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IAI Actuarial Core Principles · Business Management · Issues and challenges in each main practice area

A large Indian manufacturer runs a defined benefit gratuity and pension scheme. Its finance director notes that falling long-term government bond yields have sharply increased the reported liability, while the scheme's equity-heavy assets have not moved. Which challenge does this primarily illustrate for the actuary advising the trustees?

The main challenge is interest rate risk caused by an asset-liability mismatch. Liabilities are discounted at bond-based rates, so falling yields raise their value, while equity-heavy assets do not rise correspondingly, which worsens the funding position. The other risks listed are unrelated to the yield movement described.

  1. ALongevity risk arising from improved mortality
  2. BInterest rate risk through a mismatch between assets and liabilitiesCorrect
  3. CExpense risk from higher administration costs
  4. DOption risk from members taking early retirement
  5. Currency risk on overseas investments

Explanation

Liabilities are discounted using bond-yield-linked rates, so lower yields raise their value. Equity assets do not move in the same way, so the funding position worsens. This is an asset-liability mismatch, i.e. interest rate risk, not longevity or expense risk.

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