Alternative Minimum Cost Method

  

A brief aside into music history before launching into a discussion of pension funding.

In the 1990s, a musical genre known as "alternative" became very popular. It was known as "alternative" because it was guitar-based rock-style music, but in approach and spirit, it set itself apart from the mainstream popular guitar-based rock music that dominated the charts, stuff like Guns N Roses and the pretty-boy hair bands of the day. By the end of the decade, though, the Guns N Roses types had faded from the scene and the only rock music left standing were the alternative bands, with groups like Pearl Jam and REM representing some of the most popular performers in the world. The music was still called alternative, even though it was actually just mainstream rock at that point.

Okay, on to pensions...

The alternative minimum cost method is a way to figure out how much money is needed to fund a pension plan. The name has "alternative" in it, but (like those popular alternative bands of the 1990s) the process actually represents the main proscribed way to make these calculations. In 1974, Congress passed a bill called the Employee Retirement Income Security Act, or ERISA. This put guidelines in place for how pension plans had to be funded. One of the results was that most companies started using the alternative minimum cost method for their calculations.

Basically, this technique uses demographic information to figure out how to fund the pension accounts of individual employees. There are two versions of the method and the pension fund can choose whichever one has the lower cost. Hence the name "alternative minimum cost method." The pension plan is selecting the method with the minimum cost among two alternatives.

The details of the two methods are things only an accountant could love. They involve complicated number crunching and the difference between them relates to the numbers being crunched. Just to give you the names of the two methods, though: there's the actuarial cost method and the accrued cost method.

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