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Discount rate effect on Pension fund and insurance company assets/liabilities

Hi all,

I’m confused about the discount rate effect on the assets and liabilities of pension fund, insurance company and endowment fund.

From the CFA official practice qns answers -

- A fall in discount rate increases the PV of pension benefit obligations but not the MV of assets.

- If interest rates rise, the MV of portfolio assets will decline for insurance companies.

Could someone explain the discount rate relationships for pension fund, insurance company and endowment funds?

Thank you.

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The discount rate for the liabilities in a pension plan is an assumed rate, not necessarily tied to market rates.

Simplify the complicated side; don't complify the simplicated side.

Financial Exam Help 123: The place to get help for the CFA® exams
http://financialexamhelp123.com/

Thanks S2000magician.

But what i meant was why does a change in discount rate affect the asset value of insurance company and not the asset value of a pension fund?

charlesyy wrote:

Thanks S2000magician.

But what i meant was why does a change in discount rate affect the asset value of insurance company and not the asset value of a pension fund?

Your quote said “interest rates rise, the MV of portfolio assets will decline for insurance companies.”

The key word is interest rates, not discount rate.

An insurance company has a general account that is invested in bonds/bils/etc. Interest rate changes will obviously impact the asset of the general account and likewise it will impact pension assets too.

charlesyy wrote:
Thanks S2000magician.

But what i meant was why does a change in discount rate affect the asset value of insurance company and not the asset value of a pension fund?

The discount rate doesn’t affect the asset value of an insurance company because there is no discount rate for an insurance company.  The discount rate is an artifact of a defined benefit pension plan.

Market rates affect the value of an insurance company’s assets, and they also affect the value of a defined benefit pension plan’s assets (as well as the assets of a bank, a life insurance company, a foundation, an endowment, an individual, and so on).  But market rates aren’t the discount rate that you’re trying to analyze here.

Simplify the complicated side; don't complify the simplicated side.

Financial Exam Help 123: The place to get help for the CFA® exams
http://financialexamhelp123.com/

Mark it.

The discount rate is specific to ALM and more specific to pensions, as its the Rate that discounts the liabilities to the present value or PBO (Projected benefit obligation).  If a pension is fully funded, the discount rate is the required rate of return, where the PBO = Market Value of Assets.  A reason why many pensions are in trouble, too high a discount rate (rate of return), the lower the liability, but if you fall short, unfunded status grows wider, requiring contributions. A discount rate is the number that brings a FV to a PV, that’s it.  For life insurance it get messy with different types of policies, mortality tables, etc.  not really testable in my opinion. Life insurance, will, I believe focus on estate planing, wealth transfer, human capital protection.   Discount rates don’t really apply to foundations as they manage in an asset only (AO) framework.