Chapter 5: Benefits overview and providers of benefits

Question 1

Types of pension scheme members

Answer 1

Active members - members still earning future benefits over time eg a current employee of the sponsoring company

Deferred members - members who have stopped earning any future benefits who have an existing benefit entitlement that will come into payment in the future, eg an employee who left to work for another company

Current pensioners - members who are receiving their benefit entitlement

Question 2

Defined Benefit Scheme

Answer 2

A defined benefits scheme is one where the scheme rules define the benefits independently of the contributions payable, and benefits are not directly related to the investments of the scheme

Benefits will be defined by a set formula, and might be linked to, for example:

• how long the member works for the sponsoring company
• the member’s salary at retirement

The scheme may be funded or unfunded.

The members’ benefits are promised and independent of investment return, longevity, and administration expenses. The risks, therefore, lie with the employer (if the members live longer than expected, the employer needs to pay more money into the scheme)

Question 3

Defined Contribution Scheme

Answer 3

A defined contribution scheme is one providing benefits where the amount of an individual member’s benefits depends on the contributions paid into the scheme in respect of that member, increased by the investment return earned on those contributions

The risks lie primarily with the members, for example, if investment performance is poor, then each member’s accumulated fund will be smaller than expected and hence the annual pension lower than expected

If an annuity is purchased at retirement, then longevity risk passes to the annuity provider at this time. If an annuity is not purchased, then longevity risk remains with the member

Expenses risk may lie with the employer or the members depending on whether expenses are met separately by the employer or are met from charges taken from the accumulated fund

Question 4

Hybrid Schemes

Answer 4

A hybrid scheme is one where risks are shared between the different parties involved, for example, scheme members, employers, insurers, and investment business

Investment, longevity and expense risk is shared between the members and the employer

Question 5

5 main providers of benefits

Answer 5

1. The State
2. Employers or a group of employers
3. Individuals
4. Financial institutions (insurance companies, banks, mutual funds and investment companies)
5. Other organizations (trade unions, credit unions, employee associations, religious organisations and charities)

Question 6

What benefits might the State provide?

Answer 6

The State may provide retirement, ill-health, death and unemployment benefits.

The State may also provide financial instruments such as national debt securities, State sponsored savings plans and the facility to deposit money in State bank accounts

Question 7

List the 6 key roles of the State in relation to benefit provision

Answer 7

1. Provide benefits to some, or all of the population
2. Sponsor the provision of such benefits, perhaps by providing appropriate financial instruments.
3. Provide financial incentives, usually through the tax system, either for other providers to establish appropriate provision, or to subsidize the cost of providing such provision to consumers.
4. Educate or require education about the importance of providing for the future.
5. Regulate to encourage or compel benefit provision by or on behalf of some of the population.
6. Regulate bodies providing benefits, and bodies with custody of funds, in an attempt to ensure security of promises made, or expectations created

Question 8

What is a multi-employer scheme and what is its key advantage and disadvantage?

Answer 8

A multi-employer scheme is a benefit scheme set up jointly with other employers, often from the same industry.

Advantage: It makes provision more cost effective.

Disadvantage: More care must be taken over allocating the liability for funding DBs, particularly in the event of the insolvency of one of the sponsors.

Question 9

List 3 possible roles of employers in relation to benefit provision.

Answer 9

1. Educating, and either encouraging or compelling employees to plan benefit provision
2. Financing of benefits for employees, in an orderly manner
3. Providing a facility (scheme) for the provision of benefits

Question 10

List 4 reasons why employers finance benefits for employees.

Answer 10

1. Compulsion or encouragement from the State
2. A desire to attract and retain good quality staff
3. A desire to look after employees and their dependents financially beyond the level provided by the State.
4. To pool expenses and expertise

Question 11

Describe a flexible benefit system

Answer 11

Under a flexible benefit system, employees are offered the option to choose between benefits, which the employee can ‘buy’ or ‘sell’

They are given a notional amount which they can spend

Question 12

What are the roles of the individual in relation to benefit provision?

Answer 12

The main role is to finance benefits through, for example, a scheme provided by the State, an employer, an insurance company or other financial organization.

Alternatively, individuals may use individual savings or domestic property to finance benefits, or by way of financial support from families or local community schemes.

Individuals might be incentivised to finance benefits through tax advantages or by employers matching employee contributions up to certain limits.

Question 13

What role do financial institutions play in the provision of benefits?

Answer 13

They provide benefit schemes and insurance products.

They may also educate consumers on the importance of making benefit provision.

Question 14

Give 3 examples of how domestic property can be used as a source of benefits for an individual

Answer 14

1. The home could be sold
2. Loans can be secured on the accumulated equity in the home
3. A capital sum may be available on inheritance of a domestic property

Question 15

Defined Ambition Scheme

Answer 15

A scheme where risks are shared between the different parties involved, such as a scheme member, employers, insurers, and investment businesses