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

A corporation sponsors a defined benefit (DB) pension plan. Which statement best describes who bears the investment risk if plan assets underperform the assumed return?

The plan sponsor bears the investment risk in a defined benefit plan. Benefits are promised by formula, so if assets underperform, the sponsor must contribute more to close the funding gap. Members carry this risk only in defined contribution plans, where the outcome depends on account performance.

  1. AThe plan sponsor, because it must make up any funding shortfallCorrect
  2. BThe retired members, because their benefits are reduced automatically
  3. CThe active employees only, through lower future accruals
  4. DThe insurance regulator, through a guarantee of all benefits

Explanation

In a DB plan the benefit formula is fixed (for example based on salary and service), so the sponsor carries the investment and longevity risk and must fund shortfalls. In a defined contribution plan the members bear it. Benefits are not automatically cut for retirees, and a guarantee fund covers only limited cases.

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