Inflation indexed benefits

[MrSmart]

I-will-pass wrote:

MrSmart wrote:

I-will-pass wrote:

MrSmart wrote:

I-will-pass wrote:

MrSmart wrote:

I-will-pass wrote:

MrSmart wrote:

I-will-pass wrote:
Inflation indexed means higher contributions hence higher expenses on the income statement as well as higher shortfall risk.
Was this what you wanted to know? Feels like some of the questions on the exam…if you know what I mean! No offense.

That’s not nessecarily true. I remember trying to find an answer some time ago, but never did.
First, you must define shortfall risk in the context of inflation indexed benefits before trying to come up with a solution.

that doesnt make any sense to me. Please explain. Thanks.

Indexing inflation does not always lead to higher expenses, or higher return requirements.
Measuring shortfall risk can be done with a liability only approach, or an asset-liability portfolio approach.
If the assets and liabilities are exactly matched in amounts and factor risks, then your shortfall risk is zero. The return requirement in this case would reset at each period, simillar to a floating bond. Then you would calculate a shortfall risk based on this new return requirement, using the equity’s standard deviation as your measure of risk.

Indexing to inflation does not always lead to higher return requirements? I doubt that. Are you making this up? I might habe to get my books or call for the Magician.
I would also counter that in reality you cannot perfectly match most indexed liabilities because the replication of the index is hard (for instance benefits that index with the wage inflation of the workers in the health care sector).
Everything else that you are saying reads like a copy and paste from a text book. Anyone else think that this is incorrect or is this guy right in what he is writing?

Let’s substitute fixed benefits (at say, 10%), with an inflation indexed of 8% + inflation.
You could obviously see that the volatility of return is higher, but the return requirement (or the expected return) is not higher, and in fact, known beforehand at each reset (payment) date.

look you keep on answering a question that was not asked.
In laymans terms: you pay one of your retirees 100 bucks worth of pension today. And 100 bucks tomorrow. That is non-indexed benefit payment (not obligation). Wage inflation is 10% and you pay 110 bucks than that makes it indexed. Which amount leads to higher liquidity need and hence higher return requirement? I believe this was the question. As the OP has also stated in his direct reply to your comments.

Actually, I am answering your, and his question.
Why are you assuming that changing to inflation indexed benefits would be an addition in neutral conditions?

i dont even know what you are asking. I do know that your answers sound pretty far fetched to me and I am probably not at the same intellectual level or just not interested in wasting any more time as its pointless. Hence 1 issue, multiple opinions. That happens in real life, or should I say under non-neutral conditions. Cheers to Egypt.

Let me make it more simple.
If a sponsor were to substitute fixed for linked benefits, of say 10%, then you wouldn’t price the new benefits at a 10% real rate + inflation. The increase in shortfall risk in this case was NOT due to inflation, but a higher real rate. This is what I mean by a neutral condition. Now rewind back to the beginning and explain how, or why would it lead to higher return requirements and interest expense on the P/L. While taking into account what has already been said.

 

[I-will-pass]

vgmalu wrote:

I-will-pass wrote:

MrSmart wrote:

I-will-pass wrote:

MrSmart wrote:

I-will-pass wrote:

MrSmart wrote:

I-will-pass wrote:

MrSmart wrote:

I-will-pass wrote:
Inflation indexed means higher contributions hence higher expenses on the income statement as well as higher shortfall risk.
Was this what you wanted to know? Feels like some of the questions on the exam…if you know what I mean! No offense.

That’s not nessecarily true. I remember trying to find an answer some time ago, but never did.
First, you must define shortfall risk in the context of inflation indexed benefits before trying to come up with a solution.

that doesnt make any sense to me. Please explain. Thanks.

Indexing inflation does not always lead to higher expenses, or higher return requirements.
Measuring shortfall risk can be done with a liability only approach, or an asset-liability portfolio approach.
If the assets and liabilities are exactly matched in amounts and factor risks, then your shortfall risk is zero. The return requirement in this case would reset at each period, simillar to a floating bond. Then you would calculate a shortfall risk based on this new return requirement, using the equity’s standard deviation as your measure of risk.

Indexing to inflation does not always lead to higher return requirements? I doubt that. Are you making this up? I might habe to get my books or call for the Magician.
I would also counter that in reality you cannot perfectly match most indexed liabilities because the replication of the index is hard (for instance benefits that index with the wage inflation of the workers in the health care sector).
Everything else that you are saying reads like a copy and paste from a text book. Anyone else think that this is incorrect or is this guy right in what he is writing?

Let’s substitute fixed benefits (at say, 10%), with an inflation indexed of 8% + inflation.
You could obviously see that the volatility of return is higher, but the return requirement (or the expected return) is not higher, and in fact, known beforehand at each reset (payment) date.

look you keep on answering a question that was not asked.
In laymans terms: you pay one of your retirees 100 bucks worth of pension today. And 100 bucks tomorrow. That is non-indexed benefit payment (not obligation). Wage inflation is 10% and you pay 110 bucks than that makes it indexed. Which amount leads to higher liquidity need and hence higher return requirement? I believe this was the question. As the OP has also stated in his direct reply to your comments.

Actually, I am answering your, and his question.
Why are you assuming that changing to inflation indexed benefits would be an addition in neutral conditions?

i dont even know what you are asking. I do know that your answers sound pretty far fetched to me and I am probably not at the same intellectual level or just not interested in wasting any more time as its pointless. Hence 1 issue, multiple opinions. That happens in real life, or should I say under non-neutral conditions. Cheers to Egypt.

In layman terms, what they are discussing is whether being Inflation Indexed always leads to only unfavorable circumstances for a firm and leads to increase in shortfall risk at all times?. I think generally if we are in an inflationary environment always, this should be the case (increased shortfall risk)
Now the question is what do you mean by Neutral condition, if we are going to pay all retirees (accrued benefits) inflation indexed, then in an deflationary environment(throughout) , you actually end up paying lesser (leads to lower shortfall risk)
I doubt whether it is worthwhile to make scenarios and get into so much detail.

I agree of course as it echoes what most of us here have been writing ever since. But he is persistent - lets give him that much. I am officially calling for the master: Magician where art thou?