Benefit payments

Question 1

4 Types of benefit payments

Answer 1

▪ Guaranteed in money ( nominal) terms
▪ Guaranteed in terms of index
* The index may be published
▪ Discretionary
* with profit ( bonus payments ) or pension increases in excess of
guaranteed amounts
* Payable at discretion of the provider
▪ Investment -linked
* unit linked benefits
* amount determined by value of the investments underlying
contracts

Question 2

Expenses outgo

Answer 2

▪ Tend to increase over time
▪ The increase normally depends on the price and earnings inflation
▪ Investment expenses – linked to prices or earnings
▪ Administrative expenses – may be broadly real but rarely guaranteed

Question 3

Premiums

Answer 3

▪ Fixed in monetary terms
▪ Increase in line with an index
▪ Premiums may be considered fixed in short term between reviews

Question 4

Guaranteed in money terms

Answer 4

o Pure matching
▪ Investing in assets to match the liability outgo which is guaranteed
▪ Match needs to be in both timing and the amount of liability outgo
o Approximate matching
▪ It is sometimes impossible to find assets that match exactly the expected
liability outgo
* Due to price being unreasonably high
* Terms of available assets may be shorter than the corresponding
liabilities , especially when long term liabilities are considered
* Existence of options in liabilities and assets makes it impossible to
match
▪ Best match may be achieved by Invest in high quality fixed interest bond of
a term suitable for match the expected term of the liability outgo
▪ Could also use derivatives but these are expensive and exact matching may
not always be possible

Question 5

Guaranteed in terms of prices of index or similar

Answer 5

o Most suitable is investing in index linked securities, where available , ideally chosen
to match the expected term of the liability outgo
▪ In the absence of these securities, substitute would be assets that produce
a real return , e.g. equity type investments and property
▪ They are not perfect match for these liabilities because their return is not
guaranteed
* Either absolute or index linked terms
* However the return moves in line with price inflation to some
extent

Question 6

Discretionary benefits

Answer 6

o The main aim of the provider will be to maximise these and hence the investments
of assets that will produce highest returns will be considered
o This is subject to the risk appetite and risk of client expectations

Question 7

Investment Linked

Answer 7

o Invest in the same assets as used to determine the benefits
o Replication of market indices is expensive and so the companies might choose to use
Collective investments schemes or derivative strategy to achieve this

Question 8

Currency

Answer 8

liabilities denominated in that particular currency should be matched by assets in that
currency , to reduce currency risk