Pension Scheme Design - Defined Contribution vs Defined Benefit Arrangement

Topics: Pension, Cash balance plan, Life annuity Pages: 4 (1084 words) Published: April 11, 2013
Table of Contents

Defined Benefit1
Description2
Defined Contribution2
Description2
Comparison2
Cost of benefit provision2
Risks3
Portability3
Annuity Rate4
Investment strategies4
In addition4
Another option: Hybrid Schemes5
Conclusion and Recommendations5

Defined Benefit (DB)
Description
(a) Benefit
The benefit is defined in the scheme rules by a formula independent of the contribution rate. (b) Contribution
The contribution rate from the employee is fixed whilst the employer’s rate is left to vary according to the funding level. The employer meets the extra cost required to meet the liability.

Defined Contribution (DC)
Description
(a) Benefit
The benefit is whatever the accumulated account comes to when the member retires. (b) Contribution
The contribution rates are defined at the outset. The employer and employee provide a fixed contribution rate usually expressed as a percentage of the salary.

Comparison
Cost of benefit provision
From the employer’s perspective, the DB option can be more onerous since the contribution is not known in advance. Under the DC arrangement, the employer knows the contribution rate so costs of benefit provision are known in advance which allows planning. The better control of cost of benefit provision for the pension may be in the interest of both the employees and employers since they have an interest in the continued existence of the company as opposed to the situation where the employer may become insolvent and fail to pay salaries due to the high pension fund obligations.

Risks
An employer sponsoring a DB scheme is exposed to the risk that actual experience may turn out to be significantly different from that assumed when setting the contribution rates. Some of these risks include investment risk, longevity risk and salary escalation being higher than expected. The member’s benefit is guaranteed whatever the experience may be, although this depends on the...
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