Chapter 27: Financial product and benefit scheme risks Flashcards
Risk of benefits for a DB scheme
ISUME LIBeNTS
Inadequate funds due to:
- Sponsor insolvency
- Under funding
- Mismatching of A and L / Mortality rates (pre and post retirement)
- Economic mismanagement / Experience (entries + withdrawals)
Liquidity of the scheme to meet benefits
Inflation may erode real value of benefits
Benefit changes risk - index linked, changed by State, scheme rules
Needs of member not met - design or inflation
Take over by company who’s unwilling to meet beneficiary promises
State sponsored benefits changed
Factors affecting the certainty of contributions made to the benefit scheme (LUI IFANTA)
Liquidity constraints
Unaffordable contribution rates (solvency)
Inflationary increase of contributions
Incorrect contributions made
Fraud
Advice not correct
Non-compliance to regulation - fine or loss of tax reduction
Tax terms change / Takeover by company not willing to meet the promised contributions
Administration costs
Factors causing overall uncertainty of benefit schemes contribution rates
Da CoMPaS
Data errors - beneficiaries or parameters
Contributions or premium calculation error
Model error
Parameter error
Security of the sponsor
Factors affecting the contribution level for a benefit scheme (I PIE)
Inflation
Promised/Needed benefit
Investment return
Eligibility to accrue/receive benefits
Risks in a DC scheme
OLIE AI
Operational risk- fraud
Longevity risk- Terms of annuity to not meet the needs
Investment risk- bad investment performance
Expense risk - higher than expected
Annuity price is higher than expected
Inflation may erode real value of benefits
Additional considerations for a insurance company in a group scheme agreement:
PRE ABC
- Profit sharing arrangements that might be put in place
- Relationship between the company and the group scheme
- Economies of scale that can be leveraged
- Additional benefits to provide
- Bargaining power
- Company reputation
Mitigating against inappropriate advice:
CARSHoW GRound
Cooling off periods
Advisors: Trusted source, qualifications, fee basis rather than commission
Research on products done individually
Shop around for quotes
Honesty about needs, health and financial state
Write to regulator or ombudsman if inappropriate advice was given
Government advice questioning financial savvy
Read fine print
Defined Benefit scheme definition
Under a defined benefit scheme, the scheme rules define the benefits independently of the contributions payable, and the benefits are not directly related to the investment of the scheme
The scheme may be funded or unfunded or pay as you go.
Defined contribution scheme definition
A defined contribution scheme provides the benefits where the amount of an individuals members benefits depends on the contributions paid into the scheme in respect of the member, accumulated by investment return earned on those contributions.
Investment risks of a benefit scheme (DRUMOLITE):
Default Reinvestment Uncertainty over timing/amount of return Mismatching of A/L Opportunity cost of capital Lack of appreciation from beneficiaries Inflation (income and capital proceeds) do the index of investment return and the benefit provided correlate Taxation Expenses
Risk to sponsors of a benefit scheme
IMoC LI
Risk of cost of providing benefit more than expected
o Cost of benefit changing
o More people accruing benefit
o More people receiving benefit
- Improved rates
o Inflation
o Investment return
Risk of payments coming at an inopportune time
- Difficulty in setting Investment strategy due to
uncertain nature
- Liquidity problems
