DB req rate of return

CFA Level III
#1

Is the req rate of return always the discount rate ?

When do we include inflation in the calculation and when not to include it?

#2

depends if payments indexed or not to inflation

#3

if payments are indexed then it should be included

if they are not indexed, then we should add it?

can anyone confirm plz?

thanks

#4

I havent seen anywhere including inflation for the defined benefit return… its always the discount rate of liab

#5

What i know is that if the plan is indexed to inflation, inflation is already included but if the plan is not indexed, do we include it or not?

#6

always discount rate unless the plan is underfunded and their goal is to bring it back to funded status.

In that case, its discount rate + return required to make up for the shortfall.

I think the actuarial discount rate would have inflation already built into it.

#7

Inflation is already included in DB plan discout rate. No matter whether salaries are indexed or not because those concern past salaries. Inflation is a component of future benefits so company need to take it into account because discount rate discounts future stream of liabilities.

#8

amazing thanks!

#9

If the plan is underfunded, shouldn’t they submit cash payment to bring it back to funded status.

I believe if their intention is to decrease future contributions or grow the surplus (taking into consideration they are doing well), they would set required return higher than discount rate… am i right?

#10

Kato is correct, in one of the schweser practice exams, it mentioned discount rate already factors inflation

#11

If they specify a desire not to use future contributions and have the plan back to funded status within x amount of years then they would need a higher rate of return. Check out Schweser exam #1 vol1 Q4…

yeah you are right they could do that.

#12

in 1 of the am sessions, they mention that it is the discount rate “since they are indexed to inflation”. That’s why i got puzzled and had to ask what would happen if they are not indexed to inflation.

#13

One should not tacke negative surplus by taking higher risk. This is done by sponsor contributions.

If, however, plan has positive surplus, it may have a goal to grow it and increase return objective (not requirement) eg 100bp above discout rate.

#14

they may have required rate, lets say 5 and objective 200bp above required. you do not add inflation to required rate.

#15

exactly, that’s my point. if the plan is underfunded, a contribution should be in place to bring it back and this shouldn’t be done by aiming for higher req rate because it would increase overall risk thus putting the plan at even more risk. However if there’s a surplus and there’s no need for future contributions anymore = > set req rate > disc rate

#16

guys this topic is worrying me a bit, schweezer book 1 exam 1 Q4 has an underfunded plan, required return is higher than the discount rate in order to bring it back to fully funded.

until now I thought req return was discount rate for any plan. plz help

#17

That’s level 3 Schweser for you. Pretty sure required return is just the discount rate (plus cost of management fees charged to earn return). Above that would be a desired return (would think that would be acceptable only if overwhelming amount of factors beside funded status indicate higher ability of the plan)