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

Which statement best describes who bears investment risk in a defined contribution (DC) pension plan compared with a defined benefit (DB) plan?

In a DC plan the employee bears investment risk because the final pension depends on contributions and market returns. In a DB plan the employer promises a formula-based benefit and must make up any funding shortfall, so the sponsor bears the investment risk.

  1. AThe employee bears investment risk in a DC plan, while the sponsor bears it in a DB planCorrect
  2. BThe sponsor bears investment risk in a DC plan, while the employee bears it in a DB plan
  3. CThe employee bears investment risk in both plan types
  4. DThe sponsor bears investment risk in both plan types

Explanation

In a DC plan the retirement income depends on contributions and investment returns, so the employee bears the investment risk. In a DB plan the sponsor promises a formula-based benefit and must fund any shortfall. The reverse option misassigns the risk.

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