Why would an increase in the discount rate increase the interest expense component of the pension expense?

CFA Level II
#1

FSA: Employee Compensation An increase in the discount rate will reduce the PV of the future pension benefits and hence decrease the current service cost. That being said, why would an increase in the discount rate INCREASE the interest expense component of the pension expense?

#2

Bcos Interest Expense = Beginning PBO * New Discount Rate

#3

b/c the company is paying interest on the value of the pension that is owed to the employees. The higher the interest rate, the higher the interest expense. Service cost decrease b/c you use the interest rate as a discounting rate to PV back the value. The higher the interest rate, the lower the Present Value of the monetary amount owed in the future today.

#4

Thanks for responding. You cleared it up for me.

#5

Are you sure about this ? I thought interest cost will also decrease with Increese in Disc rate for normal plans Unless you are talking abt a mature plan where the Interst cost will increase with a increase in dis rate Int Cost = PBO * Interest rate For mature plans , PBO doesnt drop by that much for increase in rate, so the multiplication by the higher Interest rate increases the int cost Pls confirm.Thanks

#6

I also think I read that the decrease in PBO outweighs the increasing interest cost so when you sum it up you also have decreasing interest cost. As ap1978 already mentioned for mature plans it is possible that the interest cost rises because the PBO doesn’t decrease so much.

#7

i agree with ap and higi…interest cost will decrease as discount increases as the discounted furture obligation would be a lower number…so u end up chargin interest on a lower base. however in case of mature plans, the effect of discount may not be as much and interest cost will still be high…