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A Forward Looking Asset-Smoothing Method

Funding of a going-concern pension plan has a long time frame. Satisfactory delivery of benefits is partially dependent on future investment returns. The most common asset valuation methods used today involve either the current market value or an average of the last few years' market values. In a period of protracted market declines, for example, the last few years, either of these methods will show that asset growth has not kept pace with liability growth. This may result in increased contributions. Such additional contributions may turn out to be unnecessary if market returns revert to more normal levels. These asset valuation methods are limited since they look only at historical values. An asset valuation method for an ongoing plan would provide smoother funding results if it were also forward looking and took into account the potential variability of asset returns. Such an approach would be particularly appropriate where a projected benefit method is used to value liabilities. This paper shows an approach whereby future asset returns and liabilities are modeled taking into account the probability of various returns. It develops an asset-smoothing approach that uses an expected return on the asset mix and averages both historical and projected asset values.