Entry Age NormalEdit
Entry Age Normal (EAN) is an actuarial funding method used to determine the normal cost of a defined-benefit pension plan. It allocates the present-value cost of future benefits to years of service tied to the employee’s entry into the plan, rather than basing costs solely on years of service or attained age. This approach is widely used in both public and private pension funds as a way to level funding over time and make contributions more predictable.
In practical terms, EAN separates funding into a normal cost, which covers benefits earned by new entrants each year, and an amortization or stabilization component that spreads any unfunded liabilities over a fixed horizon. By anchoring costs to entry age, EAN aims to distribute obligations fairly across cohorts and generations, reducing the likelihood that a single generation bears an outsized portion of the plan’s long-term costs. For those studying pensions, the method is often discussed alongside other actuarial funding methods such as the projected unit credit method and the basics of actuarial valuation.
How Entry Age Normal works
Entry age and normal cost: The calculation starts with the year a worker enters the pension plan. The normal cost is the annual amount that would fund the benefits earned by that employee in the year of entry over the remainder of their working life, expressed as a level amount or as a level percentage of payroll. This connects the plan’s costs to the life-cycle of each cohort and is a cornerstone of how the EAN method smooths funding over time. For more on how future benefits are valued, see actuarial valuation and discount rate.
Actuarial accrued liability and unfunded liabilities: The total liability for benefits earned to date is the actuarial accrued liability (AAL). If the plan’s assets fall short, there is an unfunded actuarial accrued liability (UAAL) that must be addressed. The UAAL is typically amortized over a set period and added to the annual funding requirement, shaping long-term fiscal planning. See funded ratio and amortization for related concepts.
Amortization period and funding policy: The UAAL is spread over a prescribed amortization horizon, often 20 to 30 years in many plans. The choice of amortization period affects annual contributions and intergenerational fairness. A longer period smooths the annual outlay but can leave more liabilities outstanding, while a shorter period accelerates funding but increases near-term costs. See pension reform for debates about amortization horizons.
Assumptions and sensitivity: Like other actuarial methods, EAN depends on assumptions about investment returns (captured in the discount rate), wage growth, mortality, and turnover. These inputs introduce potential volatility into annual contributions, even though the method seeks to smooth costs over cohorts. See discount rate and mortality for related topics.
Comparisons with other methods: The EAN approach contrasts with methods that allocate costs primarily by service years or by attained age. For example, the projected unit credit method distributes costs based on service to date and expected future service, which can produce different contribution patterns. The choice of method interacts with governance, budgeting, and policy priorities in a given jurisdiction.
Practical considerations and governance
Budgetary impact and taxpayer accountability: Because EAN ties normal costs to entry cohorts, it can help governments and employers plan long-term contributions with more predictability. This aligns with fiscal discipline and transparent budgeting, reducing the risk of sudden tax or contribution spikes driven by short-term politics. See public finance and intergenerational equity.
Plan design and reform: Legislation and plan rules—such as the allowed amortization period, actuarial assumptions, and whether cost-of-living adjustments are earned under the plan—shape how EAN translates into actual contributions. Policymakers and trustees frequently review these elements in light of funding performance and fiscal pressures. See pension reform.
Transparency and communication: Clear disclosure of NAC (normal annual cost), UAAL, and funded ratio helps stakeholders understand the plan’s financial position. Actuarial reports underpin these disclosures and inform decisions about plan design and governance. See actuarial valuation.
Controversies and debates
From a perspective that emphasizes long-run fiscal responsibility and predictable public finance, EAN is valued for its emphasis on intergenerational fairness and avoided volatility in near-term budgets. Proponents argue that:
Intergenerational fairness: By linking costs to the entry age of workers, the method helps ensure that current and future employees share the responsibility for benefits fairly, rather than letting a small group of cohorts disproportionately bear long-term liabilities. See intergenerational equity.
Transparency and stability: The NAC and UAAL framework under EAN can produce more stable contribution requirements over time, helping governments and employers avoid abrupt funding shocks that could crowd out other priorities. See pension fund.
Critics, including some who advocate for more aggressive funding or for reallocating risk, raise concerns such as:
Potential underfunding or misalignment with actual cash flows: If assumptions prove optimistic or if amortization periods are extended, the plan may carry a heavier burden in the future. Opponents argue for shorter amortization horizons or for adjustments that reflect more immediate liabilities. See actuarial valuation.
Complexity and governance challenges: Some observers contend that actuarial methods, including EAN, can be opaque to non-specialists, complicating political accountability and citizen understanding. This has spurred calls for simpler, more transparent funding rules and clearer governance standards. See pension reform.
Interaction with investment risk: While EAN emphasizes cost allocation over time, the plan’s funded status still depends on investment performance. Critics worry that optimistic asset returns can mask underfunding, whereas proponents argue that disciplined funding and prudent asset management are the real safeguards. See discount rate and pension fund.
In debates where critics label certain reform proposals as politically motivated or insufficiently protective of taxpayers, defenders of EAN-based funding argue that the method provides a disciplined, predictable framework that reduces short-term fiddle factors in budgeting and preserves long-term program viability. They contend that criticism aimed at perceived rigidity often ignores the broader goal of sustainable, accountable pension governance.