Institutional Q

[BaseballRedhawks]

Quesiton….
For a DB plan… an option:
Freeze the Plan. All new employees will partiicpant in a new DC plan where employees can select form a list of choices that range form convservative to more aggressive than the DB plan.
Quesiton: Assume the above is adpoted and that most partiicpants choose more aggressive assets than those in the pension plan portfolio, risk for the sponsor, will most likely:
A) Increase
B) Decrease
C) Unchanged.
I had first thought ti was unchanged… since DC plan does not affect the DB plan. If a plan is frozen, the plan’s risk tolerance is lower……. So what is the question actually asking?
The answer is: B) Decrease - The risk of the plan for the plan sponsor will decrease regardless of the investment choices made by each participant.
Are they saying risk for the sponsor will decrease but there won’t be new employees getting into the DB Plan? Kind of lost, but i don’t think im fully understanding what risk means in this context.
Thanks all!

 

[myriam2222]

Where did you find this exercise?

 

[zulu007]

DB plan is frozen so no new employee additions.
We know that with DB plan, employer / sponsor bears the investment risk and with DC plan participants bear the investment risk.
Once the employees are moved to DC, investment risk shifts to employees.
Hence the risk for sponsor will decline irrespective of the aggresiveness of DC plan participants.

 

[myriam2222]

zulu007 wrote:
Once the employees are moved to DC, investment risk shifts to employees.

“are moved to DC”… you mean as time passes by, and the DB plan related debt gets paid and decreases?

 

[myriam2222]

myriam2222 wrote:

zulu007 wrote:
Once the employees are moved to DC, investment risk shifts to employees.

“are moved to DC”… you mean as time passes by, and the DB plan related debt gets paid and decreases?

I mean, here you have to take the time effect right? Because at time 0, when the plan gets frozen and the employees are asked to choose, it has not impact first. As time passes by, there is the effect your described.
I think that is what is confusing in the question. At time 0, nothing happens.

 

[zulu007]

Yes, one can be the passage of time effect as you highlighted and
2) I can also think from a funded status point of view. Surely a time 0 actuaries calculation / assumptions (fuure wage growth, workforce changes etc) regarding calculating PBO will change

 

[myriam2222]

zulu007 wrote:
2) I can also think from a funded status point of view. Surely a time 0 actuaries calculation / assumptions (fuure wage growth, workforce changes etc) regarding calculating PBO will change

Not sure about that one. I don’t see how the freeze and the option for a DC plan would have any impact on assumptions like future wage growth, workforce, etc.
And the DB plan related debt only accounts for plan benefits that have already been earned i.e. for years that employees have already worked there. So you don’t assume that they will earn further pension benefits for the work they will do in the future. If you freeze DB plan, whether offering something else instead (DC) or not (if the contract with your employees allows you to merely stop), at time 0 it shouldn’t change the amount of debt you computed so far. The computation takes into account the probability that they stay with the company, and that their wage increases, but these assumptions should also remain unchanged if you suddenly apply the policy described in the practice problem. What do you think?
I may be forgetting something that could have an impact though. I don’t remember perfectly level ii.

 

[cpk123]

All new employees move to DC plan and choose whatever aggressive assets they want. This has no impact to the DB Plan sponsor - since that risk of the investment is borne by the employees themselves.
DB Plan has been frozen - so the liabilities are known in amount, and assuming the plan assets are in place to defease those liabilities - over time the risk for the plan sponsor decreases as the plan liabilities are going to decrease - and the funded status would increase.

 

[myriam2222]

cpk123 wrote:
DB Plan has been frozen - so the liabilities are known in amount, and assuming the plan assets are in place to defease those liabilities - over time the risk for the plan sponsor decreases as the plan liabilities are going to decrease - and the funded status would increase.

Agree with you except two things:
“the liabilities are known in amount”: I don’t think so. They remain future liabilities that will depend on the wages of these people when they retire, their retirement age, their lifetime, and so on. So these remain projections. You can’t be sure.
“the funded status would increase”: not sure about that. I think not necessarily. You are using your assets to pay your liabilities. So it depends much on how each varies over time (depending on the return on your assets, contributions to the plan, and evolution on your liabilities from changes in wages, retirement age, etc.)

 

[cpk123]

myriam2222 wrote:
Agree with you except two things:
“the liabilities are known in amount”: I don’t think so. They remain future liabilities that will depend on the wages of these people when they retire, their retirement age, their lifetime, and so on. So these remain projections. You can’t be sure.

more than in the case that all employees are getting wage increases and everything else. The employees would be told that your pension benefits would be based on your salary as of date X. Not on the wage at retirement. No increases there after. The other factors - retirement age, lifetime etc. are actuarial assumptions anyway. So there is far more “confidence” in the amount of the liability - when compared to the situation when the employees’ wages increase.

myriam2222 wrote:
“the funded status would increase”: not sure about that. I think not necessarily. You are using your assets to pay your liabilities. So it depends much on how each varies over time (depending on the return on your assets, contributions to the plan, and evolution on your liabilities from changes in wages, retirement age, etc.)

these again are actuarial computations. If you are using the assets to defease your liabilities, and your liabilities are more certain (as I have stated above - because wages as of a particular date are used) and if your assets are doing what they are supposed to do - then your funded status should be progressively increasing.