DC plan paying pensions directly

I was wondering if anyone had experience with a DC plan that pays pensions directly.

I think that on retirement the benefit becomes a DB benefit, as the scheme effectively guarantees a fixed rate of pension.

Does the plan therefore need to be treated as a DB plan, eg when it comes to valuations, risks, etc?
Or are there mechanisms that remove the DB risks from the employer and onto the membership (pensioner or otherwise)

 

Ignoring UK specific issues (as we 'should' for ST4 compared to SA4 which is based on UK pensions)...

It depends on how the pension is calculated;-

- if the DC accumulated fund is converted to a fixed / increasing pension, then it should be treated as a DB pension from the point of retirement (i.e. the pension amount is locked in at the point of retirement)

- in the case of a draw-down arrangement where the pension is simply a withdrawal of part of the accumulated pot, there is no grounds to perform DB type valuation as the liability will only ever equal the amount of the remaining investment pot.

From experience with South African DC pension schemes: the existence of any guarantee that the pension calculated at retirement could only ever remain the same or increase, the scheme would then be treated as a DB or hybrid DB/DC scheme.

The important distinction to make in this case would be that any investment risk pre-retirement is borne by the member, however once the pension amount is calculated (and guaranteed) by the scheme the investment &Y mortality risk is transferred to the employer.

The member is at risk not only from bad returns pre-retirement, but also from annuity terms available through the scheme or an open-market option being unfavourable on conversion to the pension.

 

Dc <> Mp...

A quick point that I recently discovered is that Defined Contribution does not necessarily mean Money Purchase. I'm pretty sure that the ST4 notes (and the SA4 notes, for that matter) don't go too far into this type of thing.

The Money Purchase type arrangement is the type where your pot is, well, your pot. Then you're into drawdown or buyout at maturity, most likely; or the scheme sponsor may pay pensions directly (unusually, hence your question I think... I still can't get my head round it myself).

If you're a DC scheme it doesn't necessarily mean you have to be a money purchase scheme though. There could be some inventive design where the contributions into the scheme are defined and then the benefits are set every AVR or 5 years or something like that; in this type of arrangement the scheme sponsor could well pay pensions directly but if there's not enough money in the pot possibly temporarily cease increases to the pensions in payment (there may well be legal; if not moral; issues with decreasing pensions in payment in nominal terms). This would be one of those 'risk sharing' type pension schemes where it's not DB and it's not MP; it's something in the middle.

Just to keep in mind that you shouldn't necessarily restrict your answers in the exam to DC = Money Purchase...

I don't think the UK framework is particularly well defined on this point at the moment. If you are UK based, for your info there is a risk sharing consultation out at the moment (which I haven't read yet...) trying to find some middle ground between DB & MP.

 

Thanks for your responses. This confirms my understanding of the situation. I wanted to get feedback on what happens in the UK and other places since the exams are supposed to be non-country specific (yet appear with a slight UK twist)

The core reading does say that larger schemes may pay pensions directly (to save on insurer's profits etc)

YetAnotherStudent thinks it's unusual (in the UK?) and given the move to MP schemes to mitigate sponsor risk, I think they may as well buy out the annuitities.

I do actually have a (non-UK) client which does this, and we have regular actuarial valuations, but this also has to do with guaranteed conversion terms when the Plan went from DB to DC. The pensions are run similar to a with-profits arrangement (ie poor terms to start with, but with increases if experience is favorable)

 

Yip, I was talking UK specific here.

Given the main drive to DC/MP is to reduce uncertainty for the sponsor I'd think it's common worldwide to buyout - unless of course there is no buyout market.... (really developing country with no insurance market? ST4 sometimes likes those types of questions...)