Discount rate for pension

[sunpak]

Hi,
Lets say the defined benefit plan is underfunded. Assets are 1000 and liabilities are 1500. Discount rate to used for liabilities is 10%.
Management wants to be aggresive in their asset allocation so that it does not need to contribute in the future.
What is the return objective?
Should it be 10% because the plan is underfunded or is should be such that assets equal liabilities in 5 yrs?

 

[JJ1337]

(1,500/1,000)^(1/5) - 1 = 8.45% ?!

 

[Galli]

PV of liability = ?
FV of asset @ T=5 = ? / pv of asset using liability discount rate

 

[Tommy83]

JJ1337 wrote:
(1,500/1,000)^(1/5) - 1 = 8.45% ?!

They need to earn that AND the discount rate applied to liabilities (I’m assuming 1,500 in liabilities is the PBO). If they only earn 8.45% (below the discount rate on liabilities), the pension deficit will only increase. They need 10% just to keep their head above water (maintain current funded status). It’d have to be 18.45% if they want to fully fund the plan in 5 years without making any contributions.
Management “wanting to be aggressive” with its asset allocation is a hint that the return requirement needs to be above the discount rate.

 

[JJ1337]

Sounds reasonable: [(1,500x1.1^5)/1000]^(1/5) -1 = 19.29 or just 1.1 x 1.845 - 1 = 19.30 (rounding…)