DB Plan Time Horizons

CFA Level III Portfolio Management
#1

Greetings and Salutations brethren. I’m going to preface this by saying I am on the 10th floor and very close to a window. Currently reviewing a Schweser mock and going over a question that I got wrong. Basically, you have a company who has a DB plan where the average age of workers is very high. The company however is a going concern. This is an AM question asking for the time horizon in the IPS and I answered “The time horizon is long term as the company is a going concern”. EHHHHHHHHHHH WRONG. I could have sworn I read this somewhere. So I looked into it.

2018 CFA Material -

The investment time horizon for a DB plan depends on the following factors:

  • whether the plan is a going concern or plan termination is expected; and
  • the age of the workforce and the proportion of active lives. When the workforce is young and active lives predominate, and when the DB plan is open to new entrants, the plan’s time horizon is longer.

The overall time horizon for many going-concern DB plans is long. However, the horizon can also be multistage: for the active-lives portion the time horizon is the average time to the normal retirement age, while for the retired-lives portion, it is a function of the average life expectancy of retired plan beneficiaries

Schweser Response: Time horizon is short given the older age of the workforce (57.5 years) and the low ratio of active to retired lives. Both indicate significant outflows from the portfolio.

Basically what I got out of this is… CFA Material stated that if the company is a going concern, both long-term or multi stage are acceptable. In this scenario, multistage may have been more acceptable as you can indicate that the first stage is shorter. At the end of the day, short term is the only answer I could see being wrong. Somebody please help as the window is quickly becoming the best option.

#2

Greetings and Salutations to you too brother.

Average age of the work force and the ratio of retired to active lives affect the time horizon. Additional details would depend on how long does the sponsor want to keep the plan active.

So in essence, A higher average age and a higher retired lives to active lives ratio would imply a shorter duration of plan liabilities( Because major outflows would be expected around that time) and in effect this would also reduce the time horizon.

I am sure others will be able to add more info on top of this.

Also, maybe don’t jump just yet.

#3

there’s that magic combination of both high average age and low active vs retired ratio.

low active vs retired means most of your workers are already retired (short 2nd stage) while existing active workers are of old age (short 1st stage), so short horizon should make sense unless the company decides to hire enormous amount of babies to push that average age down by a ton.

the problem is what defines a long or short horizon.

also, how’s the view?

#4

Appreciate your guys input. I do understand that the high average age and low active vs retired ratio do contribute to a decreased time horizon. I guess what I am confused about is why it is not multi-stage. Multi-stage and a short-term single-stage are significantly different, and from what I have seen, CFA is a stickler between the two. In my opinion, it should be multi stage, with a short time horizon for the active portion.

#5

A multistage time horizon is usually caused when there are significant changes in constraints or circumstances. In this case, payments to the retirees is a normal part of the plan’s functioning. Even though there are significant cash outlays, they are not a reason to cause another stage in the time horizon.