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FRM Part I · FRM Exam Part I · Insurance Companies and Pension Plans

A company with a large underfunded DB plan is assessed by a credit analyst. Which consideration best reflects sponsor risk arising from the plan?

An underfunded DB plan is a debt-like claim on the sponsor. Required contributions can drain cash flow and weaken credit quality, particularly when the sponsor is weak at the same time as the plan. Plan assets are held for beneficiaries and cannot be freely withdrawn.

  1. AThe deficit acts like debt-like claim on the sponsor, and required contributions can strain cash flow and credit qualityCorrect
  2. BThe deficit is irrelevant because plan assets are legally owned by the sponsor and can be withdrawn freely
  3. CThe deficit reduces the sponsor's risk because it lowers future benefit promises
  4. DThe deficit matters only for defined contribution plans

Explanation

An underfunded DB plan creates an obligation the sponsor must eventually fund, so it behaves like debt and can compete with creditors for cash. Plan assets are held separately for beneficiaries and cannot be freely withdrawn. DC plans carry no such deficit risk for the sponsor.

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