Organization of Pension Funding and Provision Essay

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Pension Funding and Provision

Pension schemes refer to arrangements for providing retirement benefits. Occupational schemes are prepared by organizations, or for a set of organizations, for providing at least one employee with benefits. In private sector firms, these schemes, linked to trustees, are regulated through trust law. Two key forms of job pension schemes exist (Banks et al. 2002), of which one is the defined benefit plan, wherein rules lay down benefit rates to be disbursed. 'Final salary' plan is the most widely-adopted defined benefit plan; however, of late, 'career average' plans are increasingly gaining importance. Meanwhile, 'money purchase' or defined contribution plans are those wherein benefits are governed by paid-in contributions, their investment returns, and nature of annuity bought at the time of retirement.

Defined Benefit Schemes

Sometimes called final salary pension plans, these schemes are primarily employer-sponsored, although, at times, staff has to pay regularly towards them. Such plans accord employees a certain percentage of their final salary, just prior to retirement, or at the time of leaving the organization, as yearly income. The percentage is determined by tenure of employment with the company. Generally, employers fix 'accrual rates' as a share of employees' final salary. For instance, if accrual rate is fixed at 1/60th, retiring employees will receive 1/60th of their final salary (i.e., salary at the time of leaving), as retirement revenue for every year they have worked for the company. Thus, an employee who has served the company for a thirty-year period will receive 30/60ths (i.e., half) of their final salary (Banks et al. 2002).

Pension schemes coming under the defined benefit category must ensure they have adequate assets or resources for meeting their liabilities or obligations at the time they are due. If liabilities surpass assets, pension plans will witness a deficit or funding shortfall. In such instances, sponsoring organizations tend to raise contribution levels. When pension assets surpass liabilities, the pension plan will be in surplus. In such instances, organizations occasionally offer contribution holidays (i.e., breaks to employees from contributing) (Mercado 2012). Asset performance and nature of liabilities govern whether pension plans will be in surplus or in deficit.

Assets of pension plans are usually valued on basis of market price; hence, one can easily estimate them. It is relatively more difficult to gauge liabilities of pension schemes. Several factors have to be taken into account, such as interval of time each member must be paid pensions (which is dependent on life expectancy of the individual) and amount of pension increase per annum. Future payment stream should subsequently be estimated in terms of 'present value' through the discounting method, which converts future payment value made over time into equivalent current value. For fixing contributions, the scheme-specific financing regime of the United Kingdom requires agreement between sponsoring company and scheme trustees on a suitable discount rate (depending on actuarial recommendation) in collaboration with PTR (The Pensions Regulator) (Pension Protection Fund and The Pensions Regulator 2014). Such a liability measure, called Technical Provisions, differs across schemes.

The most exhaustive dataset to estimate defined benefit plans' liabilities in the United Kingdom is the one utilized for compiling PTR and PPF's (Pension Protection Fund's) Purple Book (2014). This Purple Book values liabilities for PPF plans (chiefly private sector plans) by employing the following two techniques: s179 or section-179 approach and total buy-out method. The former approach estimates costs associated with purchasing PPF compensation levels using an insurer, while the latter method gauges cost of total scheme insurance. The measure of Technical Provisions is between the above two liability measures.

Strengths

A key forte of defined benefit schemes is that no effort is needed on the individual's part. The organization and trustees are charged with ensuring obligations are met by the fund. While some risk is also associated (realized extremely if the organization becomes insolvent), all fund-related shortfalls must be compensated by the organization, through increased contributions. The organization that offers defined benefit schemes is tasked with contributing to the scheme and performing individual investment decision-making. Pensioners merely need to do their job properly, and their retirement benefits await them at the time of retirement (Wilson 2014).

One among the greatest advantages of defined benefit plans is security. Employees enrolled in such plans know the precise amount of money they will receive while retiring. They need not worry about market performance, as the amount will always be ready for them when they choose to retire from their job (Cannon & Tonks 2012).

The PBGC (Pension Benefit Guaranty Corp) represents another strength which provides safety to people covered by defined benefit schemes.

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This governmental agency regulates a number of defined benefit schemes. Organizations that use this kind of insurance are required to disburse specified amount annually, for individual pensions. If anything goes wrong with the organization, PBGC steps in and covers the pension of all enrolled employees (Cannon & Tonks 2012).

Yet another advantage such as a retirement scheme is that employees are aware of the precise duration of time they are required to work before retiring. Through such plans, employees receive a particular predefined sum of money, factoring in each year of service provided to the organization. With other retirement plan forms, it is essentially just a guess. Employees will be required to wait till they reach the specified retirement age; however, after they reach that point, they won't be sure of when they must seek retirement (Wilson 2014).

Weaknesses

The main problem linked to offering employees a defined benefit scheme starts with estimating the PBO (projected benefit obligation) of individual employees. This represents an estimation of current value of personnel pension benefits' future liabilities. Hence, one weakness of defined benefit schemes is: employees might be unable to earn as much as they would if they opted for defined contribution plans.

A second likely weakness linked to defined benefit schemes is the fact that employees have no control over these investments. There are some people who are perfectly fine with, or prefer, not being burdened with the task of watching and handling their investments, but there are other individuals who prefer having some measure of control when it comes to their investments. In case of defined benefit schemes, employees are not allowed to decide where their investment goes, and this may prove problematic for some specific kinds of investors. There are some individuals who prefer the sense of control they experience when getting to select investments for themselves and selling them whenever they desire to do so.

Money Purchase Pensions

Also called defined contribution plans, these pensions get saved into a personal, individual pension fund that comes under money purchase plan. This method is employed for saving for a majority of personal pensions. They differ in how funds are invested as well as charge levels (Mintel 2010). Such pensions can be categorized into:

Workplace Pension Plans -- In this case, organizations and employees together make regular payments once every month, and that amount is invested by some pension firm till the employees reach retirement age. Workplace pensions are principally of two kinds: contract-based and trust-based pension plans.

Trust-Based Pension Plans -- A Trustee Board Manages Investments On Behalf of Clients (i.e., Employees). Personnel and, probably, their employer pay into pension pots, and the funds are invested. This trust fund remains at arm's length (i.e., detached from the organization). Further, it allows handing of benefits to the employee's spouse/partner or any other dependent individual (Mintel 2010).

Stakeholder Pensions -- Such pensions resemble workplace pensions, with the difference being flexible and low minimum contributions, default choice of investment and capped charges. Employees need not make decisions with regard to where they must invest their cash.

Group Personal Pension Plans --Such a pension will be between workers and some third-party insurance agency, which isn't obliged to take action in the employee's best interests. While the problem is that organizations get to select the insurance provider, such arrangements normally offer employees numerous investment choices.

Sipps or Self-Invested Personal Pension Plans -- While they work identical to the above plans, Sipps are do-it-yourself pensions that allow employees to choose investments for themselves. Investors who are ready to personally perform the legwork can run Sipps at low cost, provided they make use of the right insurance agency (Mintel 2010).

Strengths

One among the greatest strengths of employing defined contribution schemes is that employees have greater control over investment/pension processes (Cannon & Tonks 2012). They will be able to decide the amount they wish to allocate to the pension, and will also be able to make investment-related decisions. Using such a scheme, employees will be able to select the kind of investment in which to put their money. Moreover, they can decide when to purchase and sell their shares, as well as their risk level. On the other hand, when opting for defined benefit schemes, personnel have no control over where their money goes or how it is utilized. Pension managers are tasked with these funds; they choose every employee's investments.

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