For the purpose of determining the going concern funded status of a defined benefit pension plan, the current actuarial practice is to determine the liabilities of the plan using a discount rate based on the expected investment return from the pension fund (the “traditional” approach). On the other hand, financial economists have advocated the use of a discount rate based on the market yields of investment-grade bonds, with an appropriately low level of risk, whose cash flows reasonably match the expected benefit payments, regardless of how the plan assets are invested (the “financial economics” approach). This paper explores the issue of selecting discount rates for assessing the funded status of target benefit plans. A target benefit plan is a pension plan that aims to provide a target retirement income to its members through the pooling of economic and demographic risks, where the employer’s funding obligation is predefined while members’ benefits may be adjusted upwards or downwards relative to the target. From the viewpoint of managing the risk of intergenerational inequity, the paper proposes that the only discount rate for assessing the funded status of a target benefit plan that serves the best interests of members is one based on the traditional approach. To support this proposition, we conduct Monte Carlo simulations on three model plans to demonstrate the impact on pension wealth distributions resulting from the two discount rate approaches.
