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

A DB plan has liabilities with a present value of USD 500 million. The liability discount rate falls sharply, while asset values are unchanged. Everything else being equal, what is the most likely effect on the plan?

The funded ratio falls. Pension liabilities are long-dated and discounted at a rate tied to high-quality bond yields, so a lower discount rate increases their present value. With assets unchanged, the deficit widens, which is why rate declines hurt underfunded plans.

  1. AThe funded ratio rises because lower rates reduce the present value of liabilities
  2. BThe funded ratio is unchanged because assets did not move
  3. CThe funded ratio falls because liabilities' present value increasesCorrect
  4. DThe sponsor's deficit disappears because future benefits are cut

Explanation

Pension liabilities are long-dated cash flows discounted at a rate linked to high-quality bond yields. A lower discount rate raises their present value. With assets unchanged, the funded ratio falls and any deficit widens.

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