C6 - Design (general)

Question 1

Decisions to be made when setting up a DB scheme7

Answer 1

• Which stakeholders should take the risks
• Level of benefit to be provided/targeted
• Benefits defined in real or monetary terms
• Benefits real relative to price or earnings inflation
• Events where benefits should be provided
• Form Benefits should be provided in
• Differing approaches between individuals
• If any options should be provided

Question 2

Different approaches adopted when providing State-sponsored benefits

Answer 2

• Targeted/means tested approach
• Flat-rate basic pensions to provide safety net for all
• Flat-rate basic pension plus earnings related pension
• Earnings related pension (maybe with ceiling/threshold)

Question 3

What is a DB scheme?

Answer 3

Benefits are defined independently of the contributions payable and are not directly related to the investments of the scheme

May be funded or unfounded

Question 4

Balance of cost scheme

Answer 4

DB scheme where individuals make a DC contribution (could be 0) and the main sponsor pays the remainder of the unknown cost of providing the benefits

Due to the gearing effect the volatility of the sponsors contributions is high under this type of arrangement

Question 5

Hybrid scheme

Answer 5

Offers both DB and DC sections or benefits which are the better of the benefits on a DB or DC contribution basis

Share risks between employers, members, insurers and investment businesses although often with the drawback of increased complexity in operation

Question 6

The ultimate cost of a DB scheme depends on:

Answer 6

Actual experience of the scheme

Question 7

Defined ambition scheme

Answer 7

Scheme where risks are shared between the different parties involved eg members, employers, insurers and investment businesses

Question 8

DA schemes that are more DB in nature

Answer 8

• Career Average Revalued Earnings schemes
• Cash balance schemes
• Using longevity adjustment factors (retirement age is increased for future service in light of increasing longevity)
• Greater use of risk management options such as longevity swaps, bonds, insurance
• Core DB Benefits, and other benefits discretionary
• Offering a defined level of benefit and converting it to a DC fund when member leaves the scheme
• Adjusting the retirement age in line with SPA

Question 9

DA schemes that are more DC in nature

Answer 9

• With profit funds
• Deferred annuities
• DC with a DB target
• Guarantees eg money back, minimum investment, retirement income

Question 10

General scheme design considerations

Answer 10

AMPLE DIRECT FACTORS
Administration 
Marketability
Profitability 
Level & form of benefits
Employees to contribute?

Discretionary benefits 
Interests & needs for members
Risk appetite of all parties
Expenses
Competitors 
Trust deed and rules

Funded or unfunded?
Accounting
Consistency 
Type of scheme
Objectives
Regulation 
Subsidies (cross)

Question 11

Integrated scheme design

Answer 11

Need to consider any benefits that the individuals may get from other sources eg:

• Employers will take note of State benefits
• State will look at common forms and levels of non-State provision or that the state incentives
• Personal wealth and earnings of individuals
• Regulations that set min/max levels
• Restrictions resulting from cross border agreements

Question 12

DC scheme

Answer 12

Benefits are not known in advance and depend on:

• contributions paid by employers and individual
• investment returns in funds in period before retirement
• level of fees paid from member’s fund
• terms in which the fund is converted to income at or during retirement

Question 13

Contribution rate structures to a DC scheme

Answer 13

• Fixed
• Age related
• Service related
• Matched (usually up to a limit)

Question 14

Lifestyling

Answer 14

Investment strategy under which the assets of a members fund are typically switched from equities into cash and bonds over the few years before retirement

Question 15

Risks of income drawdown

Answer 15

• If only income earned on fund is taken each year then income could be volatile
• If fixed income is taken the capital could reduce to zero
• Admin costs may be high
• Remaining fund on death may be insufficient to provide adequate benefits for dependants
• Tax charge on death
• If defer buying an annuity will experience mortality drag if they purchase an annuity at the end of the drawdown period. They will effectively be charged for their own survivorship during this period and lose the subsidy from those who die early

Question 16

Benefit Provision for DC schemes

Answer 16

• amount of cash taken
• purchasing an annuity from insurer/scheme
• what pension increase to secure
• what dependants benefits to provide
• income drawdown