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

A pension plan sponsor holds a group of retirees and discovers that actual longevity is improving faster than the mortality table used to value its defined benefit liabilities. What is the most direct consequence?

Liabilities are understated. If retirees live longer than the mortality table assumes, pension benefits are paid for more years, raising the present value of obligations. This is longevity risk, and it creates a funding shortfall unless the sponsor adjusts contributions or assets.

  1. ALiabilities are understated, since benefits will be paid for longer than assumedCorrect
  2. BLiabilities are overstated, since retirees will die sooner than assumed
  3. CLiabilities are unaffected because benefits are fixed in amount
  4. DAsset returns rise because retirees reduce withdrawals

Explanation

Longer lives mean annuity-type benefits are paid for more years, increasing the present value of obligations relative to the table. The plan faces longevity risk, and the funding shortfall widens unless contributions or assets are adjusted.

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