Chapter 7 - Retirement and Social Benefits Flashcards
Outline the workings of a DC fund. [3.5]
Retirement benefit payable (the member’s accumulated fund credit)✓✓ is a function of contributions✓, investment returns (fund return)✓, and expenses✓.
The rate of contribution is defined, while the level of benefit is undefined.✓✓
Benefit is typically paid as a capital lump sum✓ and may be available to the member in cash✓ or required to be used to purchase an annuity from an insurer✓, or some combination of the two✓.
Contributions may be split between the member and employer.✓✓
Contribution structures may vary but need to meet legislative requirements.✓✓
State the factors that influence the choice of the NRA. [2]
Longevity trends✓, both in general and for the fund membership✓
The relevant state retirement age✓
The ability of workers to continue working at older ages✓. For jobs that are physically demanding, a lower NRA might be more appropriate to accommodate workers who may not be able to continue working into older ages✓
Employer and national requirements for labour at older ages✓✓
The level of benefit the fund wishes to deliver✓ and the length of time it may take to build up this level of benefit✓
Regulatory Requirements✓: Government regulations or laws may set a minimum or standard NRA✓.
Describe a “self annuitised pool”. [2.5]
Traditionally at retirement✓, DC fund members would exit the fund✓; however, it is possible for DC funds to have pensioner members✓.
One mechanism for providing this is a group self-annuitised pool✓ which can be described as follows:
A form of mutual insurance✓✓
Pensioner pool bears the longevity and investment risk;✓✓ poor experience is reflected in low pension increases and vice versa✓✓
State a key advantage of a self annuitised pool. [1]
It may provide higher pension incomes than life annuities✓✓ as there is no cost of generating shareholder profit✓ and the entity does not need to hold solvency capital✓.
State the main disadvantage of a self annuitised pool. [0.75]
There are potential conflicts✓ between the interests✓ of different generations of pensioners✓.
List the measures an insurer can use to manage the conflicts between different generations of pensionsers in a self-annuitised pool. [1.25]
Conflicts between different generations are managed by strict rules✓ around
* assumptions✓,
* pricing✓, and
* the distribution of surpluses✓ and
deficits✓.
Explain the two key differences between Defined Benefit (DB) and Defined Contribution (DC) pension scheme. [2.5]
Defined Benefit (DB) Scheme: Provides a guaranteed retirement benefit✓ based on a formula✓ (e.g., years of service and final salary)✓✓. Employer bears the investment risk.✓✓
Defined Contribution (DC) Scheme: Contributions are defined✓, but the retirement benefit depends on investment performance✓. Employees bear the investment risk.✓✓
Identify and discuss three potential advantages and three potential disadvantages for the company in converting from a DB scheme to a DC scheme.[3.5]
Advantages for the Company:
Cost Predictability✓: DC schemes offer more predictable costs since contributions are fixed✓.
Reduced Financial Risk✓: Shifts investment and longevity risk away from the employer.✓✓
Simplified Administration✓: DC schemes are generally easier to manage and administer✓.
Disadvantages for the Company:
Initial Costs✓: There may be significant costs associated with transitioning, such as actuarial evaluations and legal fees.✓✓
Employee Morale✓: Employees might view the change unfavorably due to perceived reduction in benefits.✓✓
Compliance Issues✓: Ensuring that the new scheme meets regulatory requirements and safeguards employee interests.✓✓
Describe at least two potential impacts on the employees of a conversion from a DB scheme to DC Scheme particularly focusing on retirement security and financial planning. [2.5]
Retirement Security: Employees may face uncertain retirement income✓✓ as it depends on investment performance✓ and contribution levels✓.
Financial Planning: Employees need to take a more active role in managing their investments and planning for retirement.✓✓
Potential for Lower Benefits: If investment returns are poor, retirement benefits could be lower compared to the guaranteed benefits under the DB scheme.✓✓
State how conflicts between different generations can be managed under a group self-annuitised pool. [1]
Conflicts between different generations are managed by strict rules✓ around assumptions, pricing, and the distribution of surpluses and deficits✓✓✓.
factors can be considered when setting the total contribution rate when a new fund is established.:
The level of retirement benefit that the sponsor would like to target l The contribution rates on competitor schemes or other funds with the same sponsor l Members’ preferences, considering how much members are generally inclined to save and spend
l Any legal limits or tax deductibility thresholds. For example, contribution rates can exceed the maximum tax-deductible amount but the tax implications should be clearly explained to members.
Using
Advantages of matching members’ contributions include the following
Advantages of matching members’ contributions include the following: l It encourages members to save more for their retirement.
l It pays more to workers who want to save more. Savings behaviour can be correlated with other desirable worker attributes.
l It is an example of an incentive unrelated to tax; therefore, it can be used to encourage people who do not pay tax to save
Disadvantages of matching members’ contributions
Disadvantages of matching members’ contributions include the following: l Some employees, for example, those with lower incomes, may face challenges to make
significant contributions. It is expected that these members will need more assistance from the employer, rather than less.
l Increased payroll administration and costs
There are a variety of options available for member contributions in a DC fund
There are a variety of options available for member contributions in a DC fund:
l Fixed amount, for example, a percentage of an average salary for a population, but this is not common
l Fixed as a percentage of pensionable salary l Age-related or service-related contribution scales l Member-elected percentage of pensionable salary l Auto-escalating contribution rates are an alternative way to encourage higher contributions over time by automatically increasing the contribution rate, expressed as a percentage of pensionable salary, on a regular basis. The increases are typically small and the timing usually coincides with salary increases to dampen the effect on take-home pay while increasing the savings over time
When offering a choice of contribution rate, the following needs to be considered:
When offering a choice of contribution rate, the following needs to be considered:
l The range of member contribution options l How often and when contribution levels can be revised l Whether to provide an incentive for members to contribute more, at least up to a certain level, for example, matching contributions
l Ongoing monitoring to determine likely future member choices l Administrative complexity, which increases dramatically with increased options and opportunities to revise the contribution rates, must be weighed against cost and system constraints.
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