Chapter 5: Benefits overview and providers of benefits Flashcards
Types of pension scheme members
Active members - members still earning future benefits over time eg a current employee of the sponsoring company
Deferred members - members who have stopped earning any future benefits who have an existing benefit entitlement that will come into payment in the future, eg an employee who left to work for another company
Current pensioners - members who are receiving their benefit entitlement
Defined Benefit Scheme
A defined benefits scheme is one where the scheme rules define the benefits independently of the contributions payable, and benefits are not directly related to the investments of the scheme
Benefits will be defined by a set formula, and might be linked to, for example:
- how long the member works for the sponsoring company
- the member’s salary at retirement
The scheme may be funded or unfunded.
The members’ benefits are promised and independent of investment return, longevity, and administration expenses. The risks, therefore, lie with the employer (if the members live longer than expected, the employer needs to pay more money into the scheme)
Defined Contribution Scheme
A defined contribution scheme is one providing benefits where the amount of an individual member’s benefits depends on the contributions paid into the scheme in respect of that member, increased by the investment return earned on those contributions
The risks lie primarily with the members, for example, if investment performance is poor, then each member’s accumulated fund will be smaller than expected and hence the annual pension lower than expected
If an annuity is purchased at retirement, then longevity risk passes to the annuity provider at this time. If an annuity is not purchased, then longevity risk remains with the member
Expenses risk may lie with the employer or the members depending on whether expenses are met separately by the employer or are met from charges taken from the accumulated fund
Hybrid Schemes
A hybrid scheme is one where risks are shared between the different parties involved, for example, scheme members, employers, insurers, and investment business
Investment, longevity and expense risk is shared between the members and the employer
5 main providers of benefits
- The State
- Employers or a group of employers
- Individuals
- Financial institutions (insurance companies, banks, mutual funds and investment companies)
- Other organizations (trade unions, credit unions, employee associations, religious organisations and charities)
What benefits might the State provide?
The State may provide retirement, ill-health, death and unemployment benefits.
The State may also provide financial instruments such as national debt securities, State sponsored savings plans and the facility to deposit money in State bank accounts
List the 6 key roles of the State in relation to benefit provision
- Provide benefits to some, or all of the population
- Sponsor the provision of such benefits, perhaps by providing appropriate financial instruments.
- Provide financial incentives, usually through the tax system, either for other providers to establish appropriate provision, or to subsidize the cost of providing such provision to consumers.
- Educate or require education about the importance of providing for the future.
- Regulate to encourage or compel benefit provision by or on behalf of some of the population.
- Regulate bodies providing benefits, and bodies with custody of funds, in an attempt to ensure security of promises made, or expectations created
What is a multi-employer scheme and what is its key advantage and disadvantage?
A multi-employer scheme is a benefit scheme set up jointly with other employers, often from the same industry.
Advantage: It makes provision more cost effective.
Disadvantage: More care must be taken over allocating the liability for funding DBs, particularly in the event of the insolvency of one of the sponsors.
List 3 possible roles of employers in relation to benefit provision.
- Educating, and either encouraging or compelling employees to plan benefit provision
- Financing of benefits for employees, in an orderly manner
- Providing a facility (scheme) for the provision of benefits
List 4 reasons why employers finance benefits for employees.
- Compulsion or encouragement from the State
- A desire to attract and retain good quality staff
- A desire to look after employees and their dependents financially beyond the level provided by the State.
- To pool expenses and expertise
Describe a flexible benefit system
Under a flexible benefit system, employees are offered the option to choose between benefits, which the employee can ‘buy’ or ‘sell’
They are given a notional amount which they can spend
What are the roles of the individual in relation to benefit provision?
The main role is to finance benefits through, for example, a scheme provided by the State, an employer, an insurance company or other financial organization.
Alternatively, individuals may use individual savings or domestic property to finance benefits, or by way of financial support from families or local community schemes.
Individuals might be incentivised to finance benefits through tax advantages or by employers matching employee contributions up to certain limits.
What role do financial institutions play in the provision of benefits?
They provide benefit schemes and insurance products.
They may also educate consumers on the importance of making benefit provision.
Give 3 examples of how domestic property can be used as a source of benefits for an individual
- The home could be sold
- Loans can be secured on the accumulated equity in the home
- A capital sum may be available on inheritance of a domestic property
Defined Ambition Scheme
A scheme where risks are shared between the different parties involved, such as a scheme member, employers, insurers, and investment businesses
