Pension and Social Security Schemes: Benefits, Funding and Actuarial Modelling
Pension structures
This domain tests benefit structures, funding and modelling for occupational and social security schemes. A defined-benefit scheme promises a formula-based pension, often using accrual rate times pensionable service times final or average salary. A defined-contribution scheme accumulates contributions and investment returns, with retirement income depending on the fund at retirement. State pension schemes are often pay-as-you-go, with current contributions paying current benefits rather than a pre-funded pool.
Funding and valuation
A pension valuation compares scheme assets with the present value of accrued liabilities. The funding ratio is assets divided by liabilities. A deficit requires additional contributions or benefit changes. Actuarial modelling projects salary growth, service, mortality, retirement ages, investment returns and inflation. Discount rates must be consistent with the liability and funding basis. Contribution rates are set so that contributions plus investment income meet benefit outgo and build assets where needed.
Worked example
A defined-benefit scheme accrues 1/60 of final salary for each year of service. A member with 20 years and final salary 60,000 has an annual pension of 20/60 times 60,000=20,000. If scheme assets are 300 million and the present value of accrued liabilities is 350 million, the funding ratio is 300/350=85.7%. The deficit is 50 million. A contribution increase or a reduction in future accrual could address the shortfall.
Traps
Confusing accrued benefits with projected benefits; comparing assets with a liability value calculated on an inconsistent discount basis; ignoring salary growth and mortality improvement; and treating pay-as-you-go social security as if it were fully funded.