The definition is replaced by the value’
Replaced the value of the present value of future cash flows required to fulfil the pension obligations. Replaced value, thus, the net present value of future financial obligations. The total amount of pension liabilities is the product of long-term interest rates and life expectancy based on mortality tables. Depending on the age at which the employee separates from service, the number of years they need to be alive to receive pension payments and assumes a rate of return on the total amount of investment needed to create these payments are used to determine the commuted value. Upon separation from service, retired employee an opportunity to the amount of the replaced value of their pensions.
Breaking down the ‘replaced value’
A pension Fund Manager needs to calculate the replaced value in order to determine their payout obligations and reserve requirements. Process this calculation is similar to calculating the net present value of the project capital budgeting. The higher the interest rate, the less the required amount, and Vice versa. The farther into the future, the money needed, the less is replaced with the value, and Vice versa.
Example of Commuted value
For example, XYZ Corporation has a Pension plan with defined benefits for its employees. Burt-65 and leaves. He is entitled to a pension that will pay him 80% of his last salary every year for the rest of his life. On the basis of existing mortality tables, Burt is expected to live to 85 years. As Burt began working at XYZ Corporation, XYZ Corporation eliminates part of the salary of Bertha to the Pension Fund in anticipation of this future obligation. Now that Burt is ready to retire and start taking payments, enough money saved for Burt that with this level of profitability and any additional additives, it is able to generate the expected stream of payments over the remaining life of Berta. It’s commuted value. Bert can stay in the Pension plan and receive payments or Burt gets the opportunity to withdraw the replaced value as a lump sum.