Employment benefits discount rate: Any case for a current rate?

Read more about the debate on whether a current rate, an average rate or a projected rate would be appropriate for the discount rate used in determining benefit obligation.

Employees of U.S. nuclear power firm Westinghouse Electric Co. got a surprise recently. The Pension Benefit Guaranty Corp. (PBGC), a U.S. government agency that insures certain U.S. private employer pension plans, had estimated that the Westinghouse pension plan was under-funded by US$937 million.

The news came as a shock because the plan had been considered fully funded in its most recent report, filed with the U.S. Department of Labor in 2015. This shortfall is massive, given that the plan had US$926 million in assets. However, the shortfall did not arise from mismanagement, fraud or aggressive plan investment strategy. Instead, it was due to the different discount rates used by the company and the PBGC.

The report filed with the Department of Labor was based on a 25-year average of interest rates, while PBGC had used a current market rate. The two actuarial valuations were likely prepared for different purposes — the former assumed that the plan would continue to exist, and the latter assumed that it would be terminated.

According to Paragraph A02, Invitation to Comment, Employment Benefits: Discount Rate Guidance in Section PS 3250, “The main reason for the different sets of numbers is the fact that a benefit plan’s funding status can be assessed from different perspectives.” Paragraph A03 goes on to state “Since each type of actuarial valuation (accounting and funding) serves a different purpose, it is not uncommon for different financial and actuarial reports of the same benefit plan to show different results.”

The Westinghouse example, however, demonstrated the implications of using an average rate versus a current market rate in estimating benefit obligation, and the implications of using different lengths of period for the average rate.

According to an article in the Pittsburgh Post-Gazette, for 2016, “Westinghouse told retirees that their pension plan was funded at a rate of 102 per cent. But using a two-year interest rate average, that number dropped to 80 per cent and translated to a shortfall of US$226 million.”

Which rate better reflects the benefit obligation?

Some believe that a current rate better reflects the benefit obligation at the reporting date. That’s because a current rate reflects the economic conditions and market expectations at the reporting date, including expectations about the periods over which the benefit payments are expected to be made.

Others question whether a point-in-time estimate, like a current rate, could fairly represent the economic burden of benefit obligation to an entity, given the long-term nature of many benefits. They argue that using a current rate could result in more volatility in the benefit obligation reported from year to year when there is no substantial change in benefit provisions, or actual experience of the plan.

Supporters of using an average rate state that it would reduce the volatility resulting from a current rate, while opponents argue that an average rate is simply a smoothing mechanism that cannot be supported conceptually. Market expectations would have incorporated all publicly available information, including historical rates.

Lastly, some support a projected rate that focuses on the periods when benefit payments are expected to be made, believing that it may better represent the entity’s benefit obligation. Meanwhile, others are concerned that the subjective process in estimating a projected rate may leave room for managing accounting results.

What do you think?

You can participate in this debate and influence the Public Sector Accounting Board’s (PSAB) deliberations on this issue by responding to the Invitation to Comment, “Employment Benefits: Discount Rate Guidance in Section PS 3250,” by March 9, 2018.

To learn more, download the webinar and read the following two related articles:


Lydia P. So, MBA, CPA, CA
Principal, Public Sector Accounting Board
Tel: (416) 204-3281