Chapter 5: Benefits overview and providers of benefits Flashcards
Key features of pensions
- primarily used as means of providing income in retirement for individuals and possibly their dependants
- may provide other benefits, for e.g. a lump sum payment to dependants if an individual dies before retirement
- may have options to change the form or timing of the benefit, e.g. an option at retirement to exchange a proportion of the pension payments for a cash payment
- are long-term arrangements
5 main providers of benefits
- The State
- Employers or a group of employers (pension funds: occupational schemes)
- Individuals (personal pension plans)
- Financial Institutions
- Other organisations
Types of a pension scheme member
- actives: members still earning future pension benefits over time
- deferred members: members who have stopped earning any of the future benefits but who have an existing benefit entitlement that will become into payment in the future
- current pensioners: members who are receiving their benefit entitlement
Defined Benefit Scheme
- The benefit is defined in terms of a set of rules, e.g. a percentage of final salary for each year worked.
- The benefit is not directly related to the contributions paid in or the investment returns earned.
- The scheme may be funded or un-funded.
Benefits will be defined by a set formula, and might be linked to, for e.g.
* how long the member works for the sponsoring company
* The member’s salary at retirement
Defined Contributions Scheme
The benefit relates directly to the contributions paid in repect of each member, increased by the investment returns earned on those contributions
Defined Ambition / Hybrid Schemes
A scheme where risks are shared between the different parties involved, such as a scheme member, employers, insurers and investment businesses
More DB in nature include:
* cash balance schemes, where a defined lump sum is provided at retirement as opposed to a defined pension through retirement
* schemes where the retirement age is increased for future service in the light of increasing longevity
* the greater use of risk management options such as investment that transfer longevity risk (longevity swaps and bonds) and insurance company investments.
Who bears the risks
investment, longevity, expenses
- DB scheme: The risks lie primarily with the employer (fixed benefits)
- DC scheme: The risks lie primarily with the members (investment performance)
- hybrid scheme: shared
Investment Strategies
The pension scheme will need to consider the characteristics of its liabilities, in particular the nature and the term. The term of the liabilities could be very long.
DB scheme:
* fixed-interest bonds to match guarenteed in monetary terms
* index-linked bonds and equities to match benefits guarenteed in real terms
* some cash, for liquidity (immediate expenses)
- Pension schemes often receive generous tax breaks relative to investors
- Investment strategy constrained by regulation
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 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 provisions to consumers
- Educate or require education about the importance of providing for the future
- Regulate to encourage or compel (force) 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
Describe the advantages of the State legislating for compulsary pension arrangements
- assist adequate pension provisions if set at a corrects level
- remove / reduce the burden on the State to provide pension provision
- lead to larger schemes with economies of scale in investment and administration
- avoid the need for financial incentives, thereby reducing the cost
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 dependants financially beyond the level provided by the state
- To pool expenses and expertise
Describe a flexible benefit system
Under a flexible benefits system, employees are offered the option to choose between benefits, which the employee “buy” or “sell”.
They are given a notional amount which they can spend
Employees have a choice between, for e.g. additional salary, additional pension benefits, additional holiday, enhanced death-in-service benefits and long-term sickness benefits. Each benefit is valued and the employee has a notional sum of money to purchase benefits.
Multi-employer schemes and 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.
Industry-wide schemes can provide:
* economies of scale and cost savings in investment and administration
* increased mobility of the workforce between participating employers
* a wider choice of benefits arising from larger schemes
* a sense of identity for employees within the industry
Disadvantage: More care must be taken over allocating the liability for funding DBs, particularily in the event of the insolvency of one of the sponsors. Fund segregation is usually important in reducing such problems (Holding the pension scheme’s investments separate from the company, usually oversees by trustees).
What are the main roles of individuals in relation to benefit provision?
The main role is to finance benefits through, for e.g. 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.
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 avialable on inheritance of a domestic property
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 4 examples of “other organizations” that might provide benefits
- Trade unions
- Credit unions
- Charities
- Microinsurance
Microinsurance
- Provide benefits to lower-income individuals.
- Involves the insurer selling very simple products, with a lower expected premium than traditional insurance business
List 3 possible roles of employers in relation to benefit provision
- Educationg, 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
