Question

The budget director says, “In the worst case, we cannot do anything about the cost of living adjustment, the stock market tanks, and we earn very little—say 3 percent. Productivity goes to zero and other factors remain the same. That is the ‘worst case.’ How bad would that be?”

INPUTS	Value
Cost of Living Adjustment	0.03
Long Term Rate of Return	0.03
Productivity Factor	0.00
Employee Contribution Rate	0.095
Final Salary Give Back	$                                     -
State Contribution Factor	2.5
SUMMARY OF KEY RESULTS	Value
NPV of Unfunded Liability	$              23,685,305,718
Ratio of Assets to Liability NPV	62%

How would you explain this worst case scenario? What do this mean?

Answer 1

When we want to apply risk management effectively, the concept of  `worst-case scenario` is a concept where planner cosider for potential disasters, losses and take in the decision making most severe possible outcome that can be occur in a given situation. Worst case scenario helps in making strategy and scenario planning, to prepare for contigencies and try to minimize the harmful possible conditions so that it could be result in good productivity and good profit making situation.

We have to understand what is the meaning and explaination of key term used in this Situation-

1. Cost of living adjustment- in given situation, this factor is given i.e. 3 %. However this percentage is quite high and budget director to plan to lower it.

2. Long term rate of return - There is 3 % Long term rate is given. Budet Director should cosider and study the effect of change in this variable.

3. Productivity Factor- There is productivity factor is given 0 %. This sings adverse situation in the business. Key management person have to take decision to improving the productivity factor. Official hopes for greater productivity in future.

4. Employee Contribution Rate- Working Employee contribution is 9.5 %. However is it is lower contribution and budeting director and planning officials have to try for increase this rate.

5. Final Salary Give Back - Management want to dedcut final salry of employees, ths situation is called Final salary give back. Especially for pension purpose.

6. State Contribution factor - This factor means what the State contribute against the employee contribution (ie. Pension etc). In given situation, state contribution factor is 2.5 times. It means state is contributing 2.5 times more what employee contributing for fund. This factor should high for ensuring that there is enough money to pay emplyees.

7. NPV of Unfunded liability- This is simply net present value of unfunded liability of pension fund. There is summary of key result is given i.e. $ 23,685,305,718. This is unfunded liability as on that.

8. Ratio of assets to liability NPV - This is ratio of assets to liability NPV. Here ratio is given 62 %. it mean assets is 62 % against liability of NPV. Management has to increase this Ratio of assets to liability NPV. 62 % is not a good sign.

with the help of analysis of above factors we can say that in `Worst case senario` the most serious or severe outcome that may happen in a given situation, is considered. For example - While calculating NPV, one would take the highest possible discount rate and subtract the possible cash flow growth rate or the highest expected tax rate.