Answer-first summary for fast verification
Answer: Funding risk represents the true long-term risk to the plan sponsor.
B is correct. Funding risk of a defined benefit plan is the risk that the value of the pension plan assets will not be sufficient to meet the pension plan liabilities. If the plan has a deficit (that is, if the surplus turns negative), the plan sponsor (the manufacturing company) has to provide additional contributions to the fund. This additional contribution (the funding risk) is borne by the company's shareholders (and not by the employees). Thus, the funding risk represents a true long-term risk to the company (plan sponsor). The time horizon of payouts does not eliminate funding risk. In fact, it is the mismatch between assets and liabilities that creates funding risk. In a low interest rate environment, the value of assets (equities on the asset side) will rise; however, the value of liabilities is likely to increase more, thereby exacerbating funding risk. Immunizing the portfolio, essentially matching duration of assets and liabilities, will reduce funding risk.
Author: LeetQuiz Editorial Team
Ultimate access to all questions.
No comments yet.
The board of directors of a manufacturing firm is deeply concerned about the financial risks tied to the company's defined benefit plan for its pension fund. Considering the various aspects of funding risk associated with this plan, which of the following statements accurately describes the potential funding risk the pension fund might face?
A
Decreases in interest rates will reduce funding risk.
B
Funding risk represents the true long-term risk to the plan sponsor.
C
Funding risk is effectively transferred to the employees of the manufacturing company.
D
The longer the horizon for expected payouts, the lower the funding risk.