Chapter 40: Risks in Benefit Schemes Flashcards

1
Q

2 Key risks to the sponsor of a benefit scheme

A
  • the cost of the scheme may be greater than expected

- contributions may be required at an inopportune time

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2
Q

2 Key risks to the member of a benefit scheme

A
  • the benefits may be less than expected

- they may not be received at the required time

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3
Q

What is the key risk to the state in relation to benefit provision?

A

The risk is that the state is required to put right any losses that the public incurs.

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4
Q

Defined benefit scheme:

4 Key benefit risks

A
  • inadequate funds due to underfunding, sponsor insolvency, or mismatching assets and liabilities
  • illiquid assets
  • benefit changes, eg due to new state legislation
  • not meeting members needs, eg inflation protection
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5
Q

Defined contribution scheme:

3 Key benefit risks

A
  • benefits may be lower than expected, due to lower than expected due to lower than expected investment returns or higher than expected expenses
  • annuity rates may be worse than expected if an annuity is secured. This is a risk to the sponsor if the terms have been guaranteed to the member.
  • not meeting members needs. E.g. inflation protection
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6
Q

Defined benefit scheme:

5 Key contribution risks

A
  • the future level of contributions is unknown. Contributions will depend on the amount of the promised benefits, the eligibility to accrue and receive benefits, inflation and investment returns.
  • the timing of contributions is unknown
  • there may be insufficient assets with which to make the contributions
  • insolvency risk due to excessive contributions
  • takeover by a 3rd party who is unwilling to make the contributions
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7
Q

Defined contribution scheme:

3 Key contribution risks

A
  • insufficient assets with which to make the contributions
  • if contributions are linked to inflation or a salary index, and that index increases faster than expected.
  • if contributions are fixed, the benefits may be less than expected
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8
Q

In both defined benefit and defined contribution schemes, how might sponsor actions contribute to the uncertainty surrounding the benefits and the contributions?

A

The sponsor may

  • default on contributions
  • default on repayments to loans made from the scheme
  • fail to pay contributions in a timely manner
  • decide not to make any contributions
  • communicate poorly to members
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9
Q

Risks relating to the investments in a benefit scheme

A
  • uncertainty over the level and timing of investment returns
  • mismatching liabilities
  • reinvestment risk
  • default risk
  • volatility of returns
  • investment expenses
  • tax risks
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10
Q

Operational risks in a benefit scheme

A
  • fraud
  • misappropriation of assets
  • incorrect benefit payments
  • inappropriate advice
  • the costs of changes in legislation or taxation
  • wrong decision of those in power
  • fines or removal of tax status resulting from non-compliance
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11
Q

Examples of how inappropriate advice might be given

A
  • advisor might be incompetent or lacking in integrity
  • model and data errors
  • overly complex products
  • state-encouraged but inappropriate actions
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