Question

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?

Short answer

The requirement will be less due to various actuaries' assumptions. Craig may face an ethical dilemma, and the stakeholders are the company and retirees.

Step-by-step solution

Part A

It totally depends on the time value of money for N life. The cost of the capital of N Life is much lesser than F security. The premiums which are paid depend on various assumptions such as life expectance, employee turnover, salary, wage, etc. The N life actuaries' assumptions are different as compared to F security. As a result, the pension cost requirement of N life is less than F security for the same future value.

Part B

Craig is the controller of pension funds and is in a trustworthy and responsible position towards the retirees of the business. He has the responsibility of ensuring that adequate funds of pension assets are present. Craig is also responsible for enhancing the company's financial condition and acting ethically. This role of Craig will sometimes lead to ethical conflict.

Part C

The company and retirees are the stakeholders who are affected by the decision of Craig.