liability relative portfolio of a defined benefit plan

dear all

I worked on the Q bank questions and came across question 465322 which reads :

which of the following pension plan segment obligations would not be hedged by the liability relative portfolio? The segment exposure not hedged is that from :

a) future participants

b) future wage growth

c) inactive participants.

the correct answer is indicated as being A.

the explanation states as follows: the payments to inactive participants and the accruals to active participants for past service constitute accrued benefits will be hedged with nominal bonds if they are not indexed to inflation. a pension’s future obligations are those arising due to wages to be earned in the future, future service rendered and future plan participants. the first component is typically hedged with equities, nominal and real bonds . the latter two components are uncertain and not easily modeled or funded,

I’m confused…

when they state “liability relative portfolio” do they mean “asset - liability portfolio” or liability mimicking portfolio? The reason I’m asking is because I thought that asset-liability portfolio approach just looked at choosing the most efficient portfolio out of many without regards to liability to be covered.

The question is specifically talking about using the ALM framework to hedge risk in the portfolio - whether the actual strategy be cash flow matching, immunization ,etc.

That is not the point of the question though. You can only use the ALM framework when you are able to reasonably forecast the liabilities in the portfolio - otherwise how do you know what to hedge and what products to use? There is no possible/reasonable way to ever project future benefits for future participants that may/may not partake in the DB plan. Make sense?

yes, thanks so much bfry!!

you really seem on top of things - i need every day in the calendar to move forward!!