Minimum return requirement

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Mohelamin

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The minimum return requirement for DBP is the discount rate or discount rate plus inflation rate?
 
I think their return objectives should be the discount rate adjusted for inflation, otherwise future benefit payments will be exposed to the loss of purchasing power.
 
^not all pension plans have an inflation adjustment in the benefits paid. Therefore, they wouldn’t really care if there was a loss of purchasing power or not.
I think the absolute minimum is the discount rate applied to the liabilities.
 
That is absolutely true. But, have you ever heard of the “minimum” return requirement? i believe it was in 2012 exam. They used only the discount rate for net present value. It is confusing for me, that is why iam asking.
 
It has been mentioned in one of 2012 exam the discount rate for NPV! And then they elaborated that the liabilities already includes the inflation. But, what if they did mot mention the discount rate for NPV? Should we also take only the discount rate. Am unsure!
 
^technically, a discount rate should already account for inflation. Think back to L2 corporate finance (try not to cringe reading that… i know i cringed typing it).
 
Even without inflation adjustment, they need to adjust for future wage increase (hedge this part) and there is also the wage inflation, which needs to be accounted for.
 
Well, i aim both approach are correct. It is confusing to large extend
 
The return requirement for a DB plan first depends on the funded status of the plan: is the plan fully funded, is there a shortfall or surplus? For a plan w/ a surplus or shortfall, the required return is NOT the discount rate. For a fully funded plan, the return requirement = the discount rate used to find the PV of the liabilities.
 
Hypothetically, if you do not have a plan surplus, and are exposed to macro swings with above average gearing and oscillating profitability, would your DB plan be less risk tolerant, even though you have a young workforce?
 
it depends on whether you are taking an asset only or liability relative investment approach. If asset only you adjust for inflation, if liability relative you don’t.
The liability stream is already adjusted for inflation by the actuaries when they determine the PBO. So if you take a liability driven approach, the minimum return requirement is the liability discount rate. No inflation adjustment.
 
From the CFAI’s 2012 exam, as mentioned above. Minimum return objective is the discount rate of the Plan’s liabilities.
“The company’s return objective is to earn a return that will, at a minimum, “defease” the Plan’s liability (keep the value of the fund’s assets equal to the present value of liabilities). Because the Plan is currently fully funded, the return objective is the discount rate used to calculate the present value of the Plan’s liabilities.”
 
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