C9 - Risks & Uncertainties

Question 1

Why fund may be insufficient to provide a promised benefit

Answer 1

• Scheme underfunded
• Insolvent sponsor
• Combination of the above

Question 2

Main risks associated with DB benefits

Answer 2

• Inadequate funds eg through underfunding or insolvency
• Illiquid assets
• Detrimental benefit changes
• Failing to meet members needs (either due to failure by member to recognise this when promise was made or through inflation erosion)
• Unappreciated Benefits

Question 3

Main risks associated with DC benefits

Answer 3

• Investment return
• Poor annuity purchase terms
• Inadequate benefits
• Inflation risk
• Market value

Question 4

The overall contributions required for a DB scheme depends on the following factors:

Answer 4

• Probability of individuals being eligible to accrue benefits
• Probability if individuals being eligible to receive benefits
• Effect of inflation on the real level of benefits
• Investment return achieved on the contributions

Question 5

Risks to sponsor of over-funding a scheme

Answer 5

• Opportunity cost of excess funds
• Subject to financial penalty if authorities believe using the scheme for tax advantages
• Trustees, members, unions or legislators expect greater benefits to be provided
• Sponsor becomes insolvent as a result of paying excessive contributions

Question 6

Factors affecting the uncertainty of contributions (both in DB or DC schemes)

Answer 6

• Loss if funds due to fraud/misappropriation
• Incorrect benefit payments
• Inappropriate advice to members/sponsors
• Higher than expected admin cost, especially due to legislative changes
• Fines or removal of tax status due to non compliance
• Poor decisions by other parties eg actuaries

Question 7

Inappropriate advice may come from:

Answer 7

• Incompetence or insufficient experience of advisor
• Lack of integrity
• Use of unsuitable model or parameters
• Errors in data

Question 8

Investment risk areas

Answer 8

• Overall levels of return reduced by tax and expenses
• Income generated by assets held
• Capital provided on redemption/sale of assets
• Mismatching between assets and liabilities
• Reinvestment risk
• Default risk
• Opportunity cost

Question 9

Sources of error that may arise when determining contributions

Answer 9

• Use of an unsuitable model
• Use of unsuitable parameters
• Errors in any data used to determine model parameters
• Errors in member data

Question 10

Risks when setting option terms

Answer 10

• Investment risk
• Selection risk (may depend on whether a market related basis is used)
• Security of remaining benefits is weaker
• Terms offered are not fair
• Regulatory requirements are breached
• Scheme rules are breached

Question 11

Use and risk of insurance

Answer 11

Insurance can help:

• increase certainty
• better match liabilities
• with liquidity

Likely to require a premium to fund capital, contingency and profit margins