Module 15.5, LOS 15.d: Plan Assumptions and Effects of Changes in Assumptions, Ultimate Health Care Trend

The CFA recognizes 3 assumptions that firms use in pension calculations:

The discount rate is the interest rate used to compute the present value of the benefit obligation and the current service cost component of periodic pension cost.

The rate of compensation growth is the average annual rate by which employee compensation is expected to increase over time. 

The expected return on plan assets is the assumed long-term rate of return on the plan’s investments. 

Increases in the discount rate and expected return and decreases in the compensation growth rate will improve plan returns.

The assumptions are similar for other post-employment benefits except the compensation growth rate is replaced by a health care inflation rate. Generally, the presumption is the inflation rate will taper off and eventually become constant. This constant rate is known as the ultimate health care trend rate.

All else equal, firms can reduce the post-employment benefit obligation and periodic expense by decreasing the near term health care inflation rate, by decreasing the ultimate health care trend rate, or by reducing the time needed to reach the ultimate health care trend rate.

Table of Contents

Leave a Comment