I’ve seen some conflicting guideline answers for questions the impact of age of participants and the portion of retired lives on a plans risk tolerance.
On the one had, liquidity requirements are lower when a plan is young, but on the other the duration of the liability is much smaller and therefore less sensitive to changing rates.
Am I using faulty logic with the low duration, lower risk argurment?
Thanks,
AW
when you say plan is young - you mean that the age of the participants in the plan is young, right?
if that is the case - the duration of the liabilities in not small. the liabilities are going to become due much later on … when the young employees actually retire. Usually a low liquidity and a long duration go hand in hand.
remember the liability = pv (amount due when the employee retires years later) - and that amount is a % of final salary at the time of retirement.
Thanks for the reply. Right - low average and a high number of active lives will be a higher duration liability.
That means the plan is subject to more market risk right, will the below-average age, higher than average proportion of active lives plan have a lower risk tolerance then?
higher number of active lives means the liability is due after a much longer time. it means they have a longer time horizon, and a higher risk tolerance.
remember you pay them when they retire in DB plan, so the more time you have the more ability you have to take risk. Focus on duration, the longer the duration the more risk you can take till the moment they retire and your liabilities are due.
However, the more inactive participants you have, the less shortfall risk you have since they have lower noise and only risk you are bearing is them having longer longevity risk (living more than estimated). What contribute to lower shoftfall is: higher surplus with respect to plan assets, higher allocation to fixed income, higher ratio of inactive /active, and higher number of overall participants since your risk is spread more.
Thanks for the help