Ch5: Benefits overview and providers of benefits

Question 1

Defined benefits sceme description

Answer 1

Benefits
* Scheme rules define benefits independently of the contributions payable
* Benefits are not directly related to the investments of the scheme
* Scheme may be funded or unfunded
* Benefits will be defined by a set formula:
* how long a member works for the sponsoring company
* member’s salary at retirement
* accrual rate is percentage of final salary per year worked entitled pension

Risk
* Key risks related to investment, longevity and expenses
* In DB risks primarily with employer

Question 2

Defined contribution scheme description

Answer 2

Benefits
* Scheme provides benefits where the amount of an individual member’s benefits depends on the contributions paid into the scheme increased by investmnet return earned on the contributions
* Member may have some choice as to which asset classes their contributions are invested in
* Member my have choice as to how to use the accumulated fund at retirement:
* Secure pension at life insurer with immediate annuity
* Purchase income drawdown product
* Take money as a lump sum - tax and legislative implications

Risks
* Key risks are investment risk, longevity risk and expense risk
* Risks lie primarily with the members:
* Investment risk entirely with member
* Longevity risk can be transferred to annuity provider at retirement
* Expenses risk may lie with the member or employer depending on if expenses are met seperately by provider or are met from charges taken from the accumulated fund

Question 3

Role of the state in retirement provison (6)

Answer 3

• Provide benefits to some or all of the population
  * State plays a large role in ensuring the population receives or has the opportunity to receive, income after retirement
  * Individuals may simply not earn enough money during working lifetime to accumulate enough capital to provide appropriate level of income in retirement
  * May be means-tested
  * Cost is met by taxtion
• Sponsor the provision of such benefits perhaps by providing appropriate financial instruments
  * May be a state-sponsored national scheme where employees are required or incentivised to enrol or through government securities
  * Employers may do this automatically
  * Sate may only provide a scheme for its own employees
• Provide financial incentives
  * Could either be for other providers to establish appropriate provision or to subsidise the cost of provision to consumers
  * Usually done through the tax system
• Educate or require education about the importance of providing for the future
  * State may undertake educational iniatives itself
  * Impose regulations as to minimum levels of information to be disclosed by pension providers to educate pension scheme members
• Regulation to encourage or compel benefit provision
  * Can either encourage population to make provision through tax breaks
  * Or could make provision compulsory by requiring:
  * Each individual joins an employer or individual scheme
  * Minimum levels of contributions to be made or minimum levels of benefits to be provided by employer or individual scheme
• Regulation of other benefit providers
  * Balance between freedom of action and flexibility that they give providers (encourage provision) and need for regulation and supervision (to protect benefits and ensure incentives are not abused)
  * Regulations may relate to marketing rules, benefit limits, reporting requirements, investment restrictions, security of benefits and rights of beneficiaries.

Question 4

Scheme member types

Answer 4

• Actives - members still earning future pension benefits over time
• Deferred members - Members who have stopped earning future benefits, but have existing benefit entitlement that will come into payment in the future
• Current pensioners - members who are currently receiving their benefit entitlement

Question 5

Why employer may provide pension scheme (4)

Answer 5

• Compulsion or encouragement from the state (tax incentives)
• Desire to attract and retain services of good quality employees
  * Provide benefits that employees perceive to be attractive
  * Provide benefits that are at least in line with that offered by competing employers
  * Rewarding certain classes of employees (loyal staff)
• Desire to look after employees and their dependants financially beyond the level provided by the state
• Pooling of expenses and expertise