When the plan is fully funded, I understand that the required return = the rate used to discount PBO + inflation. When plan is underfunded, is it still true? What about if it’s over-funded? Thanks.
my understanding is that you use the discount pbo rate as a starting point. if the plan is underfunding you increase the rate and if it is overfunded you decrease the rate?
it also depends on the financial condition of the parent - i don’t know about increasing the return requirement when the parent won’t be able to contribute and there is a shortfall. think about GM - they are running deficits and their pension is underfunded. if the pension takes on more risk, there is no way the parent can make up the shortfall and the beneficaries lose.
Exactly cpierce…If they are currently underfunded, they will have below average ability to take risk. You definitely wouldn’t increase your return requirements and start investing in equity, PE, etc…
willispierre Wrote: ------------------------------------------------------- > Exactly cpierce…If they are currently > underfunded, they will have below average ability > to take risk. You definitely wouldn’t increase > your return requirements and start investing in > equity, PE, etc… The CFAI text said something to the effect of: When underfunded - “They will need to supress their willingess to seek higher returns because they cannot accomodate extra risk” not a direct quote… but that was the jist
yeah thats a no no. you don’t want to try and improve funded status by chasing return.
In the real world, the more risk an underfunded plan would take, the higher the probability that the parent company would NOT have to fund it further because they’ll just pass the pension to the US taxpayer…err… PBCG.
When it is underfunded, sponsor ability to take risk fall, you definitely cannot increase your required return. You should increase your contribution in this case.
Then for an underfunded pension plan, how do you formulate the return requirement (for the sake of the exam), holding everything constant?
use the discount rate used to calculate the PV of liabilities.
Do we need to add the inflation rate to the discount rate for pension funds?
Can somebody answer Vegas’ question please?
Depends on workforce characteristics If the liab (benefit payment) is fixed, 100% inactive participants (retirees/ deferred) => no need to pay for inflation If the liab is vary with inflation, composed of active participants with future wage growth => need inflation risk premium