can someone help me understand why B is correct? It seems to me if the Liability discount rate is 5% and liquidity needs are 1% - wouldn’t the return objective be at least 1.05 x 1.01- 1 = 6.05% in order to maintain the surplus?
Thanks!
EXHIBIT 1
SELECTED PENSION PLAN INFORMATION FOR CGI PRODUCTS
Funded status, excess or (deficit) $25 million Liability discount rate 5.00% Annual liquidity need as percentage of plan assets 1.00%
Zola asks Zubov, “Based on the information provided, could you give us some preliminary guidance on an appropriate return objective?” Zubov responds, “In this instance, a return objective of up to 100 bps higher than the liability discount rate would be appropriate. This return objective could potentially minimize future pension contributions and maintain or increase future pension income.”
Q. Is Zubov’s response to Zola regarding the return objective most likely correct?
No, he is incorrect with regard to future pension contributions.
Yes.
No, he is incorrect with regard to future pension income.
Thanks for the reply. However, the text states “up to 100bps” which could also just mean a few bps or none.
Even if we see return of 100bps over the liability discount rate, why would future pension income potentially increase (I’d understand if it were to be maintained).
THe discount rate is the minimum return to match the liabilities. IT says to add 100bps which is 1% on top of the minimum, which would help lower future contributions because you’re going beyond the minimal requirements to maintain funding status. When you go above, you start getting surplus.
required return = 5+ 1 = 6%.
Annual liquidity has nothing to do with required returns. All it means is that you have to set aside some cash equivalents in your asset allocation.