Certified Plan Sponsor Professional (CPSP) Practice Exam

What does Defined Benefit plan Interest Rate Risk refer to?

1. The risk of unexpected plan expenses

2. The fluctuation of interest rates affecting liabilities

3. The volatility of return on investments

4. The risk of contribution limits being exceeded

The correct answer is: The fluctuation of interest rates affecting liabilities

Defined Benefit plan Interest Rate Risk primarily concerns how changes in interest rates can influence the value of the plan's liabilities. When interest rates fluctuate, the present value of future benefit payments changes correspondingly. A decrease in interest rates generally increases the present value of those liabilities, making them more costly to fund, while an increase in interest rates can lower the present value, easing funding requirements. This relationship is critical for plan sponsors as they must ensure that they maintain sufficient assets to cover the liabilities, which are sensitive to these interest rate movements. Understanding this risk is essential for effective risk management and accurate financial planning within a Defined Benefit plan context.