Could someone clarify why frozen fund would not need equities anymore? I thought equities investment is to catch up with future real wage growth for active employees. Is active employee meaning a new participants? For existing active employee, equities investment would not be required? Many thanks!
Because the objective of the DB Plan is to fully fund all existing liabilities. Since the plan is not subject to future wage growth (i.e., it’s closed to new participants) and is not inflation adjusted (TIPS won’t be necessary), the plan can meet its outstanding liabilities solely through nominal bonds.
I don’t think that:
“plan is not subject to future wage growth = it’s closed to new participants”
Plan can be closed to new partipicants, but existing ones can still have their wages raised, so equity component may be needed.
In my opinion, if plan is frozen there will be no more growth of liabilities, either through wage growth or through new participlants, thus equity is not necessary. However, if frozen/closed plans’ payments would be adjusted for infaltion component, then real rate bonds would be appropriate.
Frozen = no future benefits = > no future wage inflation or real wage growth … Thus whats left is accrued benefits. So it depends if ur plan is indexed to inflation or not, but if its not then nominal would be the best choice if retirees are not indexed however accrued are indexed, then combination of both would be good; if both are indexed then id go for real rate bonds.
Ok, got it Bilal. So, how about closed? What’s the difference?
Closed to new entrants basically means that the plan might be underfunded, at a loss, no growth potential = no equity but wages might still increase in case of future wage inflation.
Ok let me clarify:
FROZEN PLAN - no more new participants. only accrued benefits, either to reitrees or deferrds, payments will grow only by inflation if indexed, if not than payments are constant; either real or nominal rates appropriate, no equities
CLOSED PLAN - no more new participants, but exisitng ones can have their wages raised only due to inflation, not by salary increases; again nominal and real rate bonds appropriate, no equities
Is this right guys? Anything to add/correct?
I have to agree to whats stated above.
Guys, I would consult this with Magician. This are easy points. What you wrote seems logical, but just to be certain. I was convinced that for closed plan, there is possibility for salary increases, but only for active employees who participated before the plan was closed. Hence, there would be still a marginal need for equities. What you wrote seems more reasonable though.
I was convinced that for closed plan, there is possibility for salary increases, but only for active employees who participated before the plan was closed < - - through wage inflation yes but not through real wage growth because for a plan to be closed then it should be facing difficulties. So no equities but real bonds would be used if the plan was index to inflation. But for frozen = no real wage growth and no wage inflation growth, only accrued / inactive …
A closed plan can still have an equity component I thought. The wage growth isn’t completely due to inflation is it?
if the plan is closed but there is possible wage growth, you must have real bonds or equities regardless of whether benefits are indexed to inflation because those are the only two ways to mimick the growth due to inflation
Ok, sounds reasonable. Hope this come up on the exam. Many candidates have problem with this issue. These seems to be easy points, if you undertand it though. Thanks
It depends on the case. if the plan is closed and still experiencing profitability and no shortfall then yes it can still experience real wage g
What does profitability have to do with wage growth for the employees? They still can get raises within a company that doesn’t have a fully funded pension or isn’t profitable at the moment
I think that wage growth will be included in closed plans. The plan is specified when the employee is hired, it is part of the benfit package and is spelled out in terms of åccrual, benefits, payments. If that plan closes during that employees career at the company, they cant go back and readjust the initial terms in the original benefits package, at least not easily. If they could, wouldnt thousands of companies just tell their workers to get f’ed and up their profitability and loẅer their future liability? It isnt a far stretch from what CEOs have done to make a buck.
If the company is doing good, profitable, no losses, no shortfalls in funding the pension plan, real wage can be a factor even if its closed to new participants.
If the company is not going well, incurring losses, PA < PL, underfunded, real wage will not be included as part of mimicing their liability, they will invest mostly in nominal bonds (and real rate bonds in case they are indexed to inflation).
Logic would say that if plan is frozen then no new participants and no any increaes in salaries. Payments only to retirees and deferrds and active for past serivice (nominal+real rate bonds). If plan is **closed (**closed like the door ie. closed to new participatns), those who are already in can have salary increaes. So payments will go to retirees and deferrds for past service and to active for past and future service. (equities, nominal+real bonds).
Definitely someone who knows it for sure would be of help here…
Kobi, I think you nailed it . Checke AM 2013 q3. They are buying equities for closed plan, because of salary increases of active employees who participated in the plan before it was closed. I agree that we should consult it though.
In all the cases in past AM, they link real wage growth to productivity and profitability of the firm.
From 2012 AM “Future real wage growth is correlated with the return on domestic equity securities through the relationship between productivity growth and stock market returns.” If the plan is closed they can have real wage growth but depends on how the company is doing. That’s how i see it. Can cpk or magician share their input on this one please?