Return requirement for DB plan

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johntavv

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This is 2012 past paper. Question asks to calculate the return requirement for the Defined benefit pension plan given:
- Discount rate applied to determine the PV of plan liabilities = 5%
- Expected average annual inflation rate = 1.25%
Can someone please explain further why we don’t include inflation in the return requirement?. E.g. why is return not (1.05)x(1.0125).
Answer says: the minimum return requirement for the Plan is 5% because this is the rate that is used to calculate the present value of liabilities. (Note that the expected future liabilities already incorporate expected inflation-related adjustments to benefits for Plan participants.
 
I guess because the inflation rate is already embedded in the 5% discount rate.
 
“Discount rate applied to determine the PV”
Why change it?
 
sharky7 wrote:
I guess because the inflation rate is already embedded in the 5% discount rate.
Click to expand...
But how do we know that inflation is already embedded in the 5% discount rate?
 
johntavv wrote:
sharky7 wrote:
I guess because the inflation rate is already embedded in the 5% discount rate.
Click to expand...
But how do we know that inflation is already embedded in the 5% discount rate?
Click to expand...
Read my post.
 
Quote:
” If pension assets equal the present value of pension liabilities and if the rate of return earned on the assets equals the discount rate used to calculate the present value of the liabilities, then pension assets should be exactly sufficient to pay for the liabilities as they mature. Therefore, for a fully funded pension plan, the portfolio manager should determine the return requirement beginning with the discount rate used to calculate the present value of plan liabilities.That discount rate may be a long-term government bond yield, for example.”
Click to expand...
 
MrSmart wrote:
johntavv wrote:
sharky7 wrote:
I guess because the inflation rate is already embedded in the 5% discount rate.
Click to expand...
But how do we know that inflation is already embedded in the 5% discount rate?
Click to expand...
Read my post.
Click to expand...
Good…good…let the hate flow through you.
#DarthVadar
 
Can someone please explain further why inflation is already embedded in the 5% discount rate used to calculate plan liabilities?
 
That’s how actuaries calculate the discount rate.
#trustme
 
johntavv wrote:
Can someone please explain further why inflation is already embedded in the 5% discount rate used to calculate plan liabilities?
Click to expand...
Because it is a nominal discount rate.
 
Because it’s said 5% includes the inflation,
that’s not systematically the case though.
 
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