If they give the discount rate of 6% for their liabilites and the CFO wants a return obejctive of 7.5%. Is the return required the plan the rate they want or is it the DR. I think it is the DR if they are underfunded but if overfunded they can have a higher desired return??? This is the APEX case in Reading 15.
Don’t you have to take into consideration the funding surplus/shortfall? I dont have the reading infront of me, but If I recall correctly, if the discount is 6, and there is a shortfall, you would require (lets say 7.5)?
I might be going off topic, but that’s the first thing that came to mind… shortfall/suplus.
I’m pretty fried. After re-reading your question, I think my answer above was your answer as well… Given the DB is underfunded, I believe the 7.5 would be considered required.
Should be other way around Matori.
If it’s underfunded, risk tolerance decreased and should aim for 6% however if it is overfunded/surplus, it should go for higher return.
Can someone please confirm…
I am recalling from memory, so don’t quote me.
But if you are aiming for 6%, you will alway’s be underfunded? How sustainable is that?
I see the contrary with the risk tolerance, or ability to take on risk.
The discount rate is the minimum requirement for pension plan. By merely meeting the discount rate you are ensuring the funded status does not worsen. But this does not take into other factors that will increase your liabilities (PBO) such as adjusting for inflation, accrual of additional benefits for active lives. Thus you will need additional return on top of the minimum requirement of meeting the discount rate.
Thus 7.5% would be the return objective. Unless otherwise stated or presented with other infomation, using the discount rate is fine.
Easy there. Underfunding can be taken care of using contributions from the company. It doesn’t have to be made up by portfolio returns. Required return is the actuarial requirement of 6% (if that’s what it says in the Q.)
The RR is always the actuarial accrual rate – the rate at which liabilities are discounted. It’s never the RO. The underfunding can be satisfied with additional contributions.
but if the plan is overfunded then they can use the higher rate for a return right? i don’t have the book with me today but think they showed the 7.5% as the rate of return.
Guys - it’s bad business to try to catch up on underfunding by taking on higher risk. Shortfalls are to be met by additional contributions, not by putting an already underfunded plan into a higher risk position.
I would say if it’s mentionned in the case that there is a higher return objective, you can state it as a “desired” return objective, but the “required” return objective is the actuarial rate. I think that would cover the bases.
That is my interpretation and to me that sounds like something CFAI would like to hear. Anybody agree?
If the CFO states a RETURN OBJECTIVE of 7.5%, then that should be the RETURN OBJECTIVE for the IPS. T
This might be what everyone has already said… my brain is fried, too.
i agree - must be met by additional contributions not additional risk, if the plan is underfunded. if overfunded, i would state the required return is 6% and desired is 7.5%