Transcript Slide 1

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.
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Measures of Defined Benefit
Pension liabilities
Projected Benefit obligations
 Accumulated benefit obligations
 Vested benefit obligations
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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.
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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.
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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
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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.

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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
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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.
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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.
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PBO calculation at the end of
first year (2008)
Year
Years of
service
Projected
salary
2008
1
$50,000
2009
2
$52,000
2032
25
$128,165
Years in
retirement
Benefit
payment
PV(end of
year)
PBO=
$3,460
$21,940
2033
1
$2,563
2034
2
$2,563
2047
15
$2,563
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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
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Calculations for 2008

PBO at the end of 2008 = (PV of $21,940
@ 8% for 24 years)
= $3,460
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PBO calculation at the end of
year 2009
Year
Years of
service
Projected
salary
2008
1
$50,000
2009
2
$52,000
2032
25
$128,165
Years in
retirement
Benefit
payment
PV(end of
year)
PBO=
$7,473
$43,881
2033
1
$5,126
2034
2
$5,126
2047
15
$5,126
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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
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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.
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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
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FUNDED STATUS

Funded status = plan assets - PBO
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