The Chinese Pension System
February 12, 2025
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Accounting for pension funds is considered to be much more complex than standard accounting. This is because a lot of the payments being made in the pension funds are to be done in the distant future. Hence, as an accountant, provisions have to be made to account for these expenses as well as incomes that will accrue in the distant future.
It is a known fact that as soon as assumptions start being made about the distant future, they become less and less accurate. As a result, pension funds are very sensitive to the assumptions that they make about the future.
In this article, we will have a look at the various types of assumptions that a pension fund has to make for its accounting as well as funding needs.
The value of any pension fund, as well as its funded and unfunded liabilities, is significantly influenced by these assumptions. If the assumptions are tweaked even a little bit, then the accounted-for value can change quite significantly. Hence, there will always be an incentive for the pension fund sponsor to keep tweaking the assumptions in their favor.
In most parts of the world, changing assumptions are not allowed very easily. The assumptions based on which a pension fund operates have to be agreed upon between the sponsor and an actuary.
The actuary is a licensed professional who is bound by an oath to ensure the correctness of the data that they propose. Any changes to these assumptions are not allowed and are considered very carefully by the regulatory body.
An actuary is a person who analyses statistics from past data and uses them to determine the assets and liabilities of the future.
Actuaries are generally used by insurance companies. However, in the case of pension funds too, there is a huge element of prediction. Since all assumptions about the future are made based on data and patterns about the past, these assumptions are called actuarial assumptions.
Now, there are two broad categories of actuarial assumptions which have a huge impact on pension funds. These assumption categories have been mentioned below:
Pension funds have to make certain assumptions about the larger economy. Some of the important macroeconomic factors which affect these funds are:
In pension fund accounting, this interest rate is used as a discount rate. The discount rate is used to calculate the liabilities as well as assets of the fund on the measurement date i.e. the date at which accounting estimates are made. Even a minor change in the interest rate can have a huge impact on the pension fund valuation and accounting.
The real rate of return must be greater than the inflation rate. Hence, while forecasting return, it is also vital that the inflation rate also be forecasted and compared with the nominal rate of return to make assumptions about the real rate of return which will be made by the fund.
Another category of assumptions called demographic assumptions also has a huge influence on the value of pension funds.
If the average life span of people increases, then the present value of pension benefits payable also increases. This can be detrimental to a pension fund if not taken into account at the correct time.
Different countries of the world have different retirement ages. In some countries, the age is sixty whereas, in some others, it is seventy. Also, this age is continuously changing. Pension funds need to have a proper estimate of this age.
The bottom line is that the accounting, funding as well as overall functioning of pension funds is heavily dependent upon certain kinds of assumptions. These assumptions need to be carefully made in order to ensure the smooth functioning of the fund.
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