Part E- In the q I could not find anything regarding lump sum payment- and why the longitivity risk increases in DC plan?
I read the answer- does not make any sense.
Longevity risk increases because Mattison is no longer guaranteed pension payments through retirement, and now he owns the risk of his portfolio not covering his needs through retirment.
Think about it - would you rather have $100k guaranteed until you die or take a lump sum and put it in the market and hope that it provides enough liquidity until you die. By not having the certainty your longevity risk increases (ie. larger chance he will outlive his assets).
Just above the question it had extra information. An excerpt:
”The employer offers to fund the DC plan with an amount equal to the employee’s accumulated pension benefits, plus 10% of the value of that funding as a bonus for converting. “
The assumption is the DB would set you up with annual payments from retirement until death. Taken from the CFAI 2017 level 2 FRA book:
”For example, a DB pension plan may provide for the retiree to be paid, annually until death, an amount equal to…”
With the above in mind, giving up guaranteed annual payments (risk on the firm to provide) for an unknown lump sum at retirement increases longevity risk, as your pension pot is exposed to market risk, and can go up or down in value (risk now with the client).
Thanks guys that helps.