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3_pension_obligation

# 3_pension_obligation - Determining pension obligations...

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Determining pension obligations under different assumptions. (Cfr p.166ff) Data 1. John Smith joined the pension plan exactly five years ago on January 01, 2001. He is due to retire on December 31, 2025, and is expected to live for ten years after retirement. 2. His current compensation is \$10,000 per annum. Actuarial estimates indicate that compensation is expected to increase by 4% per annum over the next twenty years. 3. The pension plan specifies the following formula for determining the employees’ pension benefits: “ The annual pension is equal to one week compensation at the time of retirement multiply by the number of years worked under the plan”. Employees vest four years after joining the plan. 4. At December 31, 2005, the fair value of assets in the pension fund is \$2,000. In 2006, the employer contributes \$200 to the pension fund. 5. Return on pension assets is 22% in 2006. The long-term return is expected to be 10% per annum. 6. The discount rate is 7% per annum. Computation 2005 Formula (5 years) 2006 Formula (6 years) 4% Assumption 5% change Actual Projected Projected Actuarial Plan (1.5 week compensation) Dec. 31, 2025 Salary per year \$10,000 21,911 () 21,911 26,533 () 26,533 Pension per year 962) 2,107 () 2,528 () 3,061 () 4,592 () PV of pension 6,753 () 14,798 () 17,757 () 21,503 () 32,254 () Dec. 31, 2005 PV of pension 1,745 () 3,824 () Dec 31, 2006 PV of pension 4,091 () 4,910 () 5,946 () 8,919 () ABO PBO \$4,091 - \$3,824 = \$267, i.e., interest cost \$4,910 - \$3,894 = \$819 i.e., service cost \$5,946 - \$4,910 = \$1,036, i.e., actuarial gain or loss \$8,919 - \$5,946 = \$2,973, i.e., Prior service cost 819 267 1,036 2,973

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Definitions ABO ABO is the actuarial present value of the future pension benefits payable to employees at retirement based on their current compensation and service to date. PBO PBO Is the actuarial estimate of future pension benefits payable to employees on retirement based on expected future compensation and service to date. PA The company has the option to fund the plan exactly (by providing assets to the plan trustee that equal the pension liability) or it can overfund or underfund the plan Fund status: =Δ (PA, PBO) < d underfunde PBO PA overfunded PBO PA If With PA = Value of the plan assets. Example: If on Dec. 31,2005, the value of the plan assets is \$2,000, the plan is underfunded by \$1,824 ( \$3,824 - \$2,000). The funded status of the plan reflects its NET ECONOMIC POSITION defined as the PBO – PA. Actuarial return on plan assets It is the pension plan’s earnings. It consists of investment income— capital appreciation and dividend and interest received, less management fees, +/- realized and unrealized appreciation/ depreciation of other plan assets. It usually reduces pension costs (unless the return is negative, in which case it increases pension costs). In our example, return on plan assets in 2006 is \$440 (22% of \$2,000).
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3_pension_obligation - Determining pension obligations...

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