"By hedging a defined benefit pension plan'sinterest-rate risk, a sponsor can eliminate pensionrisk." Comment on this statement

What will be an ideal response?

Solving the interest-rate risk dilemma does not solve all potential risk associated with managing a pension fund. Besides interest-rate risk, other risks are associated with a pension fund. For example, besides interest-rate risk, there are two other associated with a defined benefit pension fund's projected liabilities. First, there is inflation risk. Second, there is longevity risk. Below we describe these risks.

Inflation risk for a DB pension plan is the risk that the actual rate of inflation experienced over the projection period will be greater than that assumed in projecting liabilities. The sensitivity of the liabilities to inflation risk can be quantified by changing the inflation rate used in projecting liabilities and then revaluing the liabilities.

Longevity risk for a DB pension plan is the risk that actual life expectancy of plan members beyond their retirement date will exceed the life expectancy assumed in projecting the liabilities. As a result, the amount that will actually have to be paid to the plan member will exceed the amount projected. Although we consider longevity risk in the context of a DB pension plan, this risk is faced by life insurance companies in pricing insurance policies and by individuals in planning their retirement. As with inflation risk, the sensitivity to changes in the expected life used in the projection of liabilities and the new valuation for the liabilities based on that expected life can be used to assess the importance of longevity risk.