CFAI '08 exam Q3 F inflation sensitivity difference, describe, adjusted, payments

Wendy01

the question was describe one difference between the acive live and the retired lieve protion of liabilities for inflation sensitivity.
the retirees get choice of life annuity and that is stated as NOT adjusted for inflation.
the answer key from CFAI reads:
Benefit payment obligations in the retired-lives pool are exposed to less inflation risk because,
unlike the active-lives pool, payments are fixed in nominal terms and do not adjust for
inflation. Benefit payment obligations in the active-lives pool are exposed to more inflation
risk than in the retired-lives pool because, unlike the retired-lives pool, active Titan employees
accrue pension benefits based on salary increases, which include inflation as a component.
I don’t get it. It seems backwards to me….
anyone?

kkn006

Your client is the pension plan! Don’t forget that.

SFoyil

Thanks guys.
My error was looking at inflation from the point of view of the individuals, not the plan. Now its clear.
That is how i wrote my answer. I now wonder how much credit would be given to an answer written from the point of view of the active worker / retired person……

DarienHacker

For the perspective of the plan sponsor, the liabilities of retired workers have less inflation risk. Their benefits were locked in at their retirement in most cases. For active workers, the plan sponsor faces inflation risk because increases in their salary are linked to productivity gains and wage inflation. If wage inflation occurs, the sponsor is at risk of the future benefits to be paid being larger.
The caveot would be if retired workers recieved a cost of living adjustment to their pension which I think I saw in an example somewhere.

Analyze_This

There may have been another thread on this over the last few days….
If it seems backwards to you maybe you are considering it from the beneficiary (retiree) side rather than the liability side. The liabilities to the retired workers are nominal so they do not adjust for inflation, therefore the liabilities do not go up with inflation, so they are not sensitive.
The active workers salaries will adjust for inflation and will hence accrue more benefits if inflation is high.
I feel like I am only repeating the guideline answer here, but not sure how else to say it.