I want to confirm the effects of an increase in discount rate, because while I was aware of the first two below I only just came across info that the third one occurs as well. If discount rate increases: 1) Service Cost decreases 2) Interest Cost decreases 3) Actuarial gain (which is a negative amount so decreases PBO as well)
actuarial gain= (actual ROA - expected ROA) Whereas the discount rate will not have any effect on gain/loss, PBO will either go up/down (add losses, deduct gains)
no idea what you just said
Discount rate has no effect on Actuarial gain/loss on a diff note: PBO includes actuarial G/L — Actuarial gains will reduce PBO Actuarial losses will increase PBO
right thats what i thought too. then i came across schweser exam 2PM, question 93, which says that an increase in discount rate causes an actuarial gain.
An actuarial gain/loss can arise from changes in the discount rate assumptions used. PBO will decrease if your discount rate increases and vice versa. Under GAAP you have to amortize the actuarial deferred gain/loss. There are 3 inputs that can cause an actuarial gain/loss: Changes to discount rate Rate of compensation increase Actual vs. Expected return on assets
Increasing discount rate would lower service cost but increase interest cost. Overall, Pension Expense decreases unless it is a very old firm in which it is possible the increase in interest cost exceeds the decrease in service cost.
job: increase in discount rate decreases interest cost as well (only very rarely can it increase interest cost, if the firm’s pension plan is mature) chuck: you seem to be contradicting yourself. at 6:28 you said “Discount rate has no effect on Actuarial gain/loss” and at 7:05 you said “An actuarial gain/loss can arise from changes in the discount rate assumptions used.”
Chowder said that. I’m Chuck
hah sorry about that chuck, that may be a cue that its time to take a study break. in any case, i think youre right (chuck).
quick: explain why service cost decrease
If you think about it, you would not have the actuarial gain unless the discount rate change has a retrospective effect. Usual case will be that interest rate environment is changing externally, and based on that you would change it going forward (prospectively). So you would have the Interest cost impact and the service cost impact going forward, but no Actuarial gain. Actuarial gain/loss is more likely due to compensation rate changes - which can be retrospective, esp since union negotiations may cause that to happen.
PV(XXX)
- What was the most likely cause of the actuarial gain reported in the reconciliation of the projected benefit obligation for the year ended 2008? A. Incrase in the average life expectancy of the participating employees. B. Decrease in the expected rate of returrn. C. Increase in the discount rate. Your answer: C was correct! The assumed discount rate increased from 6.25% in 2007 to 6.75% in 2008 (Exhibit 5). There is an inverse relationship between the discount rate and the present value of a future sum. Thus, the increase in the discount rate resulted in an actuarial gain (lower PBO). An increase in life expectancy would result in an actuarial loss.
- What was the most likely cause of the actuarial gain reported in the reconciliation of the projected benefit obligation for the year ended 2008? A. Increase in the average life expectancy of the participating employees. B. Decrease in the expected rate of return. C. Increase in the discount rate. Your answer: C was correct! The assumed discount rate increased from 6.25% in 2007 to 6.75% in 2008 (Exhibit 5). There is an inverse relationship between the discount rate and the present value of a future sum. Thus, the increase in the discount rate resulted in an actuarial gain (lower PBO). An increase in life expectancy would result in an actuarial loss.