CFAI Text V2 P.229 (R16) In the 2nd paragraph, there is a statement : Merton (2007) draws … He points out that “using the expected return of pension fund assets to discount the liabilities they are intended to fund systematically under-prices those liabilities, and contributed to the decline of defined-benefit pension plans.” I think here under-prices shall mean under-estimates. But what does it mean by “contributed to the decline of defined-benefit pension plans” ? Anyone can explain/clarify ?
I guess you are correct with under estimates interpretation. I understand decline of pension plans means decline in proportion of total assets managed by defined vs. managed by contribution pension plan which has gone down considerably during past decade or so.
Yeah, over the past couple of decades DB plans have really fallen off in popularity for obvious reasons. (Hard to manage, overly complex, risk falls on the companies, etc…) If I had to put money down I’d bet almost everyone here is in a DC plan at this point.
I understand that using the expected return of pension fund assets to discount the liabilities they are intended to fund systematically under-estimates those liabilities. Then, the decline of defined-benefit pension plans is due to the greater risk (than commonly estimated) to the sponsors of DB plans which casue them to change to DC plans ?
Right, b/c the sponsor can’t be certain of future cash commitment needed to fund the plan, per the ERISA rules. I think, in real life, most companies w/DB pensions use the Aa-rated LT borrowing rate to approximate their discount rate on the pension liability.
Thanks to all of you ! I know what is meant by “contributed to the decline of defined-benefit pension plans” now !
And knowing is half the battle…
Yes, knowing is half the battle.