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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 earn less than assumed?

The plan sponsor bears the investment risk in a defined benefit plan. Benefits are promised by formula, so if assets earn less than assumed, the sponsor must contribute extra to cover the shortfall. In a defined contribution plan the employee bears this risk.

  1. AThe plan sponsor, because it must make up shortfalls needed to pay the promised benefitsCorrect
  2. BThe retiring employees, because their benefits fall automatically with asset returns
  3. CThe plan trustee, who personally guarantees the benefit payments
  4. DThe employees and sponsor share the risk equally under all DB plans

Explanation

In a DB plan the benefit formula is fixed, usually by salary and years of service. If assets underperform, the sponsor must contribute more to cover the promised benefits. Employees bear the investment risk in a defined contribution plan, not a DB plan.

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