Retirement Benefits Flashcards
Employer’s choice: stand-alone vs. umbrella funds.
- Costs (umbrella funds benefit from economies of scale but may not pass onto members)
- Expertise and time (umbrella fund trustees understand regulation and have time to ensure they’re compliant)
- Personal liability (if mistake is made, trustees can be blamed not company)
- Conflict of interest (umbrella funds don’t care for members)
- Segregation of assets (stand-alone don’t need to do all that)
- Sales practices (often poor in umbrella funds)
- Fiduciary risk (standalones may not use funds for what you’re supposed to)
- Operational risk and individual participant level (easier to detect in standalone)
Risks for income drawdown product members
- may live longer than expected (longevity risk), and pension doesn’t last
- cognitive ability deteriorates so might mismanage funds
- exposed to investment risk, leading to volatile income
- remaining funds on death insufficient to support depedendants
- cost of administering benefits higher than expected, which depletes fund
- deciding on how much income to take, how to invest capital etc. can be difficult
What does the choice of NRA depend on?
NRA usually differ by country, industry and occupation and could be legislated. It depedns on the following:
- State retirement age
- Longevity trends (in general and for fund)
- Ability of workers to continue working at older ages
- Employer and national requirements for labour at older ages
- Level of benefit the fund wishes to deliver and the length of time it may take to build up this level of benefit.
Members choice: DC contribution amount
- Fixed amount, for example, a percentage of an average salary for a population, but this is not common
- Fixed as a percentage of pensionable salary
- Age-related or service-related contribution scales
- Member-elected percentage of pensionable salary
- Auto-escalating contribution rates
What are the hybrid retirement funds?
Hybrid between DC and DB funds.
* Notional DC or cash-balance fund
* Combination hybrids: combination of less generous DB plan and a DC plan
* Sequential hybrids: members start off in DC plan and move to DB plan
* Underpins: DC plans where members receive a DB-type pension guarantee
What types of retirement funds do you get?
Defined contribution
Defined benefit
Hybrids
Collective defined contributions fund or defined ambition fund
What is a cash-balance fund?
- Member (and employer) contributes money to fund but money grows based on notional interest rate (not based on actual investment).
- Unlike a pure DC funds, where you can see your own baalnce, everyone’s contributions are pooled together.
- At retirement, you get what you contributed plus the notional growth
What is a defined ambition fund?
- The benefit amount is defined, and fund sets a contribution rate to reach that.
- If investment doesn’t do as well as planned, then fund can change the contribution rate.
- Works the same as DB funds, minus the sponsor who gives security if things go wrong.
- Younger members are take on more risk because they may have to cover shortfalls if investments don’t perform well.
DC fund: What benefits might you be paid on resignation, retrenchment or dismissal?
- Return of member contributions
- Return of member contributions plus (fund or pre-determined) interest or return
- Return of member and employer contributions
- Return of member and employer contributions plus (fund or pre-determined) interest or return
- Deferred pension payable from normal retirement date
- Lump sum equal to value of deferred pension
- Lump sum equal to reserve held in the fund
- Statutory calculated minimum benefit
Why might member receive smaller pension than expected from DC fund?
Lower contributions than expected:
* Break in service
* Salary growth lower than expected
* Shorter service period than expected
* Premium of risk benefits may have increased, causing decrease in contribution rate
Lower investment returns than expected
* Low capital growth or investment income
* Fall in market value of assets close to retirement
Lower annuity rates than expected:
* Fall in bond yields (lower i means lower annuity rates)
* Larger than expected increase in longevity assumptions
* Increased margins by providers
When is income drawdown approach preferable?
- Don’t qualify for impaired life annuity
- Annuity rates are poor
- Have spouse with whom they can pool longevity risk
- They have depedents to pass on excess funds to
Waiting period vs. deferred period
Waiting period: period between policy commencement and point in time when cover starts
Deferred period: period between benefit event date and date benefit starts.
Why shift from stand-alone to umbrella funds?
- Because the employer is less involved with the operation of an umbrella fund, they have more time to focus on their core business.
- Umbrella funds have become more sophisticated over time, often offering the features of stand-alone funds. These features include available investment portfolios, member investment choice and member communication.
- Due to their size, these umbrella funds can offer a wider range of benefit and investment options for members than a typical stand-alone fund.
- Due to their size and standard architecture, umbrella funds can offer the benefits at a lower cost to the employer and its members.
- Increased regulation of retirement funds means that trustees spend more time on governance issues.
- Increased regulation also increases the risks to the trustees. As the employer does not have representation on the board of trustees in an umbrella fund, they avoid these risks.
- In an umbrella fund, professional trustees deal with these issues while a participating employer can focus on the benefit package.
Why is the demand for life annuities small?
No need because there’s already stat pensions
Worried insurers won’t continue to be credit worthy and don’t trust them in general
Seems like poor value for money especially if you have a heavy expected mortality
If individual worried about consumption shocks in retirement annuity may not provide income they need at the time
May be a desire to leave bequest or inheritance. Annuities can have guarantee period so loved one paid if you die during that period or can be joint life.
Sponsor vs sponsor covenant
