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Fixed vs variable commutation factors

M

Mukul

Member
Question 18.9 (exam style questions)
Talks about the advantages and disadvantages of a fixed vs market related CCF (cash commutation factor).
A particular line (for variable factors) in the solution says - "The amount of pension commuted will increase when interest rates are high". can someone elaborate on this?
As far as I understand if an individual (in a DB scheme) has a benefit of 100 at retirement and has an option to commute say 20%. Then the cash pay out would be 20 * CCF which would be low considering the interest rate is high! CCF is a single life annuity, right?
What am I missing here?
 
Maybe because when interest rates are high, pension paid will be low, so most will prefer to get cash i.e. to commute.
 
Thanks for your reply!
Initially I had the same thing in mind. But considering it is a DB scheme, annuity rates don't really matter. Because there is no cash conversions. Thoughts ?
 
Hi Mukul, thanks for raising this.

I think the sentence "The amount of pension commuted will increase when interest rates are high" is assuming that the member will want a certain amount of cash; the sentence would be clearer if it said something like "For a given lump sum, the amount of pension that needs to be commuted will be higher when interest rates are high'

For example, if a member wants £10,000 cash and interest rates are low, so the commutation factor is relatively high, say 20, then they will need to commute £500 of pension to get £10,000 cash

In contrast, if interest rates are high, so the commutation factor is low, say 10, then the member will need to commute £1,000 of pension to get £10,000 cash.

I'll ask for this to be clarified in the next edition of the Course Notes, but hope that helps in the meantime.

Best wishes
Gresham
 
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