Section 5.7 - The objectives of pension funds and insurance that impact investment decisions

Question 1

What are the two types of pension funds

Answer 1

• DB Scheme - Provides employees with a guranteed income for when they retire. Factors taken into consideration are the employees salary and years of service
• DC Scheme - Funded by employees - can elect to defer a percentage of the salary to funds
• Low risk
• Examples include personal pensions

Question 1

What is the most popular way for a retail investor to invest

Answer 1

• Through investment instituions e.g pension funds and insurance companies
• Pension funds are paid gross and taxable

Question 2

What are the benefits to pension schemes

Answer 2

• Benefit from certain tax releif - the accumulated funds in a scheme are not liable to income tax
• Pension fund managers concentrate their investments in long term assets

Question 3

transaction costs

Why do fund managers prefer to recieve dividend income than capital gains

Answer 3

• Adjusting a portfolio by realising gains incur transaction costs - sales of secruties and purcase of new secruties
• If the fund can be rebalnced by using dividend or coupon income, transcation costs will only be incurred of the puchase of secruties

Question 4

Choosing what assets to invest in pension fund is determined by what factor?

Answer 4

• By the ‘maturity’ of the fund’ - Fund with a lot of contributing employees close to retirement should be more ‘mature’ than a fund with young contributors
• Actuaries take into account factors such as mortality tables

Question 5

What are trustees role when it comes to pension funds

Answer 5

• Often determine the proportion of asets held in asset classes - may want to invest in more fixed-income secruties rather than equties

Question 6

How does DB scheme work

Answer 6

• For a 1/80 scheme, a person retiring with **40 years of contribution and final salary of £50,000 **will recieve a pension of 50,000 x 40 = 2 million / 80 = £25,000 a year untill death

Question 7

What is the importance of a Liability-driven Investment (LDI)

Answer 7

• It involves taking future liabilties given and building a portfolio of assets needed to meet those future liabilities - portfolio of assets made up of bonds and swaps

Question 8

What is the difference between life assurance companies and general insurance companies

Answer 8

• Life assuranceinvolves long term liabilties and the portfolio of assets managed also tend to be long term
• They are subjected to CGT and income tax
• However, some can policies can be** qualifying** meaning that it is not taxable
• General insurance covers fire, theft, storm damage etc
• Liabilties are short term as most claims are made immediatley after an event so they invest in secruties that are highly liquid becuase they must be ready to pay out upon claims

Question 9

What is the simmilarties of insurance companies and pension funds

Answer 9

• They both hold long-term liabilities and the main objective will be capital growth - Main investments include equties due to it being able to generate high returns over the long term

Question 10

The amount of liquidity for a DC scheme will depend on what factor

Answer 10

• Will depend on employee turnover rates, withdrawal provisions and the average age of contributing employees

Question 11

What is the time horizion of general insurance compared to life assurance

Answer 11

• General insurance - much shorter time period lasting anywhere between 3-5 years

Question 12

What constraints in a portoflio fall under what catogery

Answer 12

1. Liquidity needs - Fixed-income instruments wukk give easier access ti cash should it be requried
2. Time horizon - The longer the time horizon of the fund, the more risk it can tolerate