How does pension plan funding status affect liquidity constraints?
underfunded status of pension plan needs more liquidity I think
I think the way to think about it is that a well funded pension should be thinking long term. Even if retirement plan participants is rather high, an overfunded status won’t place strains on the liquidity requirement. However, if plan is underfunded, it may not be generating enough excess return to cover the immediate liabilities. The assets that were once focused on long term returns, and diversification perhaps, and not necessarily centered on liquidity. Therefore, the problems that you are now facing force you to change your asset allocation to more liquid assets.
Underfunded status might require you to contribute in excess of planned contributions… = Higher Liquidity Needs
i think it depends. liquidity of DB = benefit payment - pension contributions if the underfunded DB plan has no retired lives, then, its liquidity needs are low, despite of its underfunded status. Did i miss anything?
VinceMTL Wrote: ------------------------------------------------------- > Underfunded status might require you to contribute > in excess of planned contributions… > = Higher Liquidity Needs you are thinking in terms of liquidity needs of the sponsor??
From the CFA 2020 Curriculum Book 6 Reading 33:
“DB plan funded status–If the plan is well funded, the plan sponsor may reduce contributions, generating a need to hold higher balances of liquid assets to pay benefits.”
This is how I think of it, happy to hear if someone has a better way though.
I have needs. My first priority in my life is to get food and shelter. Once that is done, I can then focus on my love-life needs. My love-life needs are higher when I’m full of food than when I’m starving. When I’m starving, I’m not looking for a hot date. Pensions work the same.
Pensions have needs. The first priority being able to get my Pension Assets = PBO. Once they’ve done that, they’ll be able to focus on their next set of needs, which is liquidity to eventually payout to beneficiaries. Likewise, when Pension Assets < PBO, they’re less concerned about liquidity as they are about increasing contributions or increasing returns (or mix of both I suppose).
Pensions are like you and I. They’re needy and they have different hierarchy of needs like we do. A pension’s funded status and its relationship to liquidity needs, is similar to you going on Tinder after you’re filled up on Taco Bell.
When PA < PBO, liquidity needs is even higher as they need more contribution from the sponsor. And that’s assuming the asset returns won’t make up for the deficit anytime soon.
But LOL, your description sounds like a romance novel. But whatever makes it easier for you to relate/remember. 
Well that would be in direct contradiction to the CFA content though.
Liquidity needs are referring to the ability to pay out benefits from the plan, not the ability of the sponsor to make contributions to plan.
CFA content outlines the following:
-
If PA > PBO, then overfunded (surplus)
-
If overfunded, then lower employer contributions
-
If lower contributions, then higher liquidity needs
That being said, it can only be true that when we talk about liquidity needs, we’re talking about the plan’s need to pay out benefits, not the sponsor’s ability to make contributions.
Yes. The liquidity needs will be the pension benefits less the amount of liquid assets/cash the pension fund has and less net of the contribution from the sponsor.
If pension benefits = $1 million and pension fund cash = $200k, then there will be liquidity needs of $800k, which the pension fund will need to obtain either through:
- liquidating the pension assets, or
- getting contribution from sponsor.
Not referring to ability of sponsor to make contributions. More on the pension fund not having enough liquid assets/cash to meet payment of pension benefits.
With all due respect, this isn’t true.
Liquidity needs don’t change based on the value of the assets or the value of the liabilities.
Liquidity needs are determined by the amount of benefits that must be paid, and the operating expenses of the plan.
2 Likes