Professional Documents
Culture Documents
EXAMINATION
1. Enter all the candidate and examination details as requested on the front of your answer
booklet.
2. You have 15 minutes before the start of the examination in which to read the
questions. You are strongly encouraged to use this time for reading only, but notes
may be made. You then have three hours to complete the paper.
3. You must not start writing your answers in the booklet until instructed to do so by the
supervisor.
5. Attempt all seven questions, beginning your answer to each question on a new page.
Hand in BOTH your answer booklet, with any additional sheets firmly attached, and this
question paper.
In addition to this paper you should have available the 2002 edition of the Formulae
and Tables and your own electronic calculator from the approved list.
Currently the Company pays the benefit as a normal business expense, and does not
insure the benefit or fund for it in advance.
Outline the advantages and disadvantages to the Company of the proposed funding
arrangement compared with the current arrangement. [5]
Pension schemes in the country are not funded. Pensions are guaranteed by the
company and the company is required to purchase an insurance policy which would
provide the pension should the company become insolvent.
(i) Set out the relevant information that could be included in company accounts
under the new disclosure requirements. [3]
(ii) Outline how this information would help investors to understand the
significance of the pension liabilities of a particular company. [3]
(iii) Explain how investors might rank companies according to the significance of
their pension liabilities when presented with this information. [2]
[Total 8]
ST4 A20152
3 A defined benefit pension scheme (the Scheme) provides a non-escalating pension
at a specific retirement age, together with a contingent spouses pension equal to a
fixed percentage of the pension payable to the member. The Scheme is set up under
trust and the trustees have decided that greater choice should be offered to members
when they reach retirement age.
(i) List the options that the trustees might consider offering to members,
assuming that there are no legislative constraints. [5]
The trustees have decided that members should be offered a transfer value at
retirement, as an alternative to the pension payable under the Scheme. The transfer
value would have to be used to purchase a lifetime annuity with an insurance
company.
(ii) Outline the issues that a member should consider when deciding whether to
accept this option. [5]
[Total 10]
The Regulator has become aware of a particular pension scheme (the Scheme)
where the disclosure requirement has not been met since the legislation was
introduced. The Regulator has contacted the Schemes trustees, and has received the
following response:
(i) Outline, with reasons, the different penalties that might be available to the
Regulator in relation to this breach. [2]
(ii) Discuss what you would expect the Regulator to take into account when
deciding whether any penalty should be imposed on the trustee board of this
Scheme. [8]
[Total 10]
It has also been proposed that the amount payable under the State Pension Scheme
should be reduced to a fixed amount intended to meet basic needs only, and that any
employee who opts out of a company pension scheme should lose the right to the state
pension entirely.
Outline:
(i) Set out, for each option, the features of the design that will need to be
determined by the Company before the scheme can be implemented. [12]
(ii) Discuss the issues that an employee should consider when deciding which of
the two arrangements to join. [8]
[Total 20]
ST4 A20154
7 A defined benefit pension scheme (the Scheme), which is closed to accrual, is
undergoing a formal actuarial valuation as at 31 December 2014. The investment
strategy is to invest 80% in return-seeking assets (such as equities and property) and
20% in matching assets (such as government bonds).
The Schemes trustee (the trustee) has just received the covenant assessment report
for the sponsoring company (the Company), which has ranked the covenant as
broadly satisfactory. However, the report shows that there are particular concerns
about the amount of debt on the Companys balance sheet, which amounts to 300m
of secured loans. The report also notes that the market capitalisation of the Company
at the valuation date was 200m, and that the pre-tax operating profits for the
preceding year were 35m.
On the valuation basis that the Schemes actuary has proposed, the value of the
Schemes liabilities is 400m on an ongoing basis and 600m on a solvency basis.
The market value of the assets is 400m.
The Company is proposing that it only pays the Schemes expenses (i.e. the costs of
administration, professional fees and regulatory charges) until the date of the next
valuation, which is due in three years time. In addition, the Company is proposing
that a financial management plan is agreed between the Company and the trustee
setting out actions which would be taken if there were a material deterioration in the
financial position of the Scheme before the next valuation is due.
(i) Discuss the risks that could impact the financial position of the Scheme,
including risks relating to the Schemes experience and the sponsor covenant,
were they to arise over the period until the next valuation is due. [14]
(ii) Discuss the monitoring arrangements that the trustee could put in place to
ensure that it has appropriate information in relation to the financial position
of the Scheme, including the sponsor covenant, over the period until the next
valuation is due. [7]
(iii) Discuss the actions that might be included in the financial management plan.
[7]
(iv) Discuss the suitability of insurance as a means of mitigating each of the risks
that you have identified in part (i). [7]
[Total 35]
END OF PAPER
ST4 A20155
INSTITUTE AND FACULTY OF ACTUARIES
EXAMINERS REPORT
April 2015 examinations
Introduction
The Examiners Report is written by the Principal Examiner with the aim of helping
candidates, both those who are sitting the examination for the first time and using past papers
as a revision aid and also those who have previously failed the subject.
The Examiners are charged by Council with examining the published syllabus. The
Examiners have access to the Core Reading, which is designed to interpret the syllabus, and
will generally base questions around it but are not required to examine the content of Core
Reading specifically or exclusively.
For numerical questions the Examiners preferred approach to the solution is reproduced in
this report; other valid approaches are given appropriate credit. For essay-style questions,
particularly the open-ended questions in the later subjects, the report may contain more points
than the Examiners will expect from a solution that scores full marks.
The report is written based on the legislative and regulatory context at the date the
examination was set. Candidates should take into account the possibility that circumstances
may have changed if using these reports for revision.
F Layton
Chairman of the Board of Examiners
July 2015
This subject examines the ability of candidates to apply core actuarial techniques and
concepts, together with specific knowledge of pensions and other benefit arrangements to
simple, but practical situations.
The examiners therefore look for candidates to apply their knowledge of the core reading to
the specific situation that the examiners asked, having read the question carefully. Too many
candidates write around the subject matter of the question in more general fashion, or focus
on one aspect of the issue at great length, in either case gaining few of the marks available.
Good candidates demonstrate that they have used the planning time well - an attempt to get a
logical flow is a big advantage in making points clearly and without repetition. This also
enables candidates to use the latter parts of questions to generate ideas for answers to the
early parts (or use their solutions to earlier parts of questions to create a structure for latter
parts). Time management is important so that candidates give answers to all questions that
are roughly proportionate to the number of marks available.
The overall standard of scripts was broadly as expected, with a pass rate very similar to the
previous sitting.
There was a less significant variation in marks than in the previous exam, meaning that there
was not that great a distinction in marks between those who were able to demonstrate
sufficient depth to their knowledge to be able to secure a pass and those who were not quite
there. It is very important that candidates consider all aspects of the question, and read the
preamble fully. There is never superfluous information in the question, and by using all of the
information available, candidates can ensure they give a full answer. Giving just a little more
to clearly show depth can turn a close fail into a pass.
The questions are set so that it should take approximately twice as long to answer a 10 mark
question as a 5 mark one. Answers should therefore be similarly proportionate, as mentioned
in the general comments above.
In addition, candidates should carefully consider the instruction for example an instruction
to list points should be answered with a list without attaching discussion. Similarly, a
question asking for a discussion cannot be answered with a list of undeveloped points.
Page 2
Subject SA2 (Life Insurance Specialist Applications) April 2015 Examiners Report
There is a cost to insurance so that in the long term the cost of the arrangements
will increase
Because insurance companies will include a margin to meet capital requirements
and want to make a profit
Any mention of opportunity cost
It may be difficult to deal with claims that are incurred but not reported at a
financial year end depending on how the insurance contract operates
The insurer may look to have exclusions (e.g. claims caused by Health & Safety
breaches) or to seek conditions on the policy which the employer would need to
satisfy in order for the insurance to be valid
It is likely to cost more to administer the arrangements with the insurance
company
Initial start-up costs
Cost of internal pricing setting up reserve, advice etc.
Counterparty risk default of insurer
Generally well answered it is important for candidates to clearly set out pros & cons, and
to make sure their answer is balanced across the two. Do not repeat points.
2 (i)
Details of the benefit design
And who has the power to change the benefit design
In relation to both future service and past service (if this is possible)
Membership information
Valuation of the liabilities
And how these have impacted the balance sheet and p&l account
For both past and future service
Page 3
Subject SA2 (Life Insurance Specialist Applications) April 2015 Examiners Report
(ii)
Details of the benefit design will allow investor to assess key risk areas
e.g. Inflation
And information on the extent to which benefits are discretionary
Membership data if complete, could be used to allow investor to do
own calculations
Or to assess concentration of risk e.g. If only a few members account for
significant liabilities
Valuation of liabilities will allow investor to produce key financial
metrics e.g. Value of liabilities as a percentage of market capitalisation
Which are comparable between companies
And over time
Sensitivity assessment will be helpful to understand the extent to which
liability values are dependent on key assumptions
Insolvency insurance premium indication of the insolvency risk
(iii)
Investors might be concerned with an absolute measure of liability or a
measure relative to the size of the company?
An absolute measure would be based on a valuation of the liabilities
Is an ongoing measure more appropriate or a measure based on insolvency,
such as the insurance premium?
The key assumptions could be prescribed or scheme-specific
A relative measure could give this valuation as a percentage of the assets
or earnings of the company
Or by considering the impact of the pension cashflows on profitability
Variability of ranking could be illustrated using sensitivity analysis or
scenario testing
Rankings will depend on the approach and assumptions used and so a
definitive ranking is unlikely to be possible
Book work sections were well answered, with better candidates able to apply their knowledge
to make a coherent argument in part (iii). Remember this is an unfunded arrangement!
Page 4
Subject SA2 (Life Insurance Specialist Applications) April 2015 Examiners Report
The member should then consider any points that are specific to the members
situation such as:
Marital status and existence of any financial dependants (including
children)
Noting that the transfer payment will include an allowance for a
spouses/dependants pension based on proportions married/financially
dependent which are relevant to the population generally
And will probably not make any specific additional allowance for
childrens pensions
Their own life expectancy (particularly if they know this is impaired as a
result of ill-health)
Noting that the transfer payment will probably be based on average life
expectancy
Both the above considerations will serve to increase the amount of the
annuity paid by the insurer in comparison to the current pension
Page 5
Subject SA2 (Life Insurance Specialist Applications) April 2015 Examiners Report
The member should then consider any preferences that might be available
under the insured arrangement but are not available under the current scheme
such as
Changing the shape of the pension (in the same ways as covered by part (i)
of the question)
Changing the amount and recipient of any contingent benefits payable on
death
It is important to answer the question in full. For example, candidates often missed obvious
points about comparison of the actual benefits themselves not just the level of transfer value
etc.
4 (i)
Mandatory training sessions
To help educate the respondents on the issue
Fine the trustees
To remove them as trustees from this scheme
To prevent them from acting for any other scheme
And potentially to imprison them (although this would generally be
considered an extreme penalty for this type of breach taken in isolation)
To act as a punishment for the breach of legislation
(ii)
The regulator is likely to consider the purpose of the requirement to
disclose this information
When the disclosure requirement was introduced and how long non-
compliance has been going on
And the reasons that the legislation was first introduced
Such as any situations where members have had their benefits reduced
unexpectedly
Leading to pressure from trade unions and lobby groups for more
information to be provided about funding and security of benefits
The regulator is also likely to have regard to the extent that a compliance
culture exists in the country
And whether other schemes have also failed to comply
In which case, he would have regard to any penalties issued in these cases
Page 6
Subject SA2 (Life Insurance Specialist Applications) April 2015 Examiners Report
Noting that if this is the first such breach, the penalty issued will be a
precedent for future cases
The regulator is likely to check how well scheme is run and whether there
have been previous breaches of law by the same trustee board
And will probably impose a harsher penalty if the trustees have been non-
compliant in the past
Or if he discovers related breaches e.g. That the trustees have not finalised
the calculations required to determine the year end funding position
The regulator may take in to account whether benefits are at risk
Because the funding position is low
Or the employer covenant is weak
Or the investment strategy is risky
Or member misled over decisions
Materiality of non-disclosure
The regulator may consider the extent to which the trustees have made any
information about the funding position of the scheme available to members
The regulator may ask why it was not consulted in advance of the decision
not to disclose
Or take in to account whether the trustees are prepared to correct the
breach and issue the statement now
The regulator may take in to account the composition of the trustee board
Noting that higher standards might be expected if any of the trustees are
paid, particularly if they are acting in a professional trustee capacity
The regulator may take account of any planned changes to the law in this
area
Particularly if any plans to repeal the legislation are in the public domain
Or in contrast if there are plans to further develop the legislation so that
additional financial information is to be made available to members
The regulator is likely to require further information from the trustee board
To check factual points such as whether the entire membership does in fact
consist of manual workers
And the extent of the consultation with employee representative groups
And will also want to form a judgement on whether the employee
representative groups represent the whole workforce
And whether they may have any political motivation for taking a particular
position on this issue
If trustees took legal advice prior to non-disclosure
Relatively well answered best candidates simply showed a greater depth and breadth to
their answers with no repetition of similar points.
Page 7
Subject SA2 (Life Insurance Specialist Applications) April 2015 Examiners Report
Page 8
Subject SA2 (Life Insurance Specialist Applications) April 2015 Examiners Report
Candidates often failed to focus on the specifics of the question by making many points that
were not directly relevant to the actual question asked. This is an important point of exam
technique to prevent wasting time.
Page 9
Subject SA2 (Life Insurance Specialist Applications) April 2015 Examiners Report
Page 10
Subject SA2 (Life Insurance Specialist Applications) April 2015 Examiners Report
Note that the same points as set out in relation to the targeted DC scheme
apply in relation to:
- At retirement options
- Withdrawal
- Death before retirement
(ii)
If the member intends to stay until retirement age, they should consider the
benefits that each arrangement is projected to provide at retirement
Which should be close to the equivalent defined benefit for the targeted
DC scheme
But there is nothing in the question to suggest the target benefit under the
cash balance scheme
As well as the projected benefit, the member should seek to gain some
understanding about the level of risk to that benefit
In terms of investment risk in the accumulation phase
And any risk that the rebalancing mechanism under the targeted DC
scheme will fail to function satisfactorily
For example, if the employer reserves the right to vary the arrangements
or there are upper limits to the contributions payable
In practice, it will be hard for the member to gain a full appreciation of
these risks
Other considerations will include the minimum rate of member
contribution payable under each arrangement
Or higher contributions
And the ancillary benefits provided under each arrangement
Such as benefits on death in service and withdrawal
Note that if the member expects to leave service prior to retirement, they
would want to compare the projected benefits at different withdrawal ages
The member should consider their attitude to risk when making investment
choices
And review the different investment options available
In terms of the choice of different types of asset strategies
And any default option
Page 11
Subject SA2 (Life Insurance Specialist Applications) April 2015 Examiners Report
Generally quite well answered again successful candidates demonstrated more depth and
breadth to answers with no repetition.
Page 12
Subject SA2 (Life Insurance Specialist Applications) April 2015 Examiners Report
Employer Covenant
The scheme will also face risks in relation to the strength of the employer
covenant
Although without the financial management plan the impact is unlikely to
be assessed until the time of the next actuarial valuation when the trustee
next reviews the position
The trustees are concerned about the level of debt
And there is a risk that profits will fall
Due to adverse market conditions
Or management failures
To such an extent that interest payments on the debt will not be met
So that the debt will be called in by the debtholders and replaced on worse
terms or not replaced at all
In which case, scheme benefits would need to be reduced
Because the scheme is only 67% funded on a solvency basis
The trustees should be particularly alert to risks that negatively impact
both the pension scheme and the employer covenant
Other Issues
Other risks that might impact the financial position of the scheme relate to
retrospective legislation
Or any legal claims that members might have for higher benefits
Or the emergence of data errors leading to materially higher benefits
Page 13
Subject SA2 (Life Insurance Specialist Applications) April 2015 Examiners Report
(ii)
The trustee requires information about the status of each key risk listed
above
For each risk, the trustee must define a measure (or measures) intended to
give information on the status of the related risk indicator
And obtain information relating to that measure on a timely basis
The measures can be at the aggregate scheme/employer level or can be at
an individual risk level
For example, the most appropriate measure at the aggregate scheme level
would be the ongoing funding level
Updated to take account of experience and changes in market conditions
since the valuation date
Possibly made available on a daily basis
And in relation to the employer covenant, the trustees might choose to
consider just a single measure such as an average of credit rating agency
scores
However, more information can be obtained by considering measures
related to the individual risks themselves
If it is possible to obtain such information e.g. it may not be possible to
obtain up to date market value information for a direct property investment
At the scheme level, the trustee should expect a breakdown of the reasons
for a change in the funding position
Which attributes the change against each risk indicator ie an analysis of
surplus
Covering actual investment performance
Changes in market conditions affecting future investment
performance/discount rate
Changes in inflation impacting salary (if accrued benefits retain salary
link) and pension increases
Together with an assessment of any non-market information that might
impact the next valuation of the scheme e.g. the anticipated introduction of
mortality tables reflecting higher life expectancy
At the employer level, there is no generally accepted measure of employer
covenant strength
And there are a variety of different information sources including
- sponsors published accounts
- published credit ratings
- information from retained covenant adviser
- information provided by the company to the trustees
Which could be used to detect
- further indebtedness
- changes in NOI
- changes in free cash flow
Page 14
Subject SA2 (Life Insurance Specialist Applications) April 2015 Examiners Report
(iii)
If the funding level falls below a specified level
Or if the chosen measure of employer covenant strength gives a trigger
reading
The financial management plan is likely to give the trustees a number of
different powers
Such as demanding the introduction of employer contributions (in excess
of expenses)
Noting that it is difficult to specify in advance the size of such payments
So that it is more likely that the power would relate to the ability to call an
early valuation
Giving both parties the opportunity to consider the issues within the
standard timelines of such a valuation
The trustees will be keen to ensure that any free cash in the business is
used for the benefit of the business or ideally paid in to the scheme
So the plan might state that the company will not make any dividend
payments to shareholders whilst the valuation is being undertaken
Including making capital payments to the parent company
Or give effect to any share buybacks
Or that the company will not increase its level of debt without the consent
of the trustees
Or that a temporary charge over assets is put in place
The plan might also cover circumstances where changes to the investment
strategy would be undertaken to reduce the risk of the strategy
Noting that it is likely that moving a portion of growth assets to matching
assets will reduce the expected return from the asset portfolio
So increasing expected long term costs
And potentially making it even more likely that contributions will need to
be introduced in the short term (particularly if an early valuation has also
been triggered)
So placing even more dependence on the employer covenant
At the extreme, the trustees might want to consider what protections could
be available to protect the scheme in the event of an employer default
And insurance or other financial instruments where a payment is triggered
by such a default could be considered
Although this will be very expensive and therefore unlikely to be a
practical option.
(iv)
Failure to achieve investment returns assumed by the actuary
- Insurance contracts generally offer only a very low guaranteed rate of
return
- And are unlikely to be helpful in mitigating this risk
Reductions in market yields leading to lower growth returns being
assumed by the actuary when setting the discount rate
Page 15
Subject SA2 (Life Insurance Specialist Applications) April 2015 Examiners Report
This question was less well answered. Answers were often incomplete. For example, in (ii)
some candidates focused only on monitoring the covenant and did not discuss monitoring the
scheme experience. In part (iv) quite a few candidates only considered the appropriateness
of buying out the benefits entirely - they overlooked other possible insurances, for example,
death in service, longevity swaps etc.
Page 16
1
2 INSTITUTE AND FACULTY OF ACTUARIES
3
4
5
6
7 EXAMINATION
8
9
8 October 2015 (am)
10
19 2. You have 15 minutes before the start of the examination in which to read the
questions. You are strongly encouraged to use this time for reading only, but notes
20
may be made. You then have three hours to complete the paper.
21
3. You must not start writing your answers in the booklet until instructed to do so by the
22 supervisor.
23
4. Mark allocations are shown in brackets.
24
5. Attempt all six questions, beginning your answer to each question on a new page.
25
26 6. Candidates should show calculations where this is appropriate.
27
AT THE END OF THE EXAMINATION
28
29 Hand in BOTH your answer booklet, with any additional sheets firmly attached, and this
question paper.
30
31 In addition to this paper you should have available the 2002 edition of the Formulae
and Tables and your own electronic calculator from the approved list.
32
33
34
ST4 S2015 Institute and Faculty of Actuaries
35
1 (i) Define the term Net Replacement Ratio. [1]
In a developed country, no income tax is levied on the first $15,000 per annum of an
individuals income, which includes income from pensions. A 30% rate of income
tax is levied on income in excess of $15,000 per annum. There is no income tax relief
given for pension contributions or repayments on house loans.
Adam is currently working and earns a pre-tax income of $60,000 per annum. He
pays pension contributions of 10% of pre-tax earnings and repayments on house loans
of $1,000 per month, both of which will cease on retirement.
(ii) Calculate the Net Replacement Ratio if Adams pre-tax pension in retirement
is $30,000 per annum. [2]
(iii) (a) Explain why this may be an inappropriate target in order to sustain his
living standards after retirement.
(b) Propose, with reasons, a more appropriate Net Replacement Ratio for
Adam. [6]
[Total 9]
In your answers to parts (i) (iii) below, define all symbols used and state any key
assumptions.
(i) Write down a formula for the expected cost over the next year of the benefit
expressed as a proportion of total salary. [1]
(ii) Derive a formula for the standard deviation of the cost over the next year of
the benefit expressed as a proportion of total salary. [3]
(iii) Write down a formula for the probability that there is at least one death in a
given year. [1]
(iv) Discuss whether it will be preferable for Company B to insure the benefit
rather than meeting the cost of claims out of business cashflow.
Your answer should make reference to, but is not restricted to, your answers to
parts (i) (iii) above. [6]
[Total 11]
ST4 S20152
3 The HR Director at a large employer is considering establishing an arrangement to
meet in full all post-retirement medical fees and healthcare costs of its employees.
(i) List the assumptions that would need to be made in order to estimate the cost
of the arrangement. [5]
(ii) Discuss three approaches the employer could take to financing the
arrangement. [10]
(iii) Discuss four key aspects of benefits design that could be adjusted to achieve
the employers objective. [12]
[Total 27]
The managers of the pension scheme are concerned about the risks of domestic
inflation and are proposing switching their fixed interest corporate bond holdings into
domestic inflation-linked government bonds.
(iii) Suggest, with reasons, other asset classes that the pension schemes managers
could adopt in order to reduce the risk to the scheme of domestic inflation. [6]
[Total 13]
(i) List six ways that the managers of the scheme could achieve this. [3]
The managers of the scheme wish to continue running the scheme, funding it on a
self-sufficiency basis, without the further accrual of benefits.
(ii) Discuss the factors that the managers should consider in their approach to the
following aspects:
funding;
investment strategy; and
provision of discretionary benefits. [7]
[Total 10]
(i) List the items of membership data the actuary will require to complete the
actuarial valuation. [7]
(ii) Describe the data checks that the actuary should carry out on the membership
data. [10]
(iii) Set out a formula for the early retirement pension, defining any terms you use.
[4]
The sponsor does not wish the early retirement option to introduce significant
additional risk into the scheme.
(iv) Describe the risks introduced by the early retirement option. [4]
END OF PAPER
ST4 S20154
INSTITUTE AND FACULTY OF ACTUARIES
EXAMINERS REPORT
September 2015
Introduction
The Examiners Report is written by the Principal Examiner with the aim of helping candidates, both
those who are sitting the examination for the first time and using past papers as a revision aid and
also those who have previously failed the subject.
The Examiners are charged by Council with examining the published syllabus. The Examiners have
access to the Core Reading, which is designed to interpret the syllabus, and will generally base
questions around it but are not required to examine the content of Core Reading specifically or
exclusively.
For numerical questions the Examiners preferred approach to the solution is reproduced in this
report; other valid approaches are given appropriate credit. For essay-style questions, particularly the
open-ended questions in the later subjects, the report may contain more points than the Examiners
will expect from a solution that scores full marks.
The report is written based on the legislative and regulatory context pertaining to the date that the
examination was set. Candidates should take into account the possibility that circumstances may
have changed if using these reports for revision.
F Layton
Chairman of the Board of Examiners
December 2015
1. The aim of the Pensions and Other Benefits Specialist Technical subject is to instil in
successful candidates the ability to apply, in simple situations, the mathematical and
economic techniques and the principles of actuarial planning and control needed for the
operation on sound financial lines of providers of pensions or other employee benefits.
2. This subject examines the ability of candidates to apply core actuarial techniques and
concepts, together with specific knowledge of pensions and other benefit arrangements
to simple, but practical situations.
3. The examiners therefore look for candidates to apply their knowledge of the core reading
to the specific situation that the examiners asked, having read the question carefully.
Too many candidates write around the subject matter of the question in more general
fashion, or focus on one aspect of the issue at great length, in either case gaining few of
the marks available.
4. Good candidates demonstrate that they have used the planning time well - an attempt to
get a logical flow is a big advantage in making points clearly and without repetition. This
also enables candidates to use the latter parts of questions to generate ideas for answers
to the early parts (or use their solutions to earlier parts of questions to create a structure
for latter parts). Time management is important so that candidates give answers to all
questions that are roughly proportionate to the number of marks available.
1. The overall standard of scripts was broadly as expected, with a pass rate slightly higher
than in the previous sitting. There was a wide spread of marks and the paper enabled
the better candidates to demonstrate their knowledge and understanding of the syllabus.
2. It is very important that candidates consider all aspects of the question, and read the
preamble fully. Candidates should consider the specific scenario given in the question
and tailor their answers to the relevant points rather than listing all they know about a
topic. There is never superfluous information in the question, and by using all of the
information available, candidates can ensure they give a full answer. Giving just a little
more to clearly show depth can turn a close fail into a pass.
3. The questions are set so that it should take approximately twice as long to answer a
10 mark question as a 5 mark one. Answers should therefore be similarly proportionate,
as mentioned in the general comments above.
Page 2
Subject ST4 (Pensions and other Benefits Specialist Technical) September 2015 Examiners Report
C. Comparative pass rates for the past 3 years for this diet of examination
Year %
September 2015 43
April 2015 39
September 2014 43
April 2014 40
September 2013 41
April 2013 41
Reasons for any significant change in pass rates in current diet to those in the
past:
The pass rate for this examination diet is broadly in line with previous diets. Some variation
in the pass rate between sessions is expected as different cohorts of students sit the
examination.
Solutions
(iii) (a)
There are other reasons why a lower replacement ratio may be sufficient:
Page 3
Subject ST4 (Pensions and other Benefits Specialist Technical) September 2015 Examiners Report
There are some reasons why a higher replacement ratio may be needed:
(b)
Because he does not incur these costs in retirement, a net replacement ratio
of $28,500 / $46,500 = 61% would be sufficient to give him the same
amount of income to spend.
Other well argued, sensible approaches were credited even if they resulted
in a different figure to 61%.
(ii)
For one employee, the probability distribution of the cost is:
4S with probability q
0 with probability (1 q)
Page 4
Subject ST4 (Pensions and other Benefits Specialist Technical) September 2015 Examiners Report
For n independent random variables, the variance of the sum equals the
sum of the variances
Therefore, the variance of the cost for the n employees is 16nS2 * (q q2).
4 * (q q2)1/2 * n1/2.
(iii) Because the lives are independent, the probability of no deaths is (1 q)n
Therefore the probability of at least one death is 1 (1 q)n.
(iv)
The standard deviation is a measure of the risk of providing the benefit
The standard deviation of the cost of the benefit for n employees,
expressed as a proportion of payroll, is inversely proportional to the square
root of n
And therefore reduces as n gets larger
Hence, for a small firm of 50 employees the risk is fairly high
E.g. just one death of an employee on average salary will increase the
companys costs by a significant percentage of payroll in that year
Particularly if it is one of the managers
The resulting volatility of profits may be too great without insurance
And may cause liquidity problems for the employer
The risk is further increased by the fact that the lives are not
independent
but may be positively correlated
For example, because all employees work at one site
an accident at work could cause multiple deaths at the same time
The managers of the business have much higher wages than average
are older (higher probability of death)
and positively correlated (husband and wife)
and therefore represent a significant amount of mortality risk
By insuring the benefit the company would pay a known insurance
premium
rather than an unknown cost of claims each year
The insurance premium is likely to be higher than the expected cost of
claims
because of the insurance companys operating expenses
capital requirements
Page 5
Subject ST4 (Pensions and other Benefits Specialist Technical) September 2015 Examiners Report
Many candidates struggled with this question. Some appeared not to know
the formula to calculate variance, and others failed to simplify the answer
sufficiently. The answers for final part (iv) were stronger although few
candidates were able to demonstrate the link to the earlier part of the
question.
Q3 (i)
Pre retirement mortality
Leaving service / staff turnover rates
Expected retirement age
Ill-health early retirement rates
Post retirement mortality
including projections for future improvement
Expected number of medical claims per annum in retirement
broken down by age
and sex
Expected cost of medical claims
and recovery rates / duration of illness
Expected rate of medical expense inflation
and other inflation e.g. administrative expenses
Discount rate / investment return
(ii)
Pay as you go
Claims are paid as and when they are made by beneficiaries when they
arise
No monies are put aside to fund for the claims
although the company may wish to establish a book reserve
This method has minimal cash outflow initially
The cashflow will increase greatly later on when eligible employees have
retired
It is possible that the company may not have the resources to meet the
cashflow at this time
There is little security of the benefit for the member
Security could be improved by combining with Just-in-Time funding
triggered by certain events such as takeover of the sponsoring employer
The cashflow is likely to be volatile
a smoothed PAYG approach could be adopted to reduce the volatility
No opportunity cost
Page 6
Subject ST4 (Pensions and other Benefits Specialist Technical) September 2015 Examiners Report
Terminal Funding
A fund is established at the retirement of a member
by means of a capital payment at that time
The fund would be calculated to be sufficient to meet the cost of claims
during the period after retirement
This method has minimal cash outflow initially
The cashflow will increase greatly later on when eligible employees reach
the point of retirement
The presence of a fund provides an element of security to retired members
during the course of the scheme the adequacy of the fund will need to be
monitored
and adjustments made either by means of further payments or offsetting
against future retirement payments (if there is a surplus)
Opportunity cost if funds could be more profitably deployed elsewhere
Funded in advance
E.g. Lump Sum in Advance or Regular Contributions
A fund is established by making contributions over the working lifetime of
each member
which are calculated to be sufficient to meet subsequent costs after
retirement
This method places an immediate cashflow requirement on the employer
But cashflow should be more stable than the other two methods as there
should not be significant increases at or during retirement
The cost is paid during the time that each employee is providing services
to the company
and there should be no need to provide additional contributions in
respect of an employee after he has left service of the company
The fund will need to be monitored for its adequacy on a regular basis
and adjustments made to the contribution rate on account of surplus or
deficit
This method provides greater benefit security for members
Opportunity cost if funds could be more profitably deployed elsewhere
Insurance
The sponsoring employer pays premiums to an insurance company
The insurance company will then be responsible for funding the medical
benefits
Premiums could be paid annually during the retirement of each member
(variant of PAYG)
Lump sum premiums could be paid at the point of retirement of each
member (variant of Terminal Funding)
Regular premiums could be paid during the working lifetime of employees
(variant of Funded in Advance)
The risk / variability of costs will be reduced by taking out insurance
But the sponsoring employer remains exposed to the risk that the insurance
rates vary over time
Would be expected to be more expensive than meeting costs directly
Page 7
Subject ST4 (Pensions and other Benefits Specialist Technical) September 2015 Examiners Report
(iii)
Introduce benefit accrual
The scheme currently covers medical costs in full whether an employee
works for one day or all the way up to retirement
The cost would be significantly reduced if members accrued the benefit
over their working lifetime up to retirement
or at a fixed rate per annum (e.g. 2.5% per year up to 40 years)
This might help to attract / retain staff
as it will reward long-serving employees
Page 8
Subject ST4 (Pensions and other Benefits Specialist Technical) September 2015 Examiners Report
This question was answered well, and most candidates were able to obtain
points in relation to three funding methods, and changing the benefit design of
the scheme (although few suggested that the benefit could accrue with
service and missed some marks as a result).
Q4 (i)
They provide a fixed rate of interest (coupon)
And fixed redemption proceeds at a given point in time
Often a higher running yield than equities
They are normally tradable at any point up to the redemption date
Liquidity will vary greatly between different bonds
Depending on things such as the issue size
Security of return depends on the creditworthiness of the issuer
The yield is typically higher than equivalent government bonds
Accounting for higher credit risk
And lower liquidity
Higher yielding (junk) and lower yielding (investment grade) varieties
reflect the creditworthiness of the issuer
Available in a number of different currencies
A small amount of inflation-linked corporate bonds are available
(ii) Advantages
Disadvantages
Page 9
Subject ST4 (Pensions and other Benefits Specialist Technical) September 2015 Examiners Report
(iii)
Equities
Volatile investment returns
Therefore not a close match for inflation in the short-term
But over the long-term company profits may be correlated with inflation
Property
As rents may be correlated with inflation over the medium term
Or have specific inflation-linked increased built into the rental agreement
Not a good short-term inflation match
Overseas assets
As high domestic inflation should cause a depreciation of the domestic
currency over time
Leading to overseas assets rising in value when measured in the domestic
currency
The inflation protection is only approximate
And this introduces currency risk
A relatively straightforward question that was answered well. For part (iii), in
some cases, candidates lost marks for not making sufficient points regarding
how the alternative asset class would reduce domestic inflation risk.
Q5 (i)
gradual removal of liabilities by the continuation of the scheme without
any further accrual of benefits
transfer of the liabilities to another pension scheme with the same sponsor
transfer of the funds to the beneficiary to extinguish the liability
either as cash or transfers to individual DC pension schemes
transfer of the funds to an insurance company to invest and provide a
benefit
Page 10
Subject ST4 (Pensions and other Benefits Specialist Technical) September 2015 Examiners Report
(ii)
The funding target scheme should ensure that the Scheme has a very good
chance of meeting its liabilities without further help from the employer.
Prudent assumptions should be used for funding
Together with a prudent funding/valuation method
These may be similar to the assumptions used for a buyout valuation
Including future expenses
Without the margins for insurance company profit
Scheme will be moving from fully funded to a deficit position
Consideration needs to be given to the amount and timing of contributions
to eliminate the deficit
member expectations
And the extent to which they are provided for in the funding target
Are there any restrictions in the scheme rules or legislation?
Fairness between different generations of member
And different categories of member will be difficult
If generous discretionary benefits are provided early on then there may not
be sufficient funds to provide discretionary benefits later on
if mortality or investment experience is adverse
Whereas if the managers adopt a more cautious approach to discretionary
benefits, then only members still alive when the discretionary benefits are
granted will benefit
Page 11
Subject ST4 (Pensions and other Benefits Specialist Technical) September 2015 Examiners Report
Some candidates answered this question well, but others missed obvious
points (e.g. that the change to a self-sufficiency basis would likely put the
scheme in to deficit). A number of candidates struggled with the implications
for discretionary benefits, in some cases making the assumption that the
provision of such benefits was being considered for the first time.
(ii)
Reconciliation of membership in each category compared with the data
used for the last valuation
and the pension scheme accounts
taking account of new entrants, leavers, retirements and deaths
and checking date of leaving/retirement within last 3 years where there
is a status change
Check than new entrants have not been omitted
Page 12
Subject ST4 (Pensions and other Benefits Specialist Technical) September 2015 Examiners Report
(iii)
x is the members age
AP is the members accrued pension
EP is the members early retirement pension
r is the assumed rate of price inflation (and revaluation in deferment)
i is the discount rate
l65 and lx are from the mortality table used in the valuation
a65 and ax are annuity rates at a net interest rate of i pension increase rate
C is the members contributions to the Scheme
The simplifying assumption has been made that death in deferment would
occur half way to retirement age
Page 13
Subject ST4 (Pensions and other Benefits Specialist Technical) September 2015 Examiners Report
(iv)
Liquidity risk pensions will be brought into payment sooner and the
Scheme my not have sufficient assets to pay the benefits
There may be a surge of early retirements in the first year
Mortality risk if pensioners and spouses live for a shorter period than
expected then they will normally receive a more valuable benefit under the
early retirement option
Although early retirees with no spouse who die very quickly may receive
less pension than the death in deferment return of contributions lump sum
Investment risk duration of liabilities will change and existing liability
matching may be inappropriate
and matching will be less precise as duration will be harder to calculate
when members have the option
Selection risk members in poor health may be more inclined to take early
retirement than members in good health
so that the mortality assumptions in the equation of value are not
appropriate and the option is more expensive than expected
Changing market conditions
may mean that the discount rate is not appropriate and paying the
pension at age 65 would be less expensive
Administrative expenses of implementing the option are greater than
expected
Operational risk calculation errors
Reputational risk if conversion terms turn out to be poor value for
members
(v)
Give the employer the power to set the terms of the option
Make it a requirement for members to obtain the consent of the employer
before early retirement is permitted
Both of these will give the employer greater control
For example allowing it to suspend early retirements if liquidity is an issue
for the Scheme
Mortality and selection risk will be difficult to mitigate
Because individual underwriting is unlikely to be practical
An approximate solution might be to make the option less generous
By assuming slightly heavier mortality in the equation of value
Restrictions on the availability of the option could be introduced
For example relating to health status or minimum retirement age
The early retirement factors could be dependent on market interest rates
To account for changing market conditions
Although this will make the administration more complicated and
expensive
Compared with fixed factors
Review investment strategy to ensure correct duration of assets
and sufficient liquidity
Page 14
Subject ST4 (Pensions and other Benefits Specialist Technical) September 2015 Examiners Report
Most candidates provided good answers to the first three parts of this
question, but struggled with the final two parts often as a result of failing to
consider a sufficiently wide range of risk types. In particular, in part (iv) most
candidates focused on the risks of defined benefit pension schemes in
general rather than on the introduction of the option.
Page 15