Syllabus objectives
Syllabus objectives
4.2 Determine an appropriate funding method, together with suitable financial and demographic assumptions, that can be used to value benefits and contributions in specific scenarios.
5.2 Describe how projection models may be used to develop strategies.
Purpose of Valuation Methods
Purpose of Valuation Methods: A SMEC
- Allocate liabilities between past and future service.
- Set contribution requirements.
- Measure the scheme’s funding level under different objectives (funding, accounting, solvency, buy-out).
- Ensure equity between different cohorts of members.
- Communicate financial health of scheme to trustees, sponsors, regulators.
List the four main funding methods and state into which of the two broad categories of methods they fall.
Prospective benefits methods:
1. Attained Age
2. Entry Age
Accrued benefits methods:
3. Projected Unit
4. Current Unit
Aggregate Method - AA
Defined Accrued Benefits - CU, value wind up
Describe Defined Accrued benefit Method
- Models Liability on the winding-up of a scheme
- Benefits -entitled on wind-up of the scheme
- Allows for def reval
- DRC if L > A
- Control period - Time till wound up.
- FSR - includes wound up costs
Factors affecting the choice of funding methods in practice
Factors affecting the choice of funding methods in practice - DR FLOSS
Durability (long-term sustainability).
Realistic measure of long-term cost (Scheme design & Demographics)
Flexibility
Liquidity
Opportunity cost / efficient use of money Security
Stability (of Conts)
For a final salary scheme where the salary link remains, rank the Actuarial Liabilities of the AAM, EAM, PUM and CUM in descending order of magnitude, under normal assumptions. State the ‘normal’ assumptions.
EA > AA = PU > CU
If Inv Retrun > Sal Inc > Def Reval
And Avg Age Act > Assumed Entry Age
Higher Liab - > Higher security
Assuming benefits continue to accrue, list the conditions that are required for the Standard Contribution Rates of each of the four main funding methods to be stable
The benefit structure, method and assumptions should remain the same.
EAM: simply requires no change in the assumed entry profile of new joiners.
AAM: stable age / sex / salary profile of the membership, or a closed scheme where the SCR is calculated once at closure
PUM: stable age / sex / salary profile of the membership
CUM: stable age / sex / salary and past service profile of the membership
Reasons for calculating scheme liabilities
The calculation of scheme liabilities for on-going funding purposes might include:
- funding valuation
- buy-out valuation with an insurer
- self-sufficiency valuation
4, accounting valuation - interim reviews.
- transfer to a non-insurance consolidator
- valuation of additional funding objectives
The calculation of scheme liabilities for other purposes might include:
1. valuation on scheme discontinuance
2. individual pension arrangements
3. bulk transfer value
4. individual transfer value
5. calculation for conversion or amendment of members’ accrued benefits
What are the different Valuation Method (discount rate approaches):
Valuation Method (discount rate approaches):
- Asset-based discount rate.
- Market-consistent (replicating portfolio).
- Bond yields + risk premium
Different Modelling approaches
Modelling Approaches:
Deterministic (single assumptions, transparent).
Stochastic (distribution, risk-focused).
Asset-Liability Modelling (ALM):
- Combines stochastic economic models with deterministic demographic models.
-Tests strategy robustness, identifies contribution risk.
Scenarios where different Funding methods are more suited
Applications
Open, young scheme → PUM/EAM, contribution stability needed.
Mature, closed scheme → AAM/DABM, focus on stability and prudence.
Sponsor wants smooth % salary → EAM.
Weak covenant → AAM, conservative assumptions.
Strong covenant → PUM + longer recovery.
Use of ALM → set triggers for de-risking, negotiate risk budget with sponsor.
Impact/Reasons for choosing a funding method
Funding methods
1. allocate pension cost/liabilities across service periods
2. Set contribution patterns.
3. The choice affects contribution stability, intergenerational fairness, and funding risk.
Q1. Describe and compare the main actuarial funding methods. (15 marks)
Describe and compare the main actuarial funding methods. (15 marks)
Cover PEAC + Aggregate + DABM.
Apply DR FLOSS to assess suitability.
Q2. What criteria should be used to assess a funding method? (10 marks)
Use DR FLOSS mnemonic.
Give scheme-specific examples: e.g.,
Flexibility important for hybrid schemes; Contribution stability key where sponsor has volatile profits.
Q3. Compare market, smoothed, and book value of assets in valuations. (8–10 marks)
Q3. Compare market, smoothed, and book value of assets in valuations. (8–10 marks)
Market → fair but volatile.
Smoothed → good for contribution planning.
Book → irrelevant in modern context, but may be seen in India for legacy schemes.
Q4. Discuss the main approaches to setting a discount rate. (10 marks)
Q4. Discuss the main approaches to setting a discount rate. (10 marks)
Asset-based: aligned to actual investment.
Market-consistent: replicating portfolio, objective.
Bond yields + risk premium: widely used, but debate over risk premium allowance.
Exam tip: highlight subjectivity in choice.
Q5. Compare deterministic and stochastic models. (12 marks)
Q5. Compare deterministic and stochastic models. (12 marks)
Deterministic → simple, transparent.
Stochastic → captures probabilities, tail events.
Both should be used together for trustee decision-making.
Q6. Explain the role of asset-liability modelling (ALM) in strategy setting. (12 marks)
Q6. Explain the role of asset-liability modelling (ALM) in strategy setting. (12 marks)
- Uses stochastic for economics, deterministic for demographics.
- Assesses risk of high contributions.
- Allows sponsor to see trade-off between contributions and risk.
- Helps design glidepath strategies.
Q7. A mature scheme, closed to accrual, with weak sponsor covenant. Recommend and justify an appropriate funding method. (15 marks, scenario)
Q7. A mature scheme, closed to accrual, with weak sponsor covenant. Recommend and justify an appropriate funding method. (15 marks, scenario)
AAM or DABM more appropriate.
Contribution stability essential.
Prudence in discount rate.
ALM can demonstrate insolvency scenarios.
Communicate to trustees/sponsor.
