Early retirement INCREASES surplus????

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benjaminvw

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Fom Schweser: Study Session 5 - Self test on pg 60 of Book 2- Questions 3
The questions basically asks what the effect is of adding an option to retire early and take 5% cut in benefits (within the context of a DB plan).
The answer says it will increase liquidity needs (I agree) and increase the surplus (I’m confused).
An early retirement option will pull forward future payments and, in my mind, will increase PBO (by more than the 5% reduction in benefits), which should reduce the surplus.
What am I missing? thanks
 
the early retirement increases the Liquidity needs.
the PBO decreases - actually if you look at it. They are talking about a 5% reduction in benefits - and for a shorter period of time (5 years less) - so overall the amount of accumulation would need to become smaller. And hence the surplus = FV Plan Assets - PBO would INCREASE.
 
Isn’t PBO as present value #? Why would you subtract it from FV of plan assets?
I agree that the the payout will now be smaller (5%), but I’m more confused about the effect of making it 5 years earlier.
Maybe I just misunderstood your answer - could you clerify?
thanks
 
PBO is present value of the Liabilities. Now you are paying out the liabilities for 5 years lesser - so there is a large sum of money you no longer need be liable for.
And Plan Surplus = Fair Value of Plan Assets - PBO (Present Value of the liabilities).
When the assets remain at a fixed value, PBO reduces, the net effect is that the Plan surplus increases
doesn’t it
 
Again, I’m trying to understand why PBO would decrease (I don’t doubt that IF it does decrease that it would cause an increase in surplus all else equal).
I assumed that the total # of payments would stay the same, and just start 5 years earlier - are you saying that this would actually increase the total # of future payments by 5 years worth?
 
One reason for PBO to decrease is because PBO includes pay increases to retirement. If there is an early retirement, then there will be fewer years of pay increases incorporated. That said, a 5% reduction for 5 years early, if that is what the question is, since I don’t have access to it, is heavily subsidized, 5 years should be closer to 35% reduction to be actuarially equivalent. The total number of payments will increase by approximately 5 years worth (not exactly, since there is mortality applied during those 5 years).
 
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