Chapter 5 Benefit Schemes Flashcards
Main PROVIDERS of benefits (5)
- State
- Employer
- Individuals
- Financial institutions
- Other corporations
What are the main objectives of the STATE (12)
- Provide for those unable to provide for themselves (minimum standard)
- Redistribution of wealth
- Paternalism
- To ensure that the population understands the benefits of education, e.g., regulate minimum level of information be disclosed when signing up for benefits
- Reduce burden on State, through encouragement of compelling private provision
- Stimulate savings and investment -> stimulate the macroeconomy
- Stable / predictable costs
- Simple scheme (low cost administration and easy to understand)
- Minimise fraud
- Avoid bureaucracy
- Positive macroeconomic effect
- Popularity with voters and employers
What are the main objectives of the EMPLOYERS (9)
- Be paternalistic
- Attract and retain staff, e.g., attractive benefits compared to competitors
- Reward certain staff e.g., high fliers, long servers
- Comply with legislation
- Control costs – affordability of contributions, stability, predictability, flexibility
- Offer benefits that are simple to understand and administer
- Take advantage of tax breaks
- Pool resources and expertise, e.g., multi-layer employers schemes
- Pooling of expenses / expertise
- Encourage employee provision, through matching constribution
What are the main objectives of the INDIVIDUALS (9)
- Protect self, and dependants against death and ill-health
- Protection – eg ill-health benefits, death benefits
- Inflation proofing of benefits so not eroded
- Ensure cost are affordable and flexible
- Minimise risk, eg secure and predictable benefits
- Ensure security and predictability of provisions
- Take advantage of tax breaks
- Comply with legislation
- Make sure that costs and benefits are understood
What is a MULTI-EMPLOYER SCHEME?
- Scheme set up jointly with other employers/ unions.
* Often within the same industry
What is a DB SCHEME?
- Scheme rules define benefits independently of the contributions made and investments achieved. Can be based on final pensionable salary.
- This is defined in the penson rules, e.g. average cost to company over past three years. This final pensionable salary is then multiplied by a factor years of service/accrual rate.
- During retirement the pension is level or increases in a fixed or indexed way
Explain the two types of DB SCHEMES (7/3)
- Occupational run:
* Set up by employer (also scheme sponsor) who meets some or most of the cost
* Trustees in place to:
- Oversee administration
- Ensure compliance
- Manage investments
* Can be contributary or non-contributary (cost met full by employer)
* Funded through regular contributions - State
* State is the sponsor
* No trustees - state is secure
* Not-funded, typically PAYG (i.e., current benefits are met from current inflows of taxation) or smoothed-PAYG (i.e., fund set aside for working balance due to timing differences, business cycles, and population changes)
What ASSETS can a DB SCHEME have and how is it VALUED? (3)
Active
- Property and equities -> match salary growth
- Can be market value or discount cashflow
Deferred
- Conventional and index-linked bonds
- Can be market value or discount cashflow
Current
- Conventional and index-linked bonds
- Can be market value or discount cashflow
Important to have consistency between the valuation of assets and liabilities
Explain the FUNDING level of DB SCHEMES and what to do with a SURPLUS (3) or DEFICIT (3)
Funding = Value of Assets / Value of Liabilities > 100% -> Surplus - Enhance benefits - Reduce benefits - Retain in scheme as a cushion
< 100% -> Deficit
- Increase contributions as one off or regular basis
- Regulation dictate approach adopted
- Reduce benefits
List POSITIVE (5) and NEGATIVES (7) for a DB SCHEME from the MEMBERS PERSPECTIVE
+ Risk of experience (investments, expenses, longevity) lie with the sponsor
+ Benefits are easy to predict
+ Easy to understand
+ Reward high-salary members
+ If funding is in surplus, members can benefit from an increase in benefits
- Risk of sponsor insolvency
- Can receive reduced benefits
- Lack of choice of investments and the provider of post-retirement benefits (annuity)
- Elements from salary might be excluded from the final salary definition
- Risk of salary falls near retirement
- Penalise early leavers (pension can grow at a revaluation rate which is lower than salary growth or contributions are returned)
- Not portable is transfer value = value of benefits giving up?
List POSITIVE (4) and NEGATIVES (3) for a DB SCHEME from the SPONSOR PERSPECTIVE
+ Good for recruitment and retenetion as benefits usually higher than DC schemes, members also appreciate predictability
+ Paternalism
+ Flexibility in level of contributions
+ Benefit from better than expected experience (receive payment holiday or refund from scheme)
- Bears risk of unpredictability of cost
- Sponsor bears experience risk (investment, expenses, longevity)
- Regulation can be onerous, especially valuation of assets and liabilities -> need actuary
What is a DC SCHEME?
- Defined contribution is a scheme providing benefits, where the amount of benefits depends on the contributions paid by the member and investment returns achieved
- Contributions and investments are allocated to individual accounts
- Accumulated funds at retirement can be exchanged for an immediate annuity (bought from an insurance company) or income drawdown
Explain the two types of DC SCHEMES (9/3)
Occupational Scheme
- Set up by employer
- Both employer and employee make contributions. Usually matched contributions
- Contributions are allocated to individual accounts
- Trustees in place to:
- Oversee administration
- Ensure compliance
- Manage investments
- Choices on how funds are invested and how benefits are taken in retirement
- Fund - through contributions
Personal savings plan
- Provider is usually an insurance company
- Purchased by an individual or by an employer (group pension plan)
- Choices on how funds are invested and how benefits are taken in retirement
List POSITIVE (5) and NEGATIVES (7) for a DC SCHEME from the MEMBERS PERSPECTIVE
+ Build up of pension fund is easy to understand
+ Choice of investments pre-retirement and benefits in retirements
+ Portable between scheme
+ Investment returns better than expected
+ If an annuity is purchased experience risk is carried by insurer
- Value can go up or down depending on investments
- Benefit options at retirement are hard to understand
- Benefits at retirement can be hard to predict
- Members lack the financial sophistication to make informed decisions
- Member bears pre-retirement experience risks
- Income drawdown / complete freedom member is exposed to exprience risk
- Death inservice can be poor
List POSITIVE (2) and NEGATIVES (5) for a DC SCHEME from the SPONSOR PERSPECTIVE
+ Experience risk with member
+ Cost is more predictable, controllable, and less volatile than DB
- Pension performance badly -> reputational risk
- Miss out on better than expected experience
- Less flexibility over timing of contributions
- Less onerous regulation, however is more administrative intensive as each member has an individual account (fund transfer, fund performance statements)
- Benefits can be seen as less attractive than DB so difficult to recruit and retain staff
