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

A sponsor with a large underfunded DB plan is concerned about the interaction between the plan and its own credit standing. Which statement best describes the sponsor risk faced by plan members?

Sponsor risk is greatest when the sponsor is financially weak and the plan is underfunded. Members depend on the sponsor to cover any shortfall, so if it cannot, benefits may be at risk. Holding equities does not remove this risk and defined contribution members do not rely on a sponsor promise.

  1. ARisk is highest when the sponsor is weak and the plan is underfunded, because the sponsor may be unable to make up the shortfallCorrect
  2. BSponsor risk is eliminated once the plan holds equities, since they have high expected returns
  3. CSponsor risk affects only defined contribution members
  4. DSponsor risk rises when the plan is overfunded, since surplus can be withdrawn only by members

Explanation

Members of a DB plan rely on the sponsor to fund any deficit, so a weak sponsor combined with an underfunded plan creates the greatest risk of unpaid benefits. Equity holdings add risk rather than remove it, and DC members bear investment risk directly instead of relying on a sponsor promise.

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