P6-12 Craig
Brokaw, newly appointed controller of STL, is considering ways to reduce his
company's expenditures on annual pension costs. One way to do this is to switch
STL's pension fund assets from First Security to NET Life. STL is a very well-respected
computer manufacturer that recently has experienced a sharp decline in its
financial performance for the first time in its 25-year history. Despite
financial Problems, STL still is committed to providing its employees with good
pension and postretirement health benefits.
Under its
present plan with First Security, STL is obligated to pay $43 million to meet
the expected value of future pension benefits that are payable to employees as
an annuity upon their retirement from the company. On the other hand, NET Life
requires STL to pay only $35 million for identical future pension benefits.
First Security is one of the oldest and most reputable insurance companies in
North America. NET Life has a much weaker reputation in the insurance industry.
In pondering the significant difference in annual pension costs, Brokaw asks
himself, “Is this too good to be true?”
Instructions
Answer the
following questions.
a. Why might NET
Life's pension cost requirement be $8 million less than First Security's requirement
for the same future value?
b. What ethical
issues should Craig Brokaw consider before switching STL's pension fund assets?
c. Who are the
stakeholders that could be affected by Brokaw's decision?
(a) The time value of money would suggest that NET Life’s discount rate was substantially higher than First Security’s. The actuaries at NET
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