Chapter 40: Risks in Benefit Schemes

Question 1

2 Key risks to the sponsor of a benefit scheme

Answer 1

• the cost of the scheme may be greater than expected

- contributions may be required at an inopportune time

Question 2

2 Key risks to the member of a benefit scheme

Answer 2

• the benefits may be less than expected

- they may not be received at the required time

Question 3

What is the key risk to the state in relation to benefit provision?

Answer 3

The risk is that the state is required to put right any losses that the public incurs.

Question 4

Defined benefit scheme:

4 Key benefit risks

Answer 4

• inadequate funds due to underfunding, sponsor insolvency, or mismatching assets and liabilities
• illiquid assets
• benefit changes, eg due to new state legislation
• not meeting members needs, eg inflation protection

Question 5

Defined contribution scheme:

3 Key benefit risks

Answer 5

• benefits may be lower than expected, due to lower than expected investment returns or higher than expected expenses
• annuity rates may be worse than expected if an annuity is secured. This is a risk to the sponsor if the terms have been guaranteed to the member.
• not meeting members needs. E.g. inflation protection

Question 6

Defined benefit scheme:

5 Key contribution risks

Answer 6

• the future level of contributions is unknown. Contributions will depend on the amount of the promised benefits, the eligibility to accrue and receive benefits, inflation and investment returns.
• the timing of contributions is unknown
• there may be insufficient assets with which to make the contributions
• insolvency risk due to excessive contributions
• takeover by a 3rd party who is unwilling to make the contributions

Question 7

Defined contribution scheme:

3 Key contribution risks

Answer 7

• insufficient assets with which to make the contributions
• if contributions are linked to inflation or a salary index, and that index increases faster than expected.
• if contributions are fixed, the benefits may be less than expected

Question 8

In both defined benefit and defined contribution schemes, how might sponsor actions contribute to the uncertainty surrounding the benefits and the contributions?

Answer 8

The sponsor may

• default on contributions
• default on repayments to loans made from the scheme
• fail to pay contributions in a timely manner
• decide not to make any contributions
• communicate poorly to members

Question 9

Risks relating to the investments in a benefit scheme

Answer 9

• uncertainty over the level and timing of investment returns
• mismatching liabilities
• reinvestment risk
• default risk
• volatility of returns
• investment expenses
• tax risks

Question 10

Operational risks in a benefit scheme

Answer 10

• fraud
• misappropriation of assets
• incorrect benefit payments
• inappropriate advice
• the costs of changes in legislation or taxation
• wrong decision of those in power
• fines or removal of tax status resulting from non-compliance

Question 11

Examples of how inappropriate advice might be given

Answer 11

• advisor might be incompetent or lacking in integrity
• model and data errors
• overly complex products
• state-encouraged but inappropriate actions