Chapter 5: Benefits overview and providers of benefit Flashcards
What are the key features of pension contracts?
The key features of pension contracts are they:
* are primarily used as a means of providing income in retirement for individuals and possibly their dependents
* may provide other beneftis, for example, lump sum payment to dependents if an individual dies before retirement
* may have options to change the form or timing of the benefit, for example, an option at retirement to exchange a proportion of the pension payments for a cash payment
* are long-term arrangements
List the 5 providers of benefits
- The State
- Employers or a group of employers
- Individuals
- Financial institutions
- Other organisations
List and explain the 3 types of pension scheme members
- Actives - members still earning future pension benefits over time
- Deferred members - members who have stopped earning any future benefits but who have an existing benefit entitlement that will come into payment in the future.
- Current pesioners - members who are receiving their benefit entitlement
List the 3 main types of pension schemes
- Defined benefit scheme
- Defined contribution scheme
- Hybrid scheme
Discuss defined benefit schemes
A defined benefit scheme is one where the scheme rules define the benefits independently of the contributions payable, and benefits are not directly related to the investmetns of the scheme.
The scheme may be funded or unfunded.
Benefits will be determined 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
Discuss defined contribution schemes
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 member may have some choice as to which asset classes their contributions are invested in.
Note that the pension is not defined and will depend on, for example, the investmetn returns achieved by these assets.
Discuss Hybrid Schemes
A hybrid scheme is one where risks are shared between the different parties involved, such as scheme members, employers, insurers and investment businesses.
Hybrid schemes are more defined benefit 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 light of increasing longevity
* the greater use of risk management options such as investments that transfer longevity risk and insurance company investments.
Who bears the risks?
The type of pension scheme is the main determinant of who primarily bears the risks.
These risks inevitably result in either the benefits received being less than expected, or the cost of providing these benefits being greater than expected.
The key risks involved are:
* investment risk
* increasing longevity after retirement
* expense risk
* credit risk
* operational risk
What benefits might the State provide?
The State is often the primary provider of:
* retirement benefits
* medical care
* unemployment benefits
* other welfare benefits
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 subsidise the cost of 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 for promises made, or expectations created.
Describe the roles of the State in relation to retirement benefits
- Direct provision:
* In countries where life expectancy extends well beyond working age, retirement benefits are likely to be of high financial significance.
* Often they are not recognised as such by the potential recipients.
* The State is likely to play a large role in ensuring the population receives, or has the opportunity to receive, income after retirement. - Sponsor the provision of benefits:
* Employers can be required to provide a pension arrangement for their employees and to enrol employees earning more than a minimum amount into the scheme automatically, giving them an option to opt out rathern than a requirement to opt in to the arrangement - Provide financial incentives:
* This can be done by giving tax-relief on either contributions or benefits - Education:
* The State may undertake educational initiatives itself.
* Alternatively, it may impose regulations as to the minimum levels of information to be disclosed by pension providers to inform and educate pension scheme members. - Regulation to encourage or compel benefit provision:
* The State can choose either to encourage the population to make provision, or it can take stronger action and compel the population to make such provision
* In many countries, certain classes of insurance are compulsory.
* These usually cover risks with low probability and potentially high payouts. - Regulation of other benefit providers:
* The State needs to strike a balance between:
- the degree of flexibility and freedom of action that they give to other providers, and
- the need for regulation and supervision.
* Regulation may relate to marketing rules, benefit limits, reporting requirements, investment restrictions, security of benefits and rights of beneficiaries.
List 3 ways in which the state can be the provider of financial instruments through which individuals can make their own provision for future benefits.
- Direct investment in the National Debt
- State-sponsored savings plans
- Deposits with the State bank, or with local authorities.
List 4 reasons why employer finance benefits for employees
- Compulsion or encouragement from the State
- A desire to attract and retain the services of good quality employees
- A desire to look after employees and their dependents financially beyond the level provided by the State
- Pooling of expenses and expertise
Describe a flexible benefit system
Flexible benefit systems are useful when it is inappropriate to provide all employees in an organisation with the same benefit package.
Employees have a choice between, for example, 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
What is a single-employer scheme?
The financing of a scheme could, subject to legislation, be shared between the employer and the employees who will receive the benefits.
What is a multi-employer scheme and what is its key advantage and disadvatage?
A multi-employer scheme is set up jointly with other employers, often from the same industry, as a means of making provision more cost effective.
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, particularly in the event of the insolvency of one of the sponsors. Fund segregation is usually important in reducing such problems. (Fund segregation means holding the pension scheme’s investments separate from the company, usually overseen by trustees)
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 organisation.
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 available 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 3 examples of ‘other organisations’ that might provide benefits
- Trade unions
- Credit unions
- Charities
