some multiemployer plans have 

been exempted from the solvency assessment for funding purposes, 

or have been granted temporary solvency funding relief, as they are 

considered going-concerns. These plans make contributions based on 

an assumed-return discount rate. However, these plans must also 

provide a solvency-based liability measure to plan sponsors, plans 

members, and regulators.

• The bond-based rates used in the solvency assessment reflect a 

combination of (i) a formula tied to Canadian government bond rates 

plus a spread intended to approximate the results that would be 

obtained from discounting using a full yield curve based on highly 

rated provincial bonds (for participants who would be assumed to take 

a lump sum), and (ii) the market prices insurers charge for immediate 

and deferred annuities (for participants who would be assumed to take 

an annuity). 

1

Employees” refers to employees in the public and private sector and includes self-employed 

workers in incorporated business (with and without paid help). Registered pension plans are plans 

established by either employers or unions to provide retirement income to employees. Statistics 

Canada, Pension Plans in Canada and Labour Force Survey (2011).

2

A margin for adverse deviation is a provision that can be applied to an actuarial assumption in a 

manner that produces higher cost, or lower revenue, than a best-estimate assumption in order to 

provide a margin of safety against the risk that actual experience proves to be less favorable than the 

best-estimate assumption. For example, if the best-estimate of future investment returns is 7 percent 

and a margin for adverse deviation of 0.5 percent is applied, then the assumed return net of the 

margin would be 6.5 percent.

At a glance

• As of 2011, 38 percent of 

Canadian employees were 

covered under a registered 

pension plan in Canada.1

Of those, 74 percent or nearly 4.5 

million Canadians were 

participants in defined benefit 

plans, with an aggregate market 

value of assets of about 1.1 trillion 

Canadian dollars. 

• Defined benefit plans are generally 

regulated at the provincial level, 

with some regulated by a separate 

federal regulator, so policies can 

vary by province and the federal 

level. Most defined benefit plans, 

both public and private, are 

prefunded.

• With the exception of Ontario 

province, which has pension 

insurance that insures a nominal 

benefit of up to one thousand 

Canadian dollars per month, there 

is no pension insurance program 

in Canada.

Source: GAO analysis of foreign agency documents and 

interviews with Canadian officials and industry experts; U.S. 

State Department (base map); Art Explosion (flags). | GAO14-264

Note: GAO did not conduct an independent 

legal analysis of the laws, regulations, or 

policies of the countries selected for this 

review.

Canada
Page 83 GAO-14-264 Pension Plan Valuation 

Appendix IV

Funding requirements and discounting approaches (cont.)

• Although the assumed-return rate used in the going-concern 

assessment is similar in concept to the approach applied by public

sector plans and private sector multiemployer plans in the U.S., the 

return assumptions differ between the two countries, with assumed 

returns in Canada typically at 6 percent or lower, reflecting both lower 

best-estimates of assumed returns and, in some cases, the 

subtraction of a margin for adverse deviation.

• For financial reporting purposes, private sector plan sponsors in 

Canada often follow the accounting standards promulgated by the 

International Accounting Standards Board (IASB).

Regulator and regulatory principles

• At the federal level, the Office of the Superintendent of Financial 

Institutions (OSFI) regulates and supervises private pension plans in 

federally regulated areas of employment, such as banking, 

telecommunications and inter-provincial transportation. Each province 

has its own regulatory body for pension plans under its jurisdiction.3

The majority of registered defined benefit pension plans are under the 

jurisdiction of either the regulator in Ontario, Quebec, or with the OSFI. 

• Regulatory principles are generally similar across all regulators, 

whether provincial or federal.4

• Generally, provincially-regulated plans are assessed once every three 

years, while federally-regulated plans and plans registered with the 

Québec regulator are assessed annually. 

• Canadian regulators have the authority to reject an actuarial report 

which allows them to implicitly set boundaries for reasonable 

assumptions.

3

One exception is the province of Prince Edward Island, which does not have a pensions regulatory 

body.

4

An exception is Quebec, which one expert told us has many differences in pension regulation 

compared to the rest of Canada.

Canada
Page 84 GAO-14-264 Pension Plan Valuation 

Appendix IV

Funding requirements and discounting approaches

• All plans discount their liabilities using a bond-based approach.5

Benefits projected to be paid within the next 20 years are discounted 

using a 3-month average of the Euro interest rate swap curve. For 

benefits projected to be paid beyond 20 years, rates are extrapolated 

from the swap curve to approach a predetermined Ultimate Forward 

Rate, currently set at a fixed rate of 4.2 percent by an independent 

commission and introduced by the De Nederlandsche Bank in

September of 2012. In the future, the fixed level of 4.2 percent will be 

replaced by a 10-year moving average of the 20-year forward rate.6

• To safeguard nominal accrued benefits, plans must be funded to a 

base funding target of 105 percent using prescribed market interest 

rates. Plans can attempt to provide inflation indexed benefits by 

investing in riskier asset portfolios. Inflation indexed benefits are 

granted only to the extent they are supported by actual investment 

returns. However, base funding targets are also “risk-adjusted,” 

meaning the base funding target is increased the riskier the plan’s 

asset allocation, in order to provide a buffer against investment risk. 

An official told us that a common asset allocation of 50 percent equity, 

40 percent bond, and 10 percent real estate would require a plan to be 

120 percent funded, based on a 2.5 percent probability of shortfall in a 

1-year horizon.

• For determining minimum required contributions, plans may use either 

market interest rates, a 10-year moving average of market interest 

rates, or assumed returns. However, the funding target would still be 

the risk-adjusted target based on the bond-based liability.

• For future projections of assets and liabilities, plans may use assumed 

returns. 

• Plans in recovery are allowed to assume investment returns based on 

plan asset allocation to project reaching funding targets within the 

recovery period. 

5

In this report, the Netherlands’ use of the Euro swap curve to discount pension liabilities is also 

referred to as a bond-based approach. 

6

A forward rate is a rate of interest for a future period that would equate the total return of a longterm bond with that of a strategy of rolling over shorter-term bonds. The forward rate is inferred from a 

yield curve. 

At a glance

• In 2013, defined benefit plans 

accounted for 78 percent of all 

retirement plans in the 

Netherlands. Participants in those 

plans represented nearly 93 

percent of all active pension plan 

participants. 

• With regard to the discount rate, 

the regulator makes no regulatory 

distinctions between public, 

private, or multiemployer defined 

benefit pension plans. 

• Pension plans are separate legal 

entities from plan sponsors and 

there is no pension insurance 

program. 

• Plan benefits can vary with 

investment performance and 

funded status. 

Source: GAO analysis of foreign agency documents and 

interviews with Dutch officials and industry experts; U.S. State 

Department (base map); Art Explosion (flags). | GAO-14-264

Note: GAO did not conduct an independent 

legal analysis of the laws, regulations, or 

policies of the countries selected for this 

review.

Netherlands
Page 85 GAO-14-264 Pension Plan Valuation 

Appendix IV

Funding requirements and discounting approaches (cont.)

• Plans with funded ratios less than the 105 percent base funding target 

must submit a recovery plan to return to full funding within 3 years.7

Nominal accrued benefits can be reduced for plans that do not achieve 

the base funding target within this allotted time. Plans with funded 

ratios less than the risk-adjusted funding target (specific to the plan’s 

asset allocation) must reduce or eliminate inflation-indexation and 

submit a recovery plan to return to this funding target within 15 years.

• For financial reporting purposes, private sector plan sponsors in the 

Netherlands often follow the accounting standards promulgated by the 

International Accounting Standards Board (IASB).

Regulator and regulatory principles

• De Nederlandsche Bank (DNB) examines the financial position of 

pension funds and regulates discount rates. The Netherlands Authority 

for the Financial Markets monitors market conduct relating to pension 

funds’ obligations to provide information to members.

• The DNB publishes discount rates on a monthly basis. 

• Pension plans must submit quarterly and annual reports to the DNB. 

• When using assumed returns, the maximum expectations that can be 

used are regulated. Currently, the maximum acceptable assumed 

return on the equity portion of the portfolio, as established by an 

independent commission, is 7 percent (the overall assumed return 

would also reflect the other asset classes in the portfolio).8

7

In 2008, the recovery period for plans under the base funding threshold was extended by the 

government from 3 to 5 years as a vast majority of plans had to file recovery plans. As of July 2013, 

the regulator told us that there are still 70 plans in recovery status in this, the fifth year. In response, 

the regulator is in the process of contemplating more comprehensive changes to the pension 

regulatory system.

8

For example, using maximum return assumptions of 7 percent for equities and 4.2 percent for 

bonds (the current predetermined maximum bond-based discount rate as introduced by the DNB), a 

static portfolio allocation of 60 percent in equities and 40 percent in bonds would result in a composite 

assumed return of about 5.9 percent. The actual composite assumed return could be even lower since 

the portfolio may contain shorter duration bonds which would likely yield less than 4.2 percent under 

current conditions.

Netherlands
Page 86 GAO-14-264 Pension Plan Valuation 

Appendix IV

Funding requirements and discounting approaches

• There is no standard actuarial method or assumptions that defined 

benefit pension plans must use beyond the requirements that actuarial 

valuations must use an accrued benefit method, assets must be at 

market value, and economic and actuarial assumptions must be 

chosen prudently based on circumstances specific to the plan. 

Regulations specifically allow plans to use either a bond-based, 

assumed-return, or a combination of both approaches to determine its 

discount rate for funding purposes.10

• Under U.K.’s Scheme Specific Funding framework, discount rates 

used by private plans for funding purposes are plan-specific and may 

incorporate elements of both the bond-based and assumed-return

approaches.

• Regulator guidance cautions sponsors to consider the strength of the 

employer sponsor to support the plan, known as the “employer 

covenant,” in plan assumptions. A strong sponsor can have some 

justification for using a somewhat higher discount rate, but the 

regulator cautions plan trustees to regularly assess sponsor strength 

because it may be subject to significant variation over relatively short 

periods of time. Conversely, a weak sponsor may find it prudent to 

take less risk and use a discount rate that assumes lower returns 

above safe bond yields.

• Discount rates for funding purposes frequently differ between the 

retired and current worker portions of the plan populations. The 

projected benefits of retired plan participants are frequently discounted 

largely with reference to U.K. government bond rates, known as “gilts,” 

and to corporate bond rates. The projected benefits of current workers 

(and deferred members) are frequently discounted at gilt rates plus 2 

to 3 percent for the period up to retirement.

• Plans under recovery are allowed to assume a higher return, over the 

recovery period, than the discount rate used to calculate the plan’s 

liability. 

• For financial reporting purposes, private-sector plan sponsors in the 

United Kingdom often follow accounting standards promulgated by the 

local Financial Reporting Council (FRC) or the International 

Accounting Standards Board (IASB). 11 FRC and IASB standards take 

an approach to the discount rate that is broadly similar to FASB in the 

United States. 

9

Workplace pension plans include defined benefit, defined contribution, and other types of pension 

plans.

10

The regulation states that “the rates of interest used to discount future payments of benefits must be 

chosen prudently, taking into account either or both–(i) the yield on assets held by the scheme to fund 

future benefits and the anticipated future investment returns, and (ii) the market redemption yields on 

government or other high-quality bonds.”

11

Accounting standards developed by the FRC are contained in Financial Reporting Standards, 

referred to as FRS.

At a glance

• In 2012, participation in workplace 

pension plans was at 46 

percent.9 91 percent of public 

sector employees with workplace 

pensions had a defined benefit 

plan while 26 percent of private 

sector employees with workplace 

pensions were in such plans. 

Overall, the proportion of 

employees with defined benefit 

pension plans continued to fall, 

with 28 percent of employees 

participating in such plans in 2012, 

compared with 46 percent in 1997. 

• Private sector defined benefit 

plans are almost always prefunded 

while public sector plans are 

generally pay-as-you-go, with 

benefits paid out of tax revenue 

(the discussion in this report is 

focused primarily on U.K. private

sector plans). 

• Trustees of private plans are 

autonomous from the sponsoring 

employer. Trustees and employers 

negotiate in setting plan policies, 

with assumptions, including the 

discount rate, and methods subject 

to a risk-based review by the 

Pensions Regulator.

• A national pension insurance 

program administered by the 

Pension Protection Fund (PPF) 

provides compensation to 

members of eligible, largely private

sector defined benefit pension 

plans when there is a qualifying 

insolvency event in relation to the 

employer, and where there are 

insufficient assets in the pension 

plan to cover the PPF level of 

compensation. 

Source: GAO analysis of foreign agency documents and 

interviews with U.K. officials and industry experts; U.S. State 

Department (base map); Art Explosion (flags). | GAO-14-264

Note: GAO did not conduct an independent 

legal analysis of the laws, regulations, or 

policies of the countries selected for this 

review.

The United Kingdom
Page 87 GAO-14-264 Pension Plan Valuation 

Appendix IV

Regulator and regulatory principles

• The Pensions Regulator is responsible for regulating work-based 

pension plans, which includes occupational defined benefit and 

defined contribution plans as well as certain aspects of work-based 

personal pensions. It has the authority to oversee the administration of 

these plans and contributions made to them based on its objective to 

protect the benefits under occupational pension plans of, or in respect 

to, members of such plans. 

• Private plan sponsors must prepare actuarial valuations on at least a 

triennial basis (provided they also produce annual updates-–otherwise 

they have to do annual valuations). Plans in deficit, and which have 

therefore prepared a recovery plan, must submit details of the 

recovery plan and valuation to the regulator. Plans in surplus must 

submit details of their valuation along with their regular plan data 

updates. The regulator conducts a risk-based assessment to 

determine if additional scrutiny or actions are necessary. 

The United Kingdom
Appendix V: GAO Contact and Staff 

Acknowledgments

Page 88 GAO-14-264 Pension Plan Valuation 

Charles Jeszeck, (202) 512-7215 or jeszeckc@gao.gov, Frank Todisco, 

(202) 512-2700 or todiscof@gao.gov

In addition to the contact named above, Kimberly Granger (Assistant 

Director), David Lin (Analyst-in-Charge), Amy Buck, and Aron Szapiro 

made key contributions to this report. Also contributing to this report were 

James Bennett, Susan Bernstein, Kenneth Bombara, David Chrisinger, 

Robert Dacey, Michael Hoffman, Gene Kuehneman Jr., Kathy Leslie, 

Ashley McCall, Sheila McCoy, Nhi Nguyen, Susan Offutt, Max Sawicky, 

Margie Shields, Roger Thomas, Kate van Gelder, and Amber YanceyCarroll.

Appendix V: GAO Contact and Staff 

Acknowledgments

GAO Contacts 

Staff 

Acknowledgments
Related GAO Products

Page 89 GAO-14-264 Pension Plan Valuation 

Private Pensions: Timely Action Needed to Address Impending 

Multiemployer Plan Insolvencies. GAO-13-240. Washington, D.C.: March 

28, 2013.

State and Local Government Pension Plans: Economic Downturn Spurs 

Efforts to Address Costs and Sustainability. GAO-12-322. Washington, 

D.C.: March 2, 2012.

State and Local Government Pension Plans: Governance Practices and 

Long-term Investment Strategies Have Evolved Gradually as Plans Take 

On Increased Investment Risk. GAO-10-754. Washington, D.C.: August 

24, 2010.

State and Local Government Retiree Benefits: Current Status of Benefit 

Structures, Protections, and Fiscal Outlook for Funding Future Costs.

GAO-07-1156. Washington D.C.: September 24, 2007.

Related GAO Products

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