The defined benefit plan is a pension plan in which the company defines a remuneration or benefit that the employee will receive once he has retired. This benefit is based on various criteria such as average salary, length of service with the company, etc.
The company assumes all the investment risk, unlike in the defined contribution plans . The company establishes a liability equal to the present value of the payments that must be made in the future to the employee. This liability is compensated by the company with an asset investment plan where it contributes as the employee gains benefits.
As it assumes the investment risk, the company has to worry about achieving the established objectives. For this you have to carry out an investment strategy and adapt to it fervently. A defined benefit plan where assets are greater than liabilities is said to be overcapitalized. Whereas if the assets are less than the liabilities, the plan is undercapitalized.
The company’s investment strategy
The strategies can be:
- Meet the profitability-risk balance established as objectives. An adjustment is usually made based on the Sharpe ratio.
- The volatility of the plan must always be within previously defined ranges.
- Meet the liquidity needs.