Insurance and Pension Fund Operations Chapter 25 contd.. Insurance and Pension Fund Operations Financial Markets and Institutions, 7e, Jeff Madura Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved.

Measures of Defined Benefit Pension liabilities Projected Benefit obligations Accumulated benefit obligations Vested benefit obligations

Measures of Defined Benefit Pension liabilities Projected Benefit obligations It is the actuarial present value of all future pension benefits earned to date, based on expected future salary increases. Accumulated benefit Obligations: It is the actuarial present value of all future pension benefits earned to date, based on current salary level, ignoring future salary increases.

Vested Benefit Obligations It is the amount of accumulated benefits obligations that is not contingent on future services. It requires employees to work for specified number of years and then he will be entitled to future benefits.

Current Service Cost It is the present value of benefits earned by employees during current period. For PBO, service cost includes an estimate of future salary increases. Interest Cost: It is the increase in obligation due to passage of time. Interest cost = Discount x Pension Rate obligation at Beg. Of period

Past Service costs: These are benefits awarded to employees when a plan is initiated or amended. Changes in Actuarial Assumptions: Gains or losses that result from changes in variables such as mortality, employee turnover, retirement age and discount rate.

Benefits Paid: benefits paid reduces the obligation to employees. Obligations at beg. Of period + Current service cost +Interest costs +Past service cost +/- Actuarial gains(losses) - Benefits paid

Calculation of PBO You are hired on Jan 1, 2008, as the employee of Transfer Trucking Inc and are eligible to participate in defined benefit plan. You are promised an annual payment of 2% of your final salary for each year of service. Pension benefit will be paid at the end of each year, beginning one year after retirement. Current Annual salary is $50,000.

PBO at the end of First year Discount rate is 8%. Salary will increase by 4% every year. You will work for 25 years. You are expected to live for 15 years after retirement. Remember that you will receive 24 salary increments.

PBO calculation at the end of first year (2008) Years of service Projected salary Years in retirement Benefit payment PV(end of year) 2008 1 $50,000 PBO= $3,460 2009 2 $52,000 2032 25 $128,165 $21,940 2033 $2,563 2034 2047 15

Calculations for 2008 Salary at retirement = FV of 50,000 @4% annual increase for 24 years = $128,165 Retirement Pension = (Final salary x 2% x payment per year 1 year) = $2563 PV of pension pmts = PV of 15 pmt @8% at retirement(2032) = $21,940

Calculations for 2008 PBO at the end of 2008 = (PV of $21,940 @ 8% for 24 years) = $3,460

PBO calculation at the end of year 2009 Years of service Projected salary Years in retirement Benefit payment PV(end of year) 2008 1 $50,000 PBO= $7,473 2009 2 $52,000 2032 25 $128,165 $43,881 2033 $5,126 2034 2047 15

2009 PBO calculation 2008 PBO = $3,460 + Current service cost =3,736.8( PV of 15 pmts of $2,563 starting in 23 years) +Interest cost = $276.80 ($3460 x 8%) 2009 PBO = $7, 473

PLAN ASSETS Plan assets consists of a portfolio of investments managed to generate the income and principal growth necessary to pay the pension benefits as they come due. Plan assets are increased by actual return on assets and by employer contributions. They decrease by benefits paid to beneficiaries.

PLAN ASSETS Fair value of plan assets at beg. of period + Actual return on assets +Employer contributions - Benefits paid Fair value of plan assets at end of period

FUNDED STATUS Funded status = plan assets - PBO