Pension plan: Reduce surplus risk rather than limit contribution risk


Just did an IFT AM exam from 2016 where it was stated that “management wants to reduce surplus risk rather than limit contribution risk”. Couldnt find another thread about this, which is why I created a new one.

  1. What is the difference between surplus risk and contribution risk?

  2. Which one is affected by immunization and how?

  3. If i were to select an allocation percentage between equity and bonds, how would these risks be affected? (e.g. high equity and low percentage to bonds)

Regards, Swe_viking

I would assuming surplus is is the risk of losing your surplus. If you have some money in the bank you want to keep it that way.

Contribution risk, in what context? It could mean risk of having to make more contributions or risk of not being able to make contribution.

I would think surplus risk.

Equities would have volatility that could cause you to lose your surplus. Bonds could too, but have lower volatility. Bonds would be subject to interest rate risk as well.

The question is about a defined benefit plan that is frozen. This plan currently have allocated most of their assets to high quality intermediate duration bonds and a lower proportion to global equities. The duration of the assets are lower than the liabilities, at least how i interpret it. The plan is over-funded.

We are asked basically to determine whether they should 1) Maintain asset allocation percentage but increase bond duration or 2) remain as is. The objective is to reduce surplus rather than limit contribution risk.

Surplus volatility is more important to the funded ratio than contribution volatility, by logic i think. You don’t want to be at risk of being underfunded but it’s not gonna hurt if the company contributes $100m 1 year and nothing the next, as long as the plan is still funded.