C10 - Financing Benefits Flashcards
Financing choices available to sponsors
Pay as you go Smoothed PAYG Terminal funding Just in time funding Regular contributions Lump sum in advance
Important factors sponsors consider for financing benefits
- Contribution stability
- Contribution predictability
- Cashflow availability
- Opportunity cost
- Accounting needs
Book reserve
A provision in a company’s accounts for a benefit liability payable in the future for which no funds have been set aside
Provides some extra security for the benefits however this depends on the ability of the employer to provide the funds when required
Issues arise when a company becomes bankrupt. Then the winding up priority of a ring fenced book reserve or existence of a third party guarantee will determine the security for the benefits
Forms of third party guarantee required in conjunction with book reserving
- Financial guarantee from a parent company
- Financial guarantee from shareholders
- Letter of credit from a bank
- Insurance policy covering the insolvency is the employer
- Solidarity agreement within an industry or profession to meet other companies debt
Aim for an insolvency insurance scheme and why it would likely be compulsory for all schemes
Aim is provide financial protection as a last resort in the event of the employer insolvency to meet any benefit shortfall or if a scheme is required to wind up
Would likely be compulsory to reduce selection risk
Factors affecting the cost of insolvency insurance
- Funding level of the scheme
- Value of the schemes liabilities
- Credit worthiness is the company
- Extent of cover provided
- Number of scheme members
Seven criteria for assessing financing methods
DR FLOSS
Durability (contribution rate not distorted by major events)
Realism
Flexibility Liquidity Opportunity cost Security Stability
Stability
Ability of a financing method to produce a contribution rate which is not unduly distorted by fluctuations in experience
Durability
Ability of a financing method to produce a contribution rate which is not distorted by major events eg ageing membership
Ageing membership may be a result of:
- employer ceasing to recruit new employees
- Scheme closed to new entrants
Rational reasons for funding in advance
If investment returns in the scheme are expected to give a higher rate of return than the cost of other sources or finance (after allowing for tax and risk)
Security to benefits
Allows sponsor to spread cost of benefit Provision in a suitable manner
Sponsors key arguments for a scheme being contributory or non-contributory
Contributory
- Cost sharing (cheaper to run or higher benefits)
- Encourage employers to make provisions
- Individuals deterred from joining, lower cost
Non-contributory
- Great control over the scheme
- Membership encouraged
- Easier admin
Pay as you go
Pay for benefits as they fall due
Lump sum in advance
Setting aside funds expected to be sufficient to meet the cost of benefits as soon as the benefit promise is made
Terminal funding
Setting aside funds expected to be sufficient to meet the cost of a series of benefit tranches as soon as the first tranche becomes payable
Regular contributions
Setting aside funds gradually, expected to be sufficient to meet the cost of the benefit over the period between the promise being made and the first benefit being payable
