Discount rate effect on Pension fund and insurance company assets/liabilities

CFA Level III Portfolio Management
#1

Hi all,

I’m confused about the discount rate effect on the assets and liabilities of pension fund, insurance company and endowment fund.

From the CFA official practice qns answers -

  • A fall in discount rate increases the PV of pension benefit obligations but not the MV of assets.

  • If interest rates rise, the MV of portfolio assets will decline for insurance companies.

Could someone explain the discount rate relationships for pension fund, insurance company and endowment funds?

Thank you.

#2

The discount rate for the liabilities in a pension plan is an assumed rate, not necessarily tied to market rates.

#3

Thanks S2000magician.

But what i meant was why does a change in discount rate affect the asset value of insurance company and not the asset value of a pension fund?

#4

Your quote said “interest rates rise, the MV of portfolio assets will decline for insurance companies.”

The key word is interest rates, not discount rate.

An insurance company has a general account that is invested in bonds/bils/etc. Interest rate changes will obviously impact the asset of the general account and likewise it will impact pension assets too.

#5

The discount rate doesn’t affect the asset value of an insurance company because there is no discount rate for an insurance company. The discount rate is an artifact of a defined benefit pension plan.

Market rates affect the value of an insurance company’s assets, and they also affect the value of a defined benefit pension plan’s assets (as well as the assets of a bank, a life insurance company, a foundation, an endowment, an individual, and so on). But market rates aren’t the discount rate that you’re trying to analyze here.

#6

Mark it.

#7

The discount rate is specific to ALM and more specific to pensions, as its the Rate that discounts the liabilities to the present value or PBO (Projected benefit obligation). If a pension is fully funded, the discount rate is the required rate of return, where the PBO = Market Value of Assets. A reason why many pensions are in trouble, too high a discount rate (rate of return), the lower the liability, but if you fall short, unfunded status grows wider, requiring contributions. A discount rate is the number that brings a FV to a PV, that’s it. For life insurance it get messy with different types of policies, mortality tables, etc. not really testable in my opinion. Life insurance, will, I believe focus on estate planing, wealth transfer, human capital protection. Discount rates don’t really apply to foundations as they manage in an asset only (AO) framework.