CH 5: Benefit schemes and providers Flashcards
4 Key features of pension contracts
- means of providing income in retirement for an individual and possibly his/her dependents
- may provide other benefits, ex lump sum payment to dependents if an individual dies
- may have options to change the form/timing of the benefit, ex. an option at retirement to exchange a proportion of the pension payments for a cash payment
- long-term arrangements
Occupational schemes
Offered by employers to their employees, where the employer usually pays a substantial percentage of the cost of providing the benefits.
Types of benefit schemes
Defined benefit scheme
5
- Define benefits independently of payable contributions.
- Benefits are not directly related to the investments of the scheme.
- Benefits defined by formula eg linked to final salary (accrual rate) / years of employment.
- The scheme may be funded/unfunded.
- All Risk on the provider, pay in if shortfall occurs.
Cash balance scheme
A defined lump sum is provided at retirement as opposed to a defined pension through retirement
Defined Contribution Scheme
4
- Benefits depend on contributions paid and investment returns
- Members have investment options
- Accum fund is used to purchase pension(annuity rate), take lump sum (33%), income drawdown
- Risk on individual, investment and annuity rate risk. Longevity passed on if purchase annuity.
Hybrid Schemes
1
A scheme where risks are shared between the different parties involved, ex. scheme members, employers, insurers and investment businesses.
Funding of benefit scheme
3,1
DB:
* Cost of benefit uncertain till all have been provided
* Unfunded: No money set aside in advance, set aside just before benefit paid eg state
* Funded Money set aside in advance before benefits due, invested
DC:
* Money set aside gradually over lifetime, Timing and investment returns key for level of return.
Reserving for a benefit scheme
3,1
DB:
* Regulatory requirement for solvency.
* Determined by funding level of scheme
* Val Assets/Val Liabilities
DC:
* Less regulation as value of assets is linked to value of liabilities(benefits). Move together.
Providers of benefits
- the state
- employers
- individuals
- financial institutions (instance, banks, mutual funds and investment companies)
- other organisations (trade union, employee association, religious organisations)
Roles of the state in provision of retirement benefits
5
Sponsor of benefits:
- For Gov employees
Provision of benefits:
- eg on retirement, death, ill health.
- Provides means-tested benefit, funded by taxation.
Incentives:
- Regulation for tax relief on contributions
Regulation:
- Tax breaks, compulsory joiners, min contributions
Education on importance of provision
SPIRE
Roles of the state in provision of other benefits
3
- Healthcare, Social security, Income protection
- eg. UIF, Child support, disability grants
- Provides financial instruments for self provisions. Gov securities/deposits.
Roles of Employers sponsoring benefit provision
6
- S: Flexible benefit sytem
- P:
- Single comp: share contributions(financing) between employer/ employee
- Mult comp: Econ of scale, easy migration
- I
- E
SPIE
Fund segregation
means holding the pension scheme’s investments separate from the company, usually overseen by trustees.
Reasons for Employers sponsoring benefit provision
4
- compulsion/encouragement from the state
- look after interests of employees
- attract and retain good staff
- to pool expenses and expertise
Roles for individuals to finance benefit provision
2
- Finance a benefit via contributions through scheme provided by state, employer, insurance company, other institution.
- Choice depends on regulation and incentives.
