Csp Q04

Front 1

QBS 4: 1 of 8
Advantages of VBO accounting over PBO accounting

Back 1

1) Immunizes employees so don't bear brunt of plan design changes
2) Clarifies employment contract
3) Reduces dependency on ambiguous implicit contracts
4) Minimizes opportunities for gaming
5) Reduces the threat and cost of regulation
6) Provides transparency to investors
7) Gives management more plan design flexibility
8) Would illuminate total cost of plan amendments immediately to shareholders
9) Avoids moral hazards

Front 2

QBS 4: 2 of 8
Types of contract risks faced by employees

Back 2

1) Demographic risk
2) Firm-specific risk
3) Moral hazard

Front 3

QBS 4: 3 of 8
Principles behind contracts

Back 3

1) Increasing employment contract risk may be efficient up to a limit
2) Exposing employees to moral hazard is generally inefficient

Front 4

QBS 4: 4 of 8
DB plan contract design from an employer and employee perspective

Back 4

1) Compensation is withheld
2) Trains employee to enhance future productivity
3) Motivates them to perform under the risk of losing value withheld
4) Rewards them at retirement

Front 5

QBS 4: 5 of 8
What is the one way to identify a frail plan design (i.e. frail pension contract)?

Back 5

- ABO significantly larger than VBO
- Puts employee's compensation at risk/creates a moral hazard
- Employees will demand higher pay in this situation

Front 6

QBS 4: 6 of 8
Frail design features

Back 6

1) Subsidized early retirement with cliff eligibility
a) A window can be a more efficient method of achieving a similar purpose
2) Revocable benefit promises
a) e.g. retiree medical cut backs or rescissions
3) Past service benefits
4) Plan shutdown benefits
a) Laying off members before plan shutdown
5) Cash balance conversions

Front 7

QBS 4: 7 of 8
Benefit design features that reduce post-employment frailty

Back 7

1) Fund individual accounts
2) Modest class-year vesting
3) Full vesting at an age when retention is no longer a goal

Front 8

QBS 4: 8 of 8
Moral hazard provides opportunity for exploitation which if acted on can?

Back 8

1) Diminish employee morale
2) Increase turnover
3) Cause recruiting difficulties
4) Lead to lawsuits