st42010 2014

Faculty of Actuaries Institute of Actuaries
EXAMINATION
23 April 2010 (pm)
Subject ST4 Pensions and other Benefits

Specialist Technical
Time allowed: Three hours
INSTRUCTIONS TO THE CANDIDATE
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.
4. Mark allocations are shown in brackets.
5. Attempt all seven questions, beginning your answer to each question on a separate
sheet.
6. Candidates should show calculations where this is appropriate.
AT THE END OF THE EXAMINATION
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.
Faculty of Actuaries
ST4 A2010 Institute of Actuaries
1 A company that does not offer any retirement benefits to its employees provides a
service that gives employees advice on how to provide for an income in retirement.
A 60 year old employee has recently received an inheritance of 200,000 currently

invested in equity and property unit trusts. She has asked for advice on how to use
this amount to fund for a retirement income from age 65. In particular she has asked
whether she should use lifestyling.
(i) List the information that should be requested from the employee so that
suitable advice can be given. [4]
(ii) Describe three options that could be considered to achieve an income in

retirement, commenting where appropriate on the use of lifestyling. [4]
[Total 8]
2 A company sponsors a final salary pension scheme that provides benefits related to
salary and service for most of its employees. A new Chief Executive Officer (CEO)
is to be appointed and it is possible that the appointment will be made from within the
company.
The Finance Director has proposed that, in respect of service as the CEO, the new
CEO should be entitled to retire at any time between ages 50 and 60 with a members
pension of 50% of total earnings in the last year of service.
(i) Discuss how the company would mitigate any risks arising from this proposal.
[8]
(ii) Suggest possible alternative approaches to the CEOs pension arrangements.

[2]
[Total 10]
3 The government of a developing country which does not have a developed insurance
market is proposing to offer its citizens a scheme under which they pay a contribution
each month which entitles them to a flat rate lump sum benefit on death before a
specified age.
(i) Outline the analysis that should be carried out to investigate whether to
implement this proposal. [3]
(ii) List the factors that should be taken into account in setting the level of
contribution. [3]
(iii) Discuss the practical issues that may arise and how they might be overcome.
[6]
[Total 12]
ST4 A20102
4 The trustees of a defined benefit pension scheme are planning to assess the strength of
the sponsoring employers covenant. One of the trustees is also the Finance Director
and the other trustees have asked him to assess the employers covenant and to
undertake the ongoing monitoring process on behalf of the trustees.
(i) Outline why the assessment of the employer covenant is important. [2]
(ii) Outline the key issues the Finance Director should consider in undertaking this
task. [4]
(iii) List the information that could be used to assess the employers covenant. [4]
(iv) Outline the main features of the ongoing employer covenant monitoring
process that the trustees should put in place. [2]
[Total 12]
5 A company provides a defined benefit pension scheme to its employees from age 65.
The scheme rules state that the pension is subject to review annually.
In 8 of the past 10 years, the scheme assets together with lump sum payments from
the company have permitted increases broadly in line with inflation to pensions in
payment. However, following a period of recent deflation, the two most recent
reviews resulted in no change in pension levels.
Scheme members have requested greater certainty over the way pensions in payment
will be adjusted each year following the annual review. The company proposes to
prepare a policy statement setting out how future reviews might be carried out and
how these reviews would be funded.
(i) Discuss the items that might be included within such a statement. [9]
(ii) Discuss the advantages and disadvantages of making this statement available
to scheme members. [5]
[Total 14]
6 The government of a developing country is setting up a State Pension scheme funded

by contributions from employees and employers. It is considering whether benefits
should be related to salary close to retirement or to salary averaged over an
employees working lifetime.
(i) Set out the advantages and disadvantages to the government of the two
alternatives. [11]
It is proposed to allow employers with existing pension arrangements to opt out of the
State Pension scheme.
(ii) Discuss the criteria that could be taken into account when setting the terms for
allowing employers to opt out of this new State Pension scheme. [4]
[Total 15]
ST4 A20103 PLEASE TURN OVER

7 Three years ago a manufacturing company closed all its defined benefit pension
schemes to new entrants. For new employees joining since then the company has put
in place a number of defined contribution pension arrangements which aim to target
particular levels of benefits.
The decision to move towards defined contribution pension provision was driven by
cost concerns. However the company is still concerned about its annual spend on
pension arrangements as it is currently paying 10 million per annum towards the
defined benefit pension schemes and 5 million per annum towards the defined
contribution pension arrangements.
The company has approached an independent actuary and asked for advice on the
options for controlling and reducing the costs of providing retirement benefits for its
entire workforce.
(i) Outline the information that the actuary would require in order to provide this
advice under the following headings:
(a) Employer information

(b) Scheme documentation
(c) Data
[10]
(ii) Outline the actions that could be considered as part of this exercise. [12]
(iii) Outline the practical difficulties the company could face when trying to reduce
the cost of pension provision. [7]
[Total 29]
END OF PAPER
ST4 A20104
EXAMINERS REPORT
April 2010 Examinations

Introduction
The attached subject report has been written by the Principal Examiner with the aim of
helping candidates. The questions and comments are based around Core Reading as the
interpretation of the syllabus to which the examiners are working. They have however given
credit for any alternative approach or interpretation which they consider to be reasonable.
R D Muckart
Chairman of the Board of Examiners
July 2010
Institute of Actuaries
Subject ST4 (Pensions and other Benefits Specialist Technical) April 2010 Examiners Report
Comments on individual questions
Q1 Most candidates scored well on this question, particularly part (i), although in part
(ii), it wasnt always clear that candidates understood lifestyling.
Q2 Very few candidates took the structured approach of identifying the risk and then
considered what the mitigations might be for each risk. The better candidates picked
up the specifics of a CEO benefit when looking at risks and mitigations but many
answered with general points which apply to all defined benefit schemes. Most
candidates struggled with part (ii).
Q3 Generally this was poorly answered, probably because it related to other benefits
although there were some good solutions. Candidates who considered the actuarial
control cycle usually scored well. For part (i), many candidates wrote at length about
the detail of a mortality investigation and missed the wider issues of need, cost and
affordability.
Q4 Some answers to this question were just too short given the marks available.
Solutions to part (i) were good but answers to part (ii) were particularly poor with
many candidates apparently not knowing what a covenant review would entail
(although most wrote at length about the potential conflict of interest).
Q5 Generally this was answered poorly with a reasonable minority misinterpreting the
question. Those who took the stance of assuming any such statement would be too
hard for members to understand limited their chance of scoring well.
Q6 Most candidates picked up the main points in part (i) but too many automatically
assumed that a final salary arrangement would be more expensive than an average
salary arrangement although details of the accrual rate in each arrangement were not
provided. Not many candidates considered why either arrangement would help the
government (eg reducing poverty in retirement). Many candidates seemed to forget
that this would be a state funded arrangement.
Q7 This question was meant to be an opportunity for candidates to score well by

generating a wide range of ideas. Only the better candidates achieved this. In other
cases answers were limited as candidates concentrated on small areas. As the
difficulties of change were specifically asked for in part (iii), it was disappointing that
many candidates wrote at length on these in part (ii). Although credit was given
where the answer to part (ii) covered part (iii), inevitably this approach meant that
the answers to what should have been part (ii) were limited.
Page 2
1 (i)
The employees risk appetite with regard to the certainty / uncertainty of
capital and income
Desired target income in retirement allowing for
current salary
.. expected day to day living expenses, including holidays etc.
.. any loans / debt / mortgages to service post retirement
.. advance allowance for other contingencies, e.g. long term care
details of any dependants
whether the employee wishes to provide for them
whether employee looking for an increasing income in retirement
What other income available, e.g. from previous employment / state
benefits / other assets available
What is current yield / how invested / is it a suitable portfolio / does it
match risk appetite
Information on health of member
How taxation might affect different options, e.g. on capital v income
(ii)
Drawdown: Keep assets invested, adjusted as necessary to meet risk
appetite
.. draw regular income, which is reviewed in the light of investment
performance, personal needs, inflation etc.
.. risk that fund will run out, e.g. if life span greater than expected
.. but if planned well, can leave capital sum for dependants
Live off income from assets: adjusted as necessary to meet risk appetite
.. risk of variable income, which may not match income needs
.. but opportunity to leave large inheritance to dependants
Might opt to buy annuity at some time (under draw down or life styling)
Purchase of annuity from insurance company on terms fixed at outset

.with ins. Company bearing all subsequent risks, mortality, investment
etc.
Terms will depend upon options purchased eg, increases, dependants
Consider life styling in period before retirement, i.e. asset allocation
whereby assets adjusted depending on age and term to retirement
.. typically switched from equity to bonds as retirement approaches
.. so suitable if the intention is to purchase an annuity at retirement
as protects against falls in the equity/property market just prior to
retirement
but period to retirement may be too short
Page 3
2 (i)
Risk Mitigation
CEO could retire at 50, Set a specified minimum retirement
so risk of paying a large pension for age, e.g. 60
a long time .. with benefits scaled down on
earlier retirement
Consider insurance/annuity purchase
at retirement
Benefit not service related Entirely service related
So could have a series of CEOs Benefit available only if > 10y
with short service whose pensions service, scaled down for less service
need to be paid for, at substantial
cost
Benefit not related to company or Could consider relating part of
individual performance pension to company or individual
performance
.. e.g. by averaging bonuses for
pension purposes
Salary strain if salary increases Relate benefits to revalued average
significantly more than inflation salary
during period of service Impose salary cap
Salary on which pension based Base pension on basic salary,

could be distorted by large bonuses or as a minimum, average
in last year of service fluctuating emoluments such as
bonuses over a period of year
Overall might be considered too Consider offsetting some of benefits
generous a package if an existing from earlier service
employee promoted .. (but is this fair when comparing
internal promotions with external
applicants?)
(ii) Alternative approaches
No pension scheme at all

.. with all remuneration provided through the salary / remuneration and
incentive bonus schemes
Defined contribution scheme

.. with suitable contribution rate negotiated in advance
.. or possibly with some element related to company performance
.. so contributions / remuneration broadly correlated with service
Improved defined benefit scheme

E.g. enhanced accrual so benefit related to actual service as CEO
Page 4
Or just usual scale benefits
3 (i)
Obtain profile of population by age / sex / occupation (as available), e.g.
from census data or other government statistics
Assess need for this cover
.. and its likely affordability
.. e.g. taking account of life cover currently available from private

schemes, or by arranged privately by individuals
Details of other state / National Insurance schemes providing same or

similar benefits
What is the likely take up rate, e.g. for different contribution levels / levels
of cover
Likely costs of setting up and administering the scheme, depending on

illustrative take up rates
How eligibility defined, e.g. is it by residency / nationality. How to deal

with immigration / emigration?
Assess appropriate ceasing age for cover provided
(ii)
Level of cover to be provided. Once this is known contributions can be
assessed
Start with historical mortality rates by age / sex
.. and any other subdivision on which it is reasonable to rate, e.g.

occupation
Allow for likely future trends over period the rates will be in force before
the next review
Allow for administration costs, if borne directly by those taking up the

cover
Build in contingency allowance, e.g. against possible poor experience
Or catastrophes
Allow for return on any invested monies
If contributions will not be flat rate, determine suitable way of banding

rates, e.g. by year of age, sex
Page 5
.. or in quinquennial ages
Whether government will meet part of costs
(iii)
Availability of data might be an issue
Monitor experience on regular basis
then carry out regular review of premiums and cover to take account of
experience / inflation / costs etc.
Adjust premiums / cover as required to ensure scheme remains self

supporting, as required
Consider possible administration issues, e.g. data base of participants,

suitable method to collect premiums, interacting with other government
scheme, e.g. tax collection
It may not always be clear who to pay the benefit to
Communication issues, e.g. when rates / cover changes following a

review, or to take account of increased age
Is advice to be provided, if so who can give it, who pays?
Is a separate fund to be maintained, requiring investment of premiums
..or is the scheme effectively PAYG, with the government collecting all
premiums, merging with taxation receipts and bearing all risks
Eligibility: starting and ceasing ages, is this determined by residency /

nationality / both / other factors?
Consider what medical questions might be asked, if it is proposed to

screen out poor risks or charge additional contribution
.. e.g. recent serious illnesses, operations etc.
Selection issues if scheme voluntary
Could not allow future opt in after opting out
Page 6
4 (i)
Shows the ability and willingness of the sponsor to pay sufficient
contributions to ensure the benefits can be paid as they fall due
Used to determine the key assumption and the level of required prudence
And the investment strategy
And general risk tolerance level
Affordability of future deficit funding plans
Can be used as part of a process to obtain contingent asset protection
(ii)
What is the employers current financial position?
What is the employers expected future financial performance?
Which assets and income streams could the pension scheme access?
What is the employers general attitude to supporting the Scheme?
Can the Finance Director share the relevant information with the other
trustees?
Is he conflicted with a vested interest?
Should the trustees request the information directly from the Employer
Is independent advice from specialists needed
Need to document an audit trail of how the covenant assessment will be

made
The assessment is made by the trustees as a whole not just the Finance
Director
Need to consider the financial data relative to the scheme funding level
If the scheme is well funded the covenant is less of an issue
Need to consider scheme ranking against other creditors
(iii) Information from employer
Details of the employers current financial position
What is the employers expected future financial performance
Page 7
Company report and accounts
Management accounts
Projections of sales, profit, cashflow, debt etc.
Details of general business outlook
Details of what the future pension contributions the employers cashflow

can support
Other available information
Financial metrics financial statistics and accounting ratios
Comparison with peer group
Analysts reports
Implied market default risk
Credit ratings
Financial / Market forecasts for the Industry sector as a whole
(iv)
Details of how often the monitoring review will be carried out
Could involve a regular update from the sponsor covering financial

position and future plans
Notification from employer of circumstances that could materially affect

the security of benefits
Regular review of publicly available metrics
Changes in risk based measures e.g. credit rating
Consider actions that may be needed if the assessment of the covenant

changes e.g. extra contribution requests
Page 8
5 (i) Setting the next years benefit
z Company to exercise discretion by maintaining as far as possible benefits

in real term
z Subject to available resources
z ..e.g. by adjusting benefits in line with a suitable index of inflation
z ..e.g. an index of prices or wages,
z .. stating which index, which month used
z .. and any maxima or minima
z .. so this may result in a reduction in benefits if inflation is negative
z .. requiring a careful communication and justification to scheme members
z Clarity on when increase paid/communicated to members
z Roles/responsibility of any other partner (eg if trustees)
Funding next years increases
z Company will try to meet any additional costs from available funded
resources within scheme
z .. so there should be advance funding to meet the target
z ..by making appropriate assumptions in the regular valuations
z But the company reserves the right not to meet the target in the event of
z .. poor investment performance from the invested assets
z .. or other adverse features of scheme experience
z .. leading to a funding deficit
z .. and being unable to make a special contribution in the short term to fund
this deficit
(ii) Advantages
z Publication would manage expectations over the likely result of future

reviews
z .. by disclosing the factors which the company takes into account in
reviewing pensions in payment
z .. e.g. overall objective, the indices used, how such changes are funded, the
possibility of a reduction, the reasons this might happen
Disadvantages
z Publication may lead members to expect the guidelines to be used in all

circumstances
z .. and so become guarantees
z .. e.g. irrespective of whether an increase can be afforded
z .. and so create unreasonable expectations which cannot be met
z Reduces the opportunity for the company to operate the guidelines flexibly
to take account of unexpected conditions
z Likely to lead to questions which will take time to resolve
Page 9
6 (i) Advantages: both
z Political objective to reduce poverty in retirement

z .. with less dependency on state handouts / means tested benefits etc. (so
can reduce scope of these over time)
z If a fund held, monies available for investment
Advantages Final Salary (FS)
z Reasonably simple to operate/communicate

z Relates benefits to salary just prior to retirement, so best chance of
maintaining standards of living in retirement for employees whose salaries
peak close to retirement in real terms
Advantages Salary (AS)
z Fairer than final salary for employees whose salaries peak in real term
earlier in their career
z .. providing the salaries used are revalued in accordance with an
appropriate index
z Salary related contributions to match salary related benefits in each year
z Limited scope for selecting against the scheme by misrepresenting salaries
Disadvantages: both
z If related to future service, scheme will take many years to mature

z Could be very unpopular if contribution rates set too high
z .. especially for employers with employees in, existing schemes
z Could be seen as extra tax, with no initial visible benefit
z Need suitable admin system to collect contributions and maintain data
records
z .. and regular audit to check on data integrity
z If PAYG (and contributions merged with normal tax receipts), could be
storing up problems for the future
z .. i.e. benefit promises cant be met by the next generation without a
substantial increase in contributions, or in tax rates
z Need to review terms periodically, and this could be unpopular if leads to
contribution increases without change in benefits
z May have inadequate population data to make satisfactory projections
z Can be many cross subsidies between different classes of member
z Provides no benefit to the unemployed
Disadvantages FS
z Employers could increase salaries close to retirement to an unreasonable

level, in order to enhance retirement benefits
z Possible fraud, by disclosing incorrect (low) salaries early on, and hence
paying insufficient contributions
z Can be difficult to treat fairly people with broken employment histories
Page 10
Disadvantages AS
z Complicated to administer
z .. need to maintain full salary history to calculate benefits
z Need to decide on a method to revalue benefits
z .. and then a mechanism to carry out the calculations
z May not be easy for beneficiaries to understand how benefits have been
calculated, or how to check benefit levels
(ii)
z Requirement for opt out schemes to have good quality of benefits overall
(suitably defined)
z And appropriate eligibility rules
z Minimum benefit levels from specified ages
z .. e.g. broadly matching benefits from state scheme
z .. so possible restrictions on early / late retirement, or commutation options
z Rates used to revalue benefits to be at least as good as those of state
scheme
z Ancillary benefits, e.g. dependants / increases in payment / death benefits,
to be at least as good as those of the state scheme
z .. e.g. in amount or value
z Restriction on investment, e.g. limited investment in high risk assets
z Regular certification of solvency from professional
z Exemption from making contributions to state scheme
7 (i) Employer information
z Detailed objectives of the exercise from the employer
z Is the employer concerned about the actual monetary costs or variability of

those costs?
z Factors driving the employers concerns on pension costs?
z Why does the employer think the costs are too high currently?
z Copies of previous advice received 3 years ago and reasoning behind the
decisions taken at that time
z What are the aims of the employer in offering pensions e.g. recruitment
and retention of staff
z Budgets the employer has available for pension arrangements for the
future
z Employers business plans e.g. expansion of workforce, or contraction of

workforce and timescales for these plans
z Wage/pension agreements that have been entered into already
Page 11
z Workers value on pensions
z Competitor practices in relation to pensions
Scheme documentation
z Copies of complete up to date scheme documentation including Trust

Deed and Rules/contracts for all pension arrangements
z Details of any special individual arrangements
z Any further documentation outlining scheme benefits, eg option terms
z Including copies of member communications such as booklets/benefit

statements etc.
z Copies of the reports on the most recent full actuarial valuation of the
defined benefit pension schemes
z Any more recent funding work completed on the schemes
z Copies of latest Trustee Annual Reports
z Latest target quotes prepared for the DC schemes
z Details of investment strategy
Data
z Current asset values on all schemes
z Current asset values subdivided by asset classes
z Current membership data (maximum of 1 mark for membership data)

(actives, deferreds, pensioners)
salary/pensionable salary roll
dates of birth/dates of joining company/dates of joining scheme/dates

of exit)
marital status
member contribution details
z Details of insurance arrangements if benefits are insured
z Details of charges and fees on all schemes (advisers/investment

managers/administration/trustees)
Page 12
(ii) Defined Benefit Pension Schemes
z Close the schemes to future accrual and/or future salary increases
z Reduce/eliminate discretionary benefits
z Include existing DB members in a DC scheme that requires lower fixed

employer contributions
z Employee contributions could be increased or introduced
z Reduce the level of benefit accrual, e.g. (Maximum of 1 mark for benefit
reductions listed)
Increase normal retirement age,
reduce accrual rate,
reduce/remove post retirement increases.
z The employer could limit the use of member options which currently
increase the cost of the schemes
z The employer could encourage the take up of options which reduce the
costs of the schemes
z Or change terms to make less valuable
z Change the investment strategy towards assets yielding higher returns
z Most cost effective method of providing death in service benefits e.g. to

insure or not?
z Similarly is it better to buy annuities at retirement(value for money versus

volatility)
z Consider other risk transfer solutions
z If the schemes are in deficit negotiate a longer recovery period
z Negotiate to use any surpluses to reduce retirement contributions going

forward
z Consolidation of defined benefit pension schemes with a view to reducing

overall costs
z Review the administration charges/advisor fees/investment manager fees.

Are these competitive? Is there any scope for their reduction?
z Wind up all defined benefit pension arrangements transferring members to

individual policies, legislation permitting.
Page 13
Defined Contribution Pension Schemes
z Reduce the target benefits
z Stop targeting benefits
z Reduce the employer defined contribution rate
z Change the definition of salary upon which contributions are based
z Introduce a contribution structure where the employer only matches the

employee rate
z Tighten up eligibility criteria to reduce the number of members covered

where possible, e.g. minimum service period, employees on short term
contracts
z Changing the balance of self-administration/outsourcing
z Cost-effectiveness of Trust versus contract based arrangements?
z If the employer is paying the expenses, then can these be reduced or shared
with employees.
z Simplify the defined contribution schemes to reduce operational expenses

e.g. reduce choice of funds on offer
z If death in service benefits are exclusive of fund values and insured and
employer pays Employees meet entire cost through fund deduction
z Alternatively make them inclusive of fund values
z Consolidation of DC schemes may result in cost savings?
z Are any tax rebates available that will reduce the cost of the scheme that
are not being availed of at present?
z Close down the schemes and do not replace them, subject to legislation
and contracts of employment
(iii) Legislation
z Any legislative barriers to removal of and reduction in benefits and closure

of schemes
z One off cost implications of altering defined benefit pension provision

for example the employer may need to buy out benefits on winding up
Scheme documentation/Governance
z Any barriers in schemes governing documentation
Page 14
z The trustees of the defined benefit pension scheme may be unwilling to

agree to employer plans e.g. changing the investment strategy towards
higher yielding equities
Workforce considerations
z Contracts of employment
z Agreements with workforce/Unions on pension arrangements
z Staff expectations
z Workforce dissatisfaction which could lead to industrial disputes and cost

the employer more in the long run if production is affected
z Will there be staff tension relating to members of staff in similar jobs

being on different pension arrangements?
z Risk of losing key staff
z Would any new arrangements be significantly worse than the norms for
the industry?
z Are pensions used as a tool for attracting and retaining workers? Will
changes be detrimental to this objective?
z Reduces HR flexibility to use the schemes to facilitate

redundancy/reorganisation exercises
Administration and execution
z Lack of management time and resources to consider options fully
z The costs of putting in place new arrangements may outweigh benefits.

E.g. adviser fees
z Difficulties and costs of administering new arrangements
z Will it be possible to negotiate discounts with investment managers /

trustees / advisers?
z Liquidity issues if need to divest lots of assets
END OF EXAMINERS REPORT
Page 15
EXAMINATION
5 October 2010 (pm)

booklet.
supervisor.
sheet.
question paper.
ST4 S2010 Institute of Actuaries
1 A fraudulent sponsoring employer operating in a certain country has used the assets of
its pension scheme to fund a risky business venture. Consequently the State regulator
is considering introducing a range of measures to enhance the security of the defined
benefit pension schemes provided in that country. It has been suggested that events
that relate to the integrity of the trustees or employer or any other events which
increase the risk of benefits not being paid should be notified to the State regulator.
(i) Suggest six possible events relating to the employer that could be notified. [3]
(ii) Suggest six possible events relating to the trustees that could be notified. [3]
[Total 6]
2 The government of a country with limited private pension provision for its citizens is
considering introducing a defined contribution State pension scheme. The objective
of the scheme is to ensure a minimum level of pension benefits for all the countrys
citizens.
Discuss the issues relating to this new scheme that the government should consider
under the following headings:
Membership
Contributions
Administration costs
Advantages for the members
Disadvantages for the members or the government
[12]
3 A sponsoring employer is putting in place a defined contribution pension scheme to

replace an existing defined benefit pension scheme. It has been decided to provide
additional features that would offer some protection for members from adverse
investment market movements.
(i) Discuss three distinct design features that could be adopted and the likely
impact of adverse movements in investment markets on each of these. [9]
(ii) Outline the funding implications of each of the three benefit design features
identified in part (i). [3]
[Total 12]
ST4 S20102
4 A member of a defined benefit pension scheme is due to retire in the near future. He
is considering whether he should exchange some or all of his pension for cash.
(i) Set out the issues the member might consider in deciding how much pension
to exchange for cash at retirement. [4]
The member is concerned that the level of cash available for pension exchanged is
low relative to the level of cash being offered by other pension schemes. He raises
these concerns with the trustees of his pension scheme.
Having recently reviewed the schemes commutation factors with their actuary, the
trustees are satisfied that they are appropriate and have asked their actuary to help
them draft a response to this member.
(ii) Outline the points to be included in the trustees response, highlighting

possible reasons why commutation factors vary from scheme to scheme. [11]
[Total 15]
5 The trustees of a large defined benefit pension scheme are about to undertake a formal
actuarial funding valuation. The scheme comprises manual factory workers,
administration and management staff.
(i) Outline the information that the trustees should consider in setting the
valuation assumptions. [4]
(ii) Outline how each of the key financial and demographic valuation assumptions
may be derived. [10]
At the valuation date investment markets had been particularly volatile.
(iii) Discuss the implications of this on the valuation process. [4]

[Total 18]
6 Company A and Company B operate mature defined benefit pension schemes.

Negotiations are currently underway for Company B to purchase Company A.
(i) Explain how the existence of the pension schemes could complicate the
negotiations. [5]
(ii) Discuss the key issues that Company B should consider regarding Company
As pension scheme. [6]
(iii) Discuss the key principles that the trustees of the pension schemes should
consider in relation to this possible transaction. [6]
[Total 17]
ST4 S20103 PLEASE TURN OVER

7 A final salary pension scheme provides a members pension related to service and
salary close to retirement. It also provides a package of benefits for dependants on
death both before and after retirement. Pensions in payment are reviewed annually
and increased from time to time having regard to increases in the cost of living.
The 2009 triennial valuation has recently been completed. Since the previous
valuation in 2006 there has been a major redundancy exercise. This resulted in a
number of scheme members leaving service or retiring early. The following
communication to scheme members covering both the 2009 valuation and the 2006
valuation has been provided.
2009 2006
valuation valuation
Ratio of assets to liabilities:

Ongoing funding basis 80% 90%
Assuming accrued benefits are purchased on the open market 50% 80%
Recommended contribution rates (% salaries)

Employer 15% 12%
Employee 5% 3%
Some members have asked the trustees of the pension scheme to explain the results of
the recent valuation. In particular they have asked whether they should be reassured
or concerned by the results. The trustees agree to arrange a more detailed
communication to be issued to all scheme members.
Discuss the items that might be covered within such a communication. Your answer
should include:
the additional information that might be provided

a description of the alternative actuarial bases
a justification for the increased contribution rates
[20]
END OF PAPER
ST4 S20104
INSTITUTE AND FACULTY OF ACTUARIES
EXAMINERS REPORT
September 2010 examinations

Introduction
T J Birse
January 2010
Institute and Faculty of Actuaries

Subject ST4 (Pensions and other Benefits Specialist Technical) September 2010 Examiners Report
The examiners were pleased to note a general improvement in standards. In particular there
was less (but still some) evidence of candidates not reading questions carefully enough.
Comments on specific questions:
Q1 This straightforward question was not answered that well. There was too much
evidence that candidates could not identify whether events were down to the employer
or trustees. For example blaming the trustees for non payment of employer
contributions or blaming the employer for the poor performance of the investments.
Some offered suggestions that would not be practical; other resorted to repetition and
listed every possible crime a director could be convicted of.
Q2 This was reasonably well answered but some candidates had not read the question
carefully and got side tracked by considering irrelevant issues for a money purchase
scheme e.g. means testing.
Q3 Too many candidates chose to ignore the word distinct in part (i) and just wrote
about different types of investment guarantee. The better candidates demonstrated
their understanding by noting whether the protection was pre or post retirement (or
both).
Given this, answers to part (ii) were limited.
Q4 Part (i) was well answered, part (ii) less so. For part (ii) those candidates who
demonstrated that they had planned their solution and followed a systematic
approach scored well.
Q5 Parts (i) and (ii) were generally answered well although too many candidates did not
mention the sponsors covenant or the schemes investment strategy in their solutions
and many did not appear to appreciate which assumptions are key and which are
minor.
Part (iii) was not well answered with most candidates writing about volatility and its
effect on the valuation results rather than the valuation process in volatile times.
Q6 Candidates found this question challenging and did not write enough given the marks
available. Again candidates struggled when asked to look at things from both the
companys and trustees perspective.
Q7 The better candidates planned and structured their solutions. The poorer candidates
either wrote too little given the marks available or wrote at length on suggestions that
would not be practical, e.g. suggesting detailed membership data is provided showing
actual costs associated with each redundancy.
Page 2
1 (i)
z A change in corporate structure that reduces the priority of the benefit
obligation in the event of insolvency
z Breach of banking covenants
z A significant change in the employers credit rating
z Significant changes in board of Directors / Chief Executive
z Employer ceasing to trade in the country
z Or entering administration/receivership
z Dishonesty conviction of any Director
z Corporate transactions e.g. Merger / acquisition
z Non payment of contributions
z Late submission of accounts
z Not disclosing conflicts
(ii)
z Granting additional benefits to members without securing additional
funding
z or without actuarial advice
z Significant changes in the schemes advisers e.g. actuary / auditor
z Significant changes in trustees
z Change in authorisation of investment managers appointed by the trustees
z Occurrence of mal administration or suspect investment practices
z Significant transfers out or transfers in representing a large proportion of
the schemes assets
z Breaches of restrictions on types of investments
z Breaches of any disclosure requirements to members or required checks on
adequacy of funds e.g. benefit statements etc
z Trustee bankruptcy/conviction
z Not disclosing conflicts.
2 Membership
z Determine the rules of eligibility e.g. in employment

z Members would have one account for the whole of their membership period
z For example if the member moves employer they still have the same account in
place
z The member will always be an active member of the Scheme whilst not in receipt
of a pension
z It would be compulsory
z Unless the member can prove the benefits earned in an alternative Scheme are at
least as good
z Consider auto enrolment
Page 3
Contributions
z Minimum contributions would need to be specified

z Could be age or salary related
z Payable by employee and / or employer
z Unless a suitable alternative pension vehicle is being used
z May be possible to contribute even if not in employment
z but who would contribute on behalf of the member when they are not in
employment
z Consider integration with tax system
Administration Costs
z The scale of the scheme should result in significant economies of scale

z However there will set up costs which need to be met
z Will all members have the same ongoing costs
z Charges need to be fair and transparent
z Consider whether totally financed by the members or partially financed by the
Government
z There would be costs associated with ensuring the adequacy of members private
arrangements
z Types of charges annual management charge, admin fee, bid/offer spread
z Who will do administration? Government body or outsourced?
Advantages for members
z Will provide a minimum contribution hence a minimum pension provision

z Charges should be competitive given economies of scale and no profit margin for
the government
z Will be available to all
z Independent of employer so not relying on their employers covenant
z Portable, facilitates job changes
z Flexibility over options
z Secure, ie backed by government, 100% funded
z Simple in design
Disadvantages for the members or government
z May be seen as political interfering

z Minimum benefits may not be at a sufficiently high level
z Existing pension schemes may switch to providing a minimum benefit only
z Leading to less pension for some people
z Does not provide an investment guarantee
z Has many of the general disadvantages of defined contribution e.g. unknown final
benefits
z Costs will be met by members not their employer
z but in practice there may be a cost for the government, if top ups needed
z Government bears establishment costs and reviewing arrangements
Page 4
3 (i)
1. A DB underpin so that the pension will never be less than a minimum
accrued amount
E.g. a minimum of 1/100th of salary at retirement for each year of
service
Impact of investment market falls
Depends on the level of the minimum accrued pension guarantee.

If it is relatively low it may not be expected to apply very often
The guarantee could be at retirement or leaving service so short
term falls in investment markets may not be very relevant
Will cover investment pre & post retirement
Members may choose risky funds as they will benefit from the
underpin if performance is poor
So may be sensible to restrict investment choices
2. Guaranteed annuity conversion rates, so that members are protected

against increases in market annuity rates
Considers post retirement interest rate only so no protection against

low investment returns prior to retirement
Annuity terms are based on bond yield rather than equity returns
Depends on the guaranteed terms offered with a higher annuity
factor meaning there is less chance of the guarantee biting
Bond yields at retirement are the important factor
3. An explicit investment guarantee
based on either a minimum fixed, indexed or real investment return

which may be checked each year or over the term to retirement
This will provide protection for members if falls in the investment
market
The actual amount will depend on the length of time over which
the guarantee is averaged
And the absolute amount of the guarantee
Members may choose risky funds as they will benefit from the
underpin if performance is poor
So may wish to restrict choices
4. Lifestyling investment option
Assets switched into bonds as member approaches retirement

Idea is to be invested in annuity matching assets for part of pot to
be used to buy annuity
So protection against falls in equity prices at point of retirement
Page 5
Relies on member retiring at chosen retirement date
(ii) General
Could hedge some of the investment risk, eg derivates, insurance products

Which may reduce or eliminate funding requirements
Is funding desirable or necessary
Watch concentration of risks, will sponsor be able to meet costs as they
arise
1.
Members effectively have a choice between two different types of
benefits
The scheme funding needs to consider both options
Even if the DC fund is currently high enough it does not mean the
resources are necessarily adequate in the long term
i.e. the DB benefit might bite sometime in the future
Could use stochastic modelling models to determine suitable
reserves
Or fund at retirement (terminal)
2.
Need to reserve separately for the annuity rate guarantee
Could set the assumptions based on insurance company rates
3.
Need to reserve separately for the investment rate guarantee
May need to restrict the investment fund choice to control risk
Need to determine at what point the guarantee is checked and build
a stochastic model accordingly
Could add a contingency margin e.g. 5% loading to liabilities
4.
Additional funding should not be necessary
4 (i)
What is cash limit?
Conversion terms, the higher the factor the more likely that the member
will exchange pension for cash
What is being given up?
Dependants pension
Escalation
Immediacy of need for cash e.g. to pay off a mortgage or other loans
Requirement for a guaranteed income stream
Financial awareness of the member to manage a large sum of money
Could lump sum be invested to provide equivalent or higher income
Desire to gain control over investment strategy of part of pension fund
Comparison of commutation factors relative to open market annuity rates
Page 6
Tax treatment of one option over the other e.g. lump sum and pension
taxed at different rates
Health status, e.g. short life span
Consider risk of employer, security of pension
(ii) General points
Factors recently reviewed and the trustees are satisfied with their
appropriateness
Factors calculated in line with the requirements of the Trust Deed and
Rules/legislation
Commutation factors may represent the value of a unit of future pension
Factors may vary from member to member depending on age and sex
On early retirement the commutation factors will be higher than normal
retirement
May also be different on ill-health early retirement
Member always has the option to take all benefits in pension form if they
wish
Comparison with other schemes
Commutation factors not directly comparable from scheme to scheme

Requirement for actuarial neutrality of pension surrendered on a given
basis
Reduction of exposure to longevity and/or investment risk in scheme
Factors designed to facilitate HR policies
Different objectives underlying commutation factors, some employers may
wish to encourage commutation
Who sets terms? Trustees/company/both
Schemes will have different benefit structures
Such as
o retirement ages
o rate of guaranteed pension increases
o allowance for any discretionary pension increases
o whether increases provided on pre/post commutation pension
o whether spouses pension affected by level of member commutation
Different methodologies of calculation & administrative constraints
o Factors market related or calculated on long term assumptions
o Reflection of actual/notional investment strategy
o Individually calculated or calculated for groups of members and
method of grouping
o Requirements for smoothed tables of factors
o Frequency at which factors can be reviewed
Assumptions used to derive commutation factors will vary among schemes
such as
o post retirement mortality
o post retirement discount rate
o allowance for discretionary pension increases
Page 7
Scheme Documentation/ Legislative Constraints

o Scheme rules may specify minimum/maximum rates of commutation
o Use of unisex factors
Other
Period since last review of commutation factors e.g. more recently

reviewed factors may allow for improvements in longevity
5 (i)
Assessment of employer covenant
i.e. the ability and willingness of sponsor to pay sufficient contributions
Current and future investment strategy
The current funding objective and last times valuation assumptions and
results
Funding method
Profile of liabilities and extent of asset matching
Historical salary data in the country, industry or company
Historical mortality data split by category e.g. factory, administration and
management
Historical scheme specific experience e.g. leavers, ill health retirements,
proportion married etc split by category
Information from the sponsor regarding any planned activity e.g.
redundancy , withdrawal and early retirement policy
Current market data and government policy statements / intentions
Any Legislative requirements e.g. use of standard / fixed assumptions
Assessment of whether past data / information is relevant for the future
And is it statistically credible?
View of future economy
Allowance for discretionary benefits
(ii) Financial assumptions
Prudence
Degree of prudence should depend on employers covenant

Not necessarily in every assumption
Overall level should be considered
Investment Return
Based on implied market discount rate on assets matching the liabilities.

Allowance for future asset outperformance in excess of gilt/ bond yield
(risk premium)
Separate assumptions for pre and post retirement may be used
Page 8
Or a combined pre & post assumptions reflecting the weighted average of

the individual discount rates based on the proportions invested in each
asset class
Could just look at bond yields
Price inflation
Use long term view of expected price inflation

Could compare the yield on fixed interest and index linked Gilts / Bonds
Or Government projections of price inflation
Pension Increases
Defined in scheme rules or established practice

If related to price inflation
Hence base on price inflation assumption derived above
Allowing for volatility
Salary growth
Consider promotional increases

split by works / staff
And general inflationary increases in salaries (linked to price inflation)
Discussions with sponsoring employer
Demographic assumptions
Mortality in retirement
Look at scheme experience of separate homogenous groups eg manual /

office based workers
Determine a suitable base mortality table
Probably based on standard tables with an appropriate adjustment
Most important demographic assumptions
Allow for future improvements in mortality
Other key assumptions
Allowance for expenses
(iii)
Valuation is a snap shot at a point in time
But a long term view is needed
The sponsor covenant is important for long term security of members
benefits (i.e strong covenant allows a greater degree of flexibility)
In volatile market conditions need to show different possible funding plans
Investigate the sensitivity of results to changes in key assumptions
And differing market conditions
Page 9
Monitoring development becomes more important

Consider developing triggers for future actions e.g. an updated valuation /
extra cash.
Consider increased explicit margins / prudence
Discussions between sponsor / trustees are more important to ensure
understanding of the impact and sensitivities of the assumptions.
Consider smoothing the key assumptions (averaging over a period) if
market related assumptions are to be used
Consider if any regulator guidance
6 (i)
Need to consider position of schemes
The funding deficits (or surpluses) may be large relative to the purchase
price
There may be disagreements on the actual size of any pension scheme
deficits
Assessment and understanding of the underlying risks in the pension
schemes is needed
e.g. investment strategy, future contribution requirements, legislative
changes
Trustees acting on behalf of members security
which may conflict with the employers objectives
Will need to be aware of Trustee powers in Trust Deed and Rules
e.g. power to wind up scheme, power to set contributions
Covenant strength of new combined employer
There may be legislative and /or pension regulator involvement to consider
Impact on future Company share price
Conditions imposed as part of sale e.g. scheme to be de-risked crystallising
a larger deficit
or extra contribution required to remove deficits in the schemes
Different benefit structures may complicate matters
(ii)
Companys primary duty is to its shareholders
Strategic and business implications are the key drivers
The pension scheme may act as a deterrent to the purchaser
Future share prices will factor in the underlying pension position and risk
May be requests from the Trustees for the schemes to be de-risked
Or contributions to return to full funding
Any pension scheme deficits will need to be factored into the price
negotiations
But will be priced differently by different parties perhaps anticipating
Trustee reaction / requests
The size of the deficit may be large in relation to sale price
Full disclosure of all pension scheme details will be needed
Including up to date funding positions
Page 10
Possible legislative / regulator involvement

Company should take its own legal and actuarial advice
Need to understand the future impact on balance sheet and other
accounting disclosures
Company B may explore the possibility of excluding the Company A
pension scheme from the transaction
Need to consider the practical issues regarding any participation periods
Whether to harmonise benefits (if different)
Consider employee relations
Problems exacerbated by scheme a having lots of former employees as
members little interest to Company B?
(iii)
Primary consideration will be the impact on the covenant
How future funding shortfalls will be addressed
Engage with the Company to perhaps request increased contributions and
or any additional security offered
Or seek to reduce investment risk
Need Information on any possible restructuring resulting in early
retirement / redundancies if they affect the finances of the Schemes
Preserving or enhancing the security of accrued benefits is a key
consideration
Updated funding positions will be needed
Understanding the details & powers in Trust Deed & Rules e.g.
contributions, wind up etc
Regulator / Legislative considerations
Managing potential conflict of interest for some of the Trustees
Seek legal & actuarial advice at an early stage
Decisions to be made on combining the schemes or keeping them separate
Consider admin, trustees, investments
Communication with members etc
Investment issues, liquidity requirements
7 (i) Additional information
Main assumptions used for ongoing and discontinuance valuations:

Discount rate, salary increases, revaluation rates, increases in payment,
mortality rates (brief description), expenses, brief comment on other
significant assumptions such as assumed ages at retirement
Membership reconciliation - table showing development of membership

between valuations, categorisation between active / deferred / pensioners
at each valuation, with number of new entrants / leavers / retirements /
transfers out, also changes in average age / average salary
Where further detail can be found, e.g. valuation reports, investment

reports, latest annual report, other recent communications , annual
Page 11
statement The parties involved in running or monitoring the scheme and

their function, e.g. company, any trustee board, advisers, regulators etc.
Analysis of change explanation of main sources (expected vs actual

return on assets, change in assumptions, experience gains or losses, effect
of redundancy exercise, discretionary pension increases
Value of assets / liabilities at each valuation on each basis

Investments : Description of how assets invested
.. summary account showing money flows in / out between valuation
.. and fund yield over period
Statement of compliance with legislative and regulatory requirements
.. commenting on any changes over inter valuation period and how scheme
has responded
Actuarial bases
Discontinuance:
o Insurance cost to guarantee benefits (mortality / interest / costs of

paying benefits)
o State factors that have led to change in % coverage, eg change in
market values / interest rates / availability of insurance / improvements
in mortality / pricing philosophy used by insurance company (eg to
make more profit)
o Doesnt mean scheme is to be wound up
Ongoing:
o Funding policy, including method
o Valuation assumptions, long term best estimate, explain changes
o .. stating why different from discontinuance basis, giving examples
Contribution rates
Show amount needed to meet deficit

Lower payroll means deficit contributions will be higher % of payroll
Main factors contributing to the increased in contribution rates
..e.g. contribution from past poor investment performance
.. expected future investment performance (link to any changes in
assumptions)
.. expected future mortality (link to any changes in assumptions)
100% of benefits still being paid
.. how decision made to share the increases between employee and
employer
.. what factors will influence whether the employees contributions might
increase / reduce after next valuation
Page 12
.. e.g. how long it will take to remove deficit

.. scope of lump sum injections form employer
options available to employees who cant afford to increase contributions
Other factors
Employers covenant (describe)

Other changes to assumptions
If company discontinues scheme, details of any payment employer
required to make to the scheme to improve solvency of scheme
Position if company becomes insolvent, e.g. details of any statutory
compensation schemes
Legislative and regulatory requirements, e.g. regular certification of
solvency, plan to meet deficits, constraints on investment strategy
Should be clear to members
Page 13
EXAMINATION
26 April 2011 (pm)

booklet.
supervisor.
5. Attempt all eight questions, beginning your answer to each question on a separate
sheet.
question paper.
ST4 A2011 Institute and Faculty of Actuaries

1 (i) List six options that may exist for providing accrued benefits when a defined
benefit scheme is discontinued. [3]
A defined benefit pension scheme has been managed for some years as a closed fund
with no further accrual of benefits. The only liabilities remaining are in respect of
current pensions in payment. The funding level at the last actuarial valuation was
100%. The rules of the scheme provide for annual pension increases in line with price
inflation, and do not allow for benefits to be reduced on account of underfunding. No
further financial support for the scheme will be available from the sponsoring
employer or any other source.
(ii) Outline the key risks that may result in pensioners benefits not being paid in
full, comparing the impact on the oldest and youngest pensioners. [5]
[Total 8]
2 (i) Describe five methods of measuring the strength of sponsor covenant. [5]
(ii) Give one advantage and one disadvantage of each method identified in (i),
ignoring any points relating to the cost of each method. [5]
[Total 10]
3 The trustees of a large defined benefit pension scheme have been reviewing their
investment strategy. The aim of the review is to reduce the degree of mismatching of
assets and liabilities by adopting an investment strategy based on corporate and
government bonds.
(i) Describe the key features of this investment strategy and the likely impact on
the schemes funding position. [5]
(ii) Discuss the issues associated with implementing this investment strategy. [5]
[Total 10]
4 (i) Give two distinct reasons why disclosure of pension scheme information in the
sponsoring companys accounts is important. [2]
(ii) With respect to the various accounting standards for pension scheme benefits:
(a) Outline the common aims of these standards, and

(b) State the areas where these standards differ.
[4]
The latest ongoing funding valuation for a defined benefit pension scheme revealed a
deficit, but the accounting valuation at the same date showed a surplus.
(iii) Suggest possible reasons why the valuations are showing different results. [4]
[Total 10]
ST4 A20112
5 A defined benefit pension scheme was closed some years ago and now contains only
pensions in payment. The pensions increase in line with inflation. The following
information is available as at 31 March 2011:
Market value of assets 125m

Value of liabilities 100m (on basis consistent with assets)
Average age of pensioners 70
Annuity at age 70 12 (on basis used to value liabilities)
Dividend yield on equities 3% per annum
Average coupon on bonds 6% per annum
The scheme is currently invested 20% in cash and 80% in a diverse portfolio of high
quality fixed interest corporate bonds.
The finance director has suggested that the scheme invests entirely in equities, as he
believes that the return on equities will significantly reduce the cost to the company of
providing the benefits. He is keen, however, to understand the risks relating to this
strategy, relative to those for the current investment strategy.
Discuss the points you would make in a report on the finance directors proposal. The
points you make should include:
the implications for the relative income and outgo of the scheme, and
the relative risks of the two strategies.
[10]
6 (i) List the criteria to consider when choosing a funding method. [2]
The government of a country has been using a simple mathematical model based on a
single assumption of the population growth rate to project its total population size.
(ii) Outline the shortcomings of using such a model to predict population change.
[3]
The government provides its population with a state pension in retirement, which is
funded using the pay as you go (PAYG) funding method. The country has had a low
birth rate, relative to the death rate, for many years, but the population has now
stabilised in a state where:
the working population is smaller than the retired population,

the population overall is no longer ageing, and
the overall population size is neither increasing or decreasing.
(iii) Discuss the suitability of PAYG for funding this pension arrangement,
suggesting actions the government could take to address any problems you
identify. [5]
[Total 10]

7 The sponsoring employer of a defined benefit pension scheme has recently closed the
scheme to future benefit accrual, and is concerned about the size and volatility of the
funding deficit.
The current valuation basis for funding purposes is prudent, while best estimate
valuation assumptions are used to determine transfer values available to members.
The employer is investigating the following options:
offering members a financial incentive to transfer out of the scheme
offering members the option of giving up future increases to their pension in

exchange for a one-off increase to their pension
(i) Discuss the issues that the sponsoring employer might need to address when
offering the above options to members. [8]
(ii) Outline the issues that the members might consider before accepting the
employers proposals. [4]
[Total 12]
8 The government of a developed country currently provides retirement benefits on a

means tested basis. If a citizen has total savings of $100,000 or less on their 65th
birthday, the State then provides a flat pension of $5,000 per annum until death. This
is the minimum income that the State considers a citizen to need in order to have an
acceptable standard of living. The pension is funded on a pay as you go basis through
general taxation. If a citizen has savings of more than $100,000 on their 65th birthday,
the State provides no benefit.
(i) Discuss whether this is an appropriate system for the government and the
citizens of the country. [10]
As a result of a global economic downturn, the countrys government is looking to

reduce its expenditure and is considering redesigning the State retirement benefits
system. The following design has been proposed:
A voluntary State-run pension scheme whereby citizens who wish to receive a State
pension may choose to pay $50,000 at age 65 in exchange for a flat pension of $5,000
per annum until death. Citizens with savings of less than $50,000 at age 65 will still
be entitled to receive the same level of pension without contributing.
(ii) Discuss the suitability of the proposed design compared with the current
system, from both the government and citizens perspectives. [13]
The government has considered the proposed design and decided that it will be too
costly. However the government does wish to maintain the core idea of a flat State
pension of $5,000 per annum.
(iii) Discuss possible changes that could be made to the proposed design in order
to reduce the cost to the State. [7]
[Total 30]
END OF PAPER
ST4 A20114
EXAMINERS REPORT
April 2011 examinations

Introduction
T J Birse
July 2011

Subject ST4 (Pensions and other Benefits Specialist Technical) Examiners Report, April 2011
General comments
The overall standard of scripts was slightly higher than previous settings, perhaps reflecting
some relatively straightforward bookwork and application questions in the paper. Questions
3, 5 and 8 appeared to cause candidates most difficulty and these required much more
application of knowledge and analysis. Candidates that struggled often made the same point
several times, or repeated points in later parts of a question they had already made, without
relating to them to the specific context of the later part, or comparing their answers with
previous parts to demonstrate understanding and structure their answers logically.
When reviewing the model solutions below, candidates should note that there are typically
more points on the schedule than were necessary to score full marks for the relevant section,
and that the passing standard would require even fewer. Even the best prepared candidate is
not expected to be able to write down all the points below in the time available. Most bullet
points listed below would score 0.5%, and examiners were also instructed to give credit for
relevant points not on the schedule that demonstrated understanding of the syllabus.
Page 2
1 (i) Discontinuance options

z Continuation of the scheme without any further accrual of benefits
z Transfer of the liabilities to another pension scheme with the same sponsor
z Transfer of the liabilities to another pension arrangement the member
holds (e.g. individual DC scheme, another DB scheme)
z Transfer of the funds to the beneficiary to extinguish the liability
z Transfer of the funds to an insurance company to invest and provide a
benefit
z Transfer of the liabilities to an insurance company to guarantee the
benefits
z Transfer of the liabilities to central discontinuance fund, operated on a
national or perhaps industry wide basis
(ii) Risks
z The principal risk is that the scheme runs out of money before the last
benefit payment is made.
This could arise for a number of reasons:
z Event may cause measure of liabilities to increase e.g. buy-out, merger
z Investment risk investment returns are lower than expected
z E.g. mismatching, reinvestment etc. (max for one example)
z Longevity risk the members live longer than expected
z Inflation risk pension increases are higher than expected
z Dependants benefits are greater than expected
z e.g. more members married or younger age of spouse
z The administrative costs of running the scheme are higher than expected
z [Maximum mark for example of other risks, e.g. legislative changes,
fraud, mismanagement]
Different impact on older and younger members

z In general, younger members are exposed to greater risk than older
members
z This is because, if the scheme runs out of money at some stage, this is
likely to happen many years into the future
z Older members may have received their benefits in full (i.e. died) before
this happens
z ... noting that dependants pensions may then be payable
z Whereas younger members are more likely to be in receipt of benefit (i.e.
still alive)
z Of those members still in receipt of benefit if the money runs out, the older
ones are likely to have received a greater proportion of their eventual
benefit than the younger ones
Q1 was well answered by most candidates.
Page 3
2
(i) Method (ii) Advantage & disadvantage
Business Outlook Relatively easy to obtain
An assessment of the business outlook in but
general and specific to the sponsors Results are subjective and difficult to
sector quantify
Simple to undertake
but
Financial Metrics Does not give an indication of the
Financial statistics and accounting ratios absolute level of risk
can be compared with similar companies Financial statistics of other
and with previous years to spot any companies can be out-of-
trends, particularly any deterioration date/infrequent
Group accounts may not provide
information specific to sponsor
Where securities traded, up to date
information is easily accessible
Implied Market Default Risk Quantifiable measure of credit risk
Where a sponsor has issued investments but
such as equities or bonds, market prices Risk to pension scheme will differ
can indicate market view of sponsors e.g. priority / security provided
credit risks, and how views can change Other factors determine market
over time prices and hence yields
Only available if investments are
regularly traded and prices quoted
Based purely on financial
circumstances of the company,
eliminating impact of market forces
Credit Rating
Agency may have access to
Companies can pay a specialist agency to
information not publicly available
provide them with a credit rating
but
Only larger companies tend to have
full credit ratings
Quantifiable measure
Merton-type credit risk models but
A model is used to determine the Requires sponsor to have traded
probability of default based on the equity
behaviour of the equities Ratings not widely available (as
securities not quoted)
Quantitatively derived credit risk Quantifiable output and wide usage
Model deriving a credit rating or but
probability of default from standard Relies on accounting information
accounting data and credit information. which may be out of date
Page 4
Can take explicit account of

Independent business review
interdependence of funding and
Report by an external credit advisory
sponsor covenant
specialist, typically an accounting firm,
but
insolvency practitioner or other niche
operator Requires sponsor cooperation for
access to confidential information
Risk based levy
Quick and easy method of obtaining
z Credit assessment used by
a broad indication of credit rating
central discontinuance
but
fund when determining
Only a one-year view
levy to be paid.
This straightforward bookwork question was very well answered by most candidates,
illustrating that recall of core reading is rarely a problem. Some candidates chose to
describe more than five methods whilst this approach was not penalised by the examiners,
it would not score extra credit, and may have taken up time candidates could have better
spent on other questions on the paper.
3 (i)
The shape of liability cash flows can be predicted with some degree of
accuracy
So a mixture of corporate bonds and governments would be suitable for
matching these cash flows ...
... as pension in payments are bond like in nature
currency of bonds needs to match liability cash flows
Could include the use of index linked bonds if available (nature)
Need to consider term of bonds vs liabilities
Swaps / derivatives may also be used to improve this match
The aim would be to remove the interest rate risk
and the inflation rate risk
As such the value placed on the assets and liabilities should move up and
down together
but the scheme would still be exposed to the longevity risk
and longevity fluctuations could invalidate cash flow projections
Investing in corporate bonds still carries a credit risk with a probability of
default...
...this risk can vary greatly from bond to bond (i.e. AAA-rated to junk)
Possible lack of diversification
Bonds and gilts may not be good match for any active salary-related
benefits
Bonds may be a good match to annuity prices if company buys out
pensions at retirement
The likely impact on funding position depends on current investment
strategy and how funding assumptions are determined
The change to this investment strategy may require a change to the
investment return assumptions used to value the liabilities
Page 5
The funding deficit may initially increase if a lower investment return

assumption is used in the calculation of the liabilities
E.g. if high proportion of equities held currently
There might be less reliance on the covenant of the sponsoring employer
Q3(i) asked for comment on the key features of the investment strategy many candidates
misinterpreted this and focused on the key characteristics of the suggested investments
themselves. Also, candidates failed to demonstrate understanding of the impact by simply
stating that, e.g. the deficit would worsen, without explaining why.
(ii)
Appropriate bonds for the liabilities might not be available
i.e. duration, nature or currency (max )
Bond cash flows are also lumpy in nature
So it will only partially match the sensitivities of the liabilities
Swaps / derivatives can overcome some of this problem
... and may be expensive and introduce counterparty risks
There will still be a reinvestment risk
Refinements to the strategy could be considered to move from a broad
match through to a partial match or a full cash flow match
This would add complexity to the investment strategy
The volatility in the future funding level will depend on how well the cash
flows are actually matched
There may be practical difficulties in directly investing in a suitable
matching portfolio
transaction costs of selling current assets and purchasing bonds & gilts
should be considered
Also need to consider the timing of such a switch
...and administration involved
Need to consider any legislation or scheme documentation restrictions
Any requirement to disclose or communicate this change?
...or any updates required to scheme documentation?
Q3(ii) was generally well answered, but some candidates concentrated solely on employer
preferences and issues, even though this part of the question was around implementation.
4 (i) Reasons for disclosure

So owners of capital of the company (and potential owners) are aware of
the significance of the benefit obligations that exist
So readers of the accounts can form a realistic opinion of the companys
current and future financial position
So members and/or regulators can assess the security/risks for defined
benefit schemes
(ii) Common Aims

Recognising the realistic cost of accruing benefits
avoiding distortions resulting from fluctuations in contributions
Page 6
consistency in the accounting treatment from year to year

(although not necessarily from company to company)
disclosure of appropriate information
Differences
Relative importance of balance sheet and profit/loss account
Choice of actuarial methodology and/or assumptions for liabilities
Smoothing of year on year fluctuations
Amount of information to be disclosed
Recognition of gains and losses
Approach to valuation of assets
(iii) {Where appropriate, candidates should be clear on why their suggestion

supports the higher funding level for the accounting results.}
Party for whom funding valuation is being completed has lower risk
appetite and/or stronger funding objectives
Funding valuation might include a margin for prudence
Explicit additional reserve or implicit in assumptions
...whilst accounts might be realistic
Accounts may show a smoothed (lower) valuation of liabilities
Actuarial method may produce a higher accrued liability for funding
Different actuarial assumptions:
E.g. Funding may have lower discount rate
Or higher inflation rate
Or lower real discount rate overall
Stronger demographic assumptions
In particular for longevity (max 2 examples, mark each)
Might allow for options and guarantees differently
E.g. funding basis ignores options that members in practice take on
unfavourable terms
Funding basis might allow for discretionary benefits
Accounting calculations were approximations (e.g. roll-forwards)
produced before funding valuation
Lower value of assets in funding valuation (e.g. admissibility criteria)
Q4 was answered well by most candidates, although, as noted in the marking instructions
deliberately left in at the start of part (iii), some candidates simply talked about different
assumptions etc., rather than demonstrating that they understood why the accounting
valuation showed a better funding position, as stated in the preamble to part (iii).
5 FDs Proposal
Supporting calculations
z Expected annual dividends 125m * 3% = 3.75m
z Expected coupons 100m * 6% = 6m
z Total pensions in payment 100/12 = 8.3m
z Surplus is 25m
Page 7
Current strategy
z Currently the company is unlikely to need to make further contributions
due to the surplus
z Liquidity risk is low
z The investment strategy should provide enough cashflow to pay the
benefits as they fall due
z As the bonds provide 6m income per year
z And there is a reasonable percentage in cash
z The bonds should be liquid if more cash is needed in the future
z There is however inflation risk...
z ... as the scheme assets are mismatched
z i.e. the risk that the fixed interest assets do not provide a high enough
return if there is a period of high inflation
z and the risk of default on the corporate bonds
z although for high quality bonds this is historically very low
Proposed strategy
z Equities are a volatile asset
z Falls in market values in real terms will contribute to investment
underperformance
z And increase the risk of not being able to pay the benefits as they fall due
z Or that the company would need to make additional contributions in the
future
z A high return on equities would only reduce company costs if surplus
could be reclaimed
z There is liquidity risk
z as expected dividends from equities are not likely provide enough income
to the scheme to pay for the pensions in payment
z Therefore equities may need to be sold each year, possibly at a low point
in the market
z It is unknown how liquid the market for equities is
z but traded shares are likely to be liquid
z Some consider equities to be a real asset, therefore should hedge inflation
risk in the long-term
z Consider risk due to lack of diversification
z Consider taxation implications
z Significant expenses in restructuring the entire portfolio
z Regulations in some countries specify a minimum % of bond investment
z May also need to consider any scheme-specific restrictions
z Bonds are likely to be a better match for buy-out/annuity costs
z Members are unlikely to want currently stable well-funded scheme to take
on risks...
z ... particularly if there is no reward for them
z If strong sponsor covenant, then implications of taking more risk are less
significant.
z Similarly if currently funding basis is strong (noting 125% funded)
z Consider just investing surplus (25m) in equities?
Page 8
Whilst answers to Q5 generally addressed some of the issues, they typically lacked
explanatory detail. The question gave a very clear steer on where comments should be
directed, e.g., implications for the relative income and outgo, yet very few candidates
used the numerical information given in the question to quantify this.
6 (i) Funding method criteria

z Security
z Stability
z Durability
z Realistic
z Liquidity
z Flexibility
z Opportunity cost
(ii) Model shortcomings

z population change has been more complex than the simple rate of growth
models suggest
z the rate of growth varies over time (due to factors such as)
z ... resource constraints
z ... inward and outward migration
z ... availability of birth control
z ...,
z when such models have been used, the estimated rate of decrease of
population growth using past data has tended to understate the actual rate
of decrease
z resulting in population projections which are too large
z simple rate of growth models can lead to anomalies
z e.g. populations increasing without limit, population sizes that become
negative
z The projection of population size in this way leads to little understanding
of the mechanisms of population change.
(iii) Suitability of PAYG

z a government is generally assured of its continual existence
z therefore the method may seem secure
z but regime / commitment to past promises may change
z If benefits are higher than the available tax revenues, it may struggle to
continue providing this benefit
z The government may need to reduce benefits
z ... or increase the tax rate charged
z ... and/or increase borrowing
z and will have less flexibility over the timing of these changes with no
reserves.
z Could set up a funded arrangement...
z ... but would need to consider political opinion, transition arrangements,
investment options, macroeconomic effects etc.
z ...in particular, unpopularity of one generation contributing twice (for
current retired population and themselves)
z PAYG has no opportunity costs
Page 9
z ... and no requirement to administer invested funds

z The level of outgo is likely to be stable in this country
z ... assuming level of benefit increases is predictable
z Stability of contributions may be an issue if total national earnings falls
relative to benefit outgo
z Instability may result from a lack of uniformity of the age profile of the
population
z there is also dependence on the stability of the size of the working
population.
z The government should now have a realistic impression of the future
pension costs
z PAYG as a funding method seems reasonable
z ...but perhaps not realistic if costs appear expensive as working population
is small relative to retired population
Q6 was generally well answered by most candidates. A common failing, however, was that
candidates discussed PAYG in generic terms in part (iii), rather than in the specific context of
the question. Once again, this leaves examiners wondering if candidates are simply recalling
core reading, rather than demonstrating their understanding of the material, and their ability
to apply it.
7 (i) Issues for sponsoring employer
General comments for both offers

If set up under trust, consider TD&R, and Trustees views
The options would need to be clearly explained to members
...and appropriate timescales given
to ensure members can make an informed decision
Ensure compliance with any legislation or regulator guidance
Consider paying for independent advice to members to mitigate reputation
risk
Employer should take appropriate legal and actuarial advice
Consider the impact on accounting disclosures
There may be significant costs in providing communication and financial
advice to members
Also, significant administration demands and costs for individual
calculations
...and no guarantees members take option so overall take up rate and cost
savings / risk reduction uncertain
Need to consider investment strategy after exercise complete
Transfer value inducement

Any transfer payment out removes longevity and investment risk
The transfer value is likely to be lower than the scheme funding reserve
Therefore members taking transfer values should result in an improvement
in the funding position for the scheme
The employer needs to decide on the size of the enhancement
Page 10
Enhancement may require the employer to provide upfront funding for the
exercise (direct cash to members or additional funding of the scheme)
So enhancement should be set to maximise the take up rate by members
but minimise the total cost of the exercise
The inducement could be as a direct cash payment
or as an uplift to the standard transfer value
Some targeting of the enhancement may be appropriate
E.g. higher enhancements for most significant liabilities
There may be future complaints from members and a reputational risk for
the employer if future benefits turn out lower
Need to consider liquidity of investments if significant volume of transfer
values will be paid
Forfeiting future pension increases

A reduction in pension increases would reduce the risk exposure
It reduces longevity risk as pension is lower for those that survive the
longest
... and inflation risk and investment risk could be reduced
May be more able to match the benefit in payment with suitable assets
Need to consider the terms of exchange to be offered
If these were less than cost neutral on the valuation basis the funding
position would improve if members accepted the offer
There may be a selection risk against the scheme
e.g. members in ill health would gain by accepting the offer
The overall take up rate however will be uncertain
Need to consider whether change will affect dependants benefits
(ii) Member issues
General comments for both offers

Need to be sure an informed decision is made
Hence financial advice may be needed
Need to consider personal circumstances e.g. other savings and income
May benefit member with shorter than average life expectancy
Transfer value inducement

May prefer to consolidate their pension benefits into one source
May prefer to have control over their investment
... and/or additional flexibility to choose form of benefit
But significant investment and longevity guarantees are being given up
May benefit member with shorter than average life expectancy
How secure do they believe their benefits are currently (sponsor
covenant)?
What is the size of the enhancement?
Forfeiting future pension increases

Members may value a higher pension now
Especially if their financial circumstances require cash in the short term
Page 11
But inflation may increase rapidly in the future

Need to consider impact on dependants benefits
What is the size of the proposed one-off increase relative to future
expected increases?
Q7 was answered reasonably well by most candidates. Some weaker candidates simply listed
issues in part (i), ignoring the instruction to discuss them in the question.
8
This relatively large question was disappointingly answered overall, with the majority of
candidates failing to score half the marks available. The Examiners wonder whether some
candidates left themselves sufficient time to both plan and write up their solutions to this
question, as many candidates simply didnt make enough points to score well. Further
comments are included below on each part of the question.
(i)
Advantages
z Ensures the needy are provided for
z Benefits not paid to wealthier citizens so keeps costs down
z Redistributive as taxes received from those with more wealth and benefits
received by those with less wealth
z Once means test is carried out, flat benefit is simple to administer
z PAYG means government does not need to put aside funds so no
opportunity cost...
z ... or need to administer and meet costs of investment
Disadvantages
z Means testing may be expensive to carry out
z and may mean benefits are not taken up by all those who are entitled to
them
z due to the perceived stigma or difficulty of claiming benefits
z Unclear what is included in the definition of savings
z ... income (e.g. private pensions, employment, investments etc.)
z ... assets (e.g. property)
z Liquid savings e.g. cash deposits are a poor measure of wealth
z It may be difficult to value illiquid assets e.g. property...
z ...and whether/how to make allowance for mortgages and other debt
z Creates a two-tier system

z with a sudden cut off point between those who meet the means test and
those who do not
z e.g. a citizen with $100,000 will receive the pension and keep their
savings
z but a citizen with $100,001 may need to use all their savings to provide an
equivalent income
z May be perceived as unfair by citizens
z Citizens may be discouraged from providing for themselves
Page 12
z May create a poverty trap whereby increasing a persons savings merely

reduces the level of State benefits
z May encourage people to squander existing savings shortly before age 65
so they meet the means test
z Or citizens may try to hide assets
z e.g. by transferring to family members or placing offshore
[1/2 mark for any valid example]
z The citizens who do not meet the means test may not be able to realise all
their assets (e.g. they may be tied up in property)
z PAYG means benefits may become unaffordable in an ageing

population
z especially in difficult economic conditions
z Value of flat pension may be eroded by inflation over time

z and may become insufficient to meet minimum standard of living
z $100,000 may not be sufficient to provide a pension of $5,000 per annum
z ...particularly if longevity improves
z ...and the government bears this risk
z Is 65 an appropriate age
z What is the expectation of life at age 65?
z Do citizens generally stop work at age 65?
z Unclear what provision, if any, for dependants on death of citizen
Some students concentrated on more complex analysis and failed to include some
straightforward key issues, ignored the possible merits of the current system, or focused on
one aspect of the design (their answers had depth but no breadth). Note that any
candidate that included half the points listed above would score close to full marks on this
question.
(ii) Citizens perspective
Citizens with savings under $50,000

z will be unaffected
Citizens with savings between $50,000 and $100,000

z will now have to give up $50,000 to obtain a State pension
z ...or opt out of the scheme...
z ...but they are unlikely to have sufficient means to provide an adequate
standard of living
Citizens with savings more than $100,000

z are now eligible for a State pension
z at a cost of $50,000 which appears to be very good value
z as under the previous system it was effectively deemed that it would cost
twice as much to obtain the same level of pension
z This may be particularly attractive to citizens who expect to live for a long
time after age 65
z Citizens are likely to be pleased with the voluntary nature
Page 13
z May not provide sufficient income for the individual so additional pension
arrangements may be needed
z The absolute cut off point for the means test means that a two-tier system
still exists
z Remains a flat pension, so value may be eroded by inflation
Governments perspective
z Ensures total State funding in retirement is targeted at only the most needy
(those with less than $50,000 savings);
z those with $100,000 savings may not be considered to be in as much need
z Citizens with savings between $50,000 and $100,000 must now contribute
towards their State pension; a cost saving
z Ensures the whole population can achieve a minimal level of pension
provision at a competitive price
z Opening the scheme up to all citizens may encourage a culture of saving
for retirement which previously did not exist
z Lowering the means test threshold may encourage more saving by citizens
z ... as citizens would face getting by on a much lower level of savings to
meet the means test
z It appears that citizens who have over $50,000 will only meet half the
expected cost of their pensions
z leaving the State to pay the rest
z ... including those with savings over $100,000, for the first time
z The State would be directing resources to citizens with savings over
$100,000 so system is less redistributive
z Depending on the savings levels of the population and voluntary take-up
rates...
z ...the proposal may cost the State more than the previous system
z and leave the State open to more risk
z Proposal does nothing to reduce the costs of means testing
z ... and adds additional complexity / administration costs
z ... and require extensive communication / education of citizens
z ... and some form of transition plan for the change from $100,000 to
$50,000 and the subsidised pension
z The government may need to review the annuity rate periodically
z The voluntary nature means there is a selection risk
z as of the citizens with over $50,000 only those who expect to have a
reasonable life expectancy will buy the pension
For part (ii), far too many students simply repeated the points they made in part (i), without
reference to whether the proposal diminished, exacerbated or left the problem unchanged.
Better candidates added logical structure (and mark-scoring opportunities!) by splitting their
answer to separately consider citizens with up to $50,000, between $50,000 and $100,000,
and over $100,000 of savings the proposed changes had very different impact on those
groups. Surprisingly few candidates commented on the potential cost implications of the
apparently government-subsidised annuity.
Page 14
(iii) Possible changes

z Increase the age from which the pension is payable
z Increase the contribution that is payable in exchange for the pension at age
65
z Would need to look at this in conjunction with the means test level
z Stricter means testing to avoid fraud...
z ... e.g. apply test over several consecutive years to catch those who hide
wealth around their 65th birthday
z Reduce the means test level below $50,000 so less people receive a
pension without contributing
z Could look at relating contribution to savings at retirement, rather than a
discrete cut-off point
z Say a fixed percentage of savings in exchange for the pension
z so the pension would become overpriced to the wealthy
z ... and they would choose not to purchase it
z Or only offer the option to buy a pension to the less wealthy citizens since
the current annuity rate is generous
z and the wealthier citizens are more likely to have other provision
z Pay a dependants pension on death of a citizen...
z ...if dependant not already in receipt of pension in their own right
z Compulsory contributions from all citizens before retirement
z which could be related to income so viewed as fairer
z this would provide some contributions from the members who currently
meet the means test for whom benefits are currently met out of general
taxation
z and could then consider removing the means test which may be costly to
carry out
z especially as with compulsory contributions a pension for all would
appear fairer to citizens
z Encourage/compel employers to provide savings vehicles so more people
have wealth over $50,000 at retirement
z Add eligibility conditions to reduce costs
z ...e.g. minimum years of residence / period of contributions
For part (iii), most students simply made far too few distinct points for the marks available.
This may have been the result of time pressure, but the solution above illustrates that a
technique such as revisiting each of the weaknesses of the design they identified earlier in the
question (creating a breadth and logical structure to the solution) and considering sensible
variations (demonstrating understanding of the issues) will help candidates to score well.
Page 15
EXAMINATION
4 October 2011 (pm)

booklet.
supervisor.
sheet.
question paper.
ST4 S2011 Institute and Faculty of Actuaries

1 (i) Define the net replacement ratio. [1]
(ii) Discuss the limitations of using the net replacement ratio as a measure for
individuals need for post-retirement income. [5]
[Total 6]
2 A company runs a non-contributory defined benefit pension scheme for its employees.
The benefits provided are one sixtieth of gross earnings in the year before retirement
for each year of service. On death before or after retirement, there is an attaching
spouses pension on the death of a member of two-thirds of the members pension
accrued at the date of death. Pension increases before and after retirement are in line
with price inflation.
The company wishes to keep the scheme open to both new entrants and future accrual
of benefits, but has expressed concerns over the ongoing cost of benefits. The
company has asked the actuary advising the scheme to suggest ways to reduce the
expected cost of future accrual to the company.
(i) List the possible changes to benefits that could be made. [5]
The actuary has also been asked to highlight which of the above changes would be
both simple to implement and would result in a significant reduction in the cost of
future benefit accrual.
(ii) Suggest three distinct changes and illustrate the approximate effect of each of
the changes on the cost of future accrual. [3]
[Total 8]
3 A 45 year old man living in a developed country has been receiving a 1,000 per
month ill-health benefit under an insurance policy for the last five years. The health
condition that led to the insurance claim prevented him from continuing in
employment but is not thought to be life-threatening. The policy pays this level of
benefit until he dies, reaches age 65, or his health recovers sufficiently to be able to
return to his previous employment, whichever is the earlier.
The insurance company has made a one-off lump sum offer to the man of 100,000 in
exchange for all future benefit payments under the policy. Long-term and short-term
interest rates, as indicated by government bond yields in that country, are currently
4% per annum.
Discuss the considerations and risks that should influence the individuals decision
whether or not to accept the offer. Tax and regulation can be ignored. [10]
ST4 S20112
4 The trustees of a defined benefit pension scheme are about to undertake a formal
actuarial funding valuation and have been discussing the possible methods available
to set the discount rate used to value the assets and liabilities.
The liabilities of the scheme are approximately 40% for pensions in payment and 60%
for non-pensioners. The scheme is currently invested 80% in equities and 20% in
government bonds. The following current market information and historic data is
available:
Gross redemption yield on over 15-year government bonds: 4.80% per annum
Gross redemption yield on under 15-year government bonds: 3.30% per annum
Period of Annual average return, in excess of inflation

measurement on equities on bonds
1946 to 2010 6.0% per annum 0.9% per annum
1970 to 2010 5.7% per annum 3.5% per annum
For each of the three approaches to setting the discount rate listed below:
an asset-based discount rate

mark to market
bond yield plus risk premium
(a) explain the key features of the approach, and

(b) suggest an appropriate discount rate, based on the information provided
[12]
5 The sponsor of a large defined contribution pension scheme has carried out an
employee satisfaction survey. This indicated poor awareness of the details of the
scheme, and that employees ranked the scheme much lower than other benefits that
cost less for the sponsor to provide. The sponsor is, therefore, carrying out a general
review of the scheme.
Outline the objectives of the review that should be considered under the following
headings:
Investments
Administration
Communication
Company considerations
Member considerations
[13]

6 A company operates a long service award scheme which pays cash lump sums to
employees completing specified periods of service with the employer. The scale of
awards is currently as follows:
Service completed Lump sum paid

5 years $500
10 years $1,000
20 years $5,000
40 years $10,000
No lump sum is paid if an individual leaves service or retires for any reason before
completion of the required service for the next payment. There is no formal
requirement to increase the level of awards, but they have been reviewed from time to
time by the board of the company, and have been increased broadly in line with price
inflation.
The finance director of the company has expressed concern that whilst this benefit
appeared relatively cheap to provide initially, it may become a problem at some point
in the future, particularly as the amounts are currently met on a pay as you go basis.
(i) Describe how the actuarial control cycle could be used as a framework for
providing advice to the finance director on this scheme. [6]
The finance director has asked for actuarial advice on establishing a funded reserve to
meet payments under the scheme.
(ii) Discuss how to establish an actuarial value for the liabilities of this scheme.
[8]
[Total 14]
7 A company with a large overseas parent operates a defined benefit pension scheme.
The company is experiencing trading difficulties and has approached the schemes
trustees to suggest closing the scheme to future accrual.
(i) Outline the immediate and longer term employer covenant assessment issues
that the trustees might consider in reaction to the above suggestion. [4]
A recent valuation of the scheme has revealed a significant deficit on the agreed
funding basis.
(ii) Discuss the security that the trustee might seek from the company as an
alternative to extra cash payments into the scheme. [6]
As part of a refinancing package to ensure the company continues in existence, the

parent company has offered to make a final one-off payment into the pension scheme
to permanently remove the companys obligation as schemes sponsoring employer.
(iii) Discuss the issues that the trustees would need to consider before accepting
the companys offer. [7]
[Total 17]
ST4 S20114
8 A large mature defined benefit pension scheme is about to undergo a full funding
valuation. The actuary has received all the membership data and has asked an
actuarial student to obtain all the other data needed to complete the valuation.
(i) Outline the other information the student should obtain, explaining, for each
item, why it is needed in order to complete the valuation. [10]
(ii) Outline the principal checks that should be performed on the membership data.
[6]
(iii) Explain why the membership data the actuary needs to calculate a cash
equivalent transfer value for an active member might differ from that used for
the same individual for the funding valuation. [4]
[Total 20]
END OF PAPER
ST4 S20115
EXAMINERS REPORT

Purpose of Examiners Reports
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 who are 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. Although
Examiners have access to the Core Reading, which is designed to interpret the syllabus, the
Examiners are not required to examine the content of Core Reading. Notwithstanding that,
the questions set, and the following comments, will generally be based on Core Reading.
For numerical questions the Examiners preferred approach to the solution is reproduced in
this report. Other valid approaches are always given appropriate credit; where there is a
commonly used alternative approach, this is also noted in the report. For essay-style
questions, and particularly the open-ended questions in the later subjects, this report contains
all the points for which the Examiners awarded marks. This is much more than a model
solution it would be impossible to write down all the points in the report in the time allowed
for the question.
T J Birse
December 2011

Subject ST4 (Pensions and other Benefits Specialist Technical) Examiners Report, September 2011
General comments on Subject ST4
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.
Comments on the September 2011 paper
The general performance was slightly worse than in April 2010 but well-prepared candidates
scored well across the whole paper. As in previous diets, questions that required an element
of explanation or analysis, such as questions 3, 4, 6 and 8 part (iii), were less well answered
than those that more directly related to specific elements of the core reading. The comments
that follow the questions concentrate on areas where candidates could have improved their
performance. Often these will relate to matters of exam technique, such as reading the
questions carefully, following the instruction (e.g. list, outline, discuss), and structuring
answers logically.
Page 2
1 (i) Net replacement ratio = After tax income in the year after retirement
After tax income in the year before retirement
Most candidates scored the full mark available, but some used gross income in the definition,
and some reversed the numerator and denominator in the calculation.
(ii) Limitations
The final years income before retirement may not be a typical year
For example if the member worked part-time or worked extra overtime in the year
before retirement
The pattern of spending may change after retirement, for example:
... if any loans the individual has taken out, particularly those to purchase
property, are repaid prior to retirement.
... People often save for retirement while working, and on retirement the level of
saving can be expected to fall
... People may face lower costs after retirement, such as travel to work costs,
contributions to pension arrangements and the State scheme.
More money may be required for leisure activities and healthcare after retirement.
Pensioners may be able to obtain subsidised products and services
... e.g. travel, cinema, eating out etc.
Wealthy individuals may be able to accommodate a significant reduction in

income...
... whereas a reduction in income for the lower-paid may cause hardship
Can be a misleading figure if it excludes other sources of income or other non-

income producing assets.
Can be misleading if excludes other short term income e.g. cash commutation or
other at retirement payments.
The initial rate of pension may not prove sufficient later on in retirement
E.g. if substantial continuing care costs arise when the individuals health
deteriorates
Question 1 part (ii) was also generally answered well the better answers considering
several aspects, i.e. pre and post-retirement changes to income and outgo, different levels of
wealth, the short-term nature of the measure versus the long-term nature of retirement and
the resulting changing needs.
Page 3
2 (i) Benefit changes
z Reduce accrual rate
z Allow for state benefits by explicit reduction to benefit or
z .. offset within pensionable salary definition
z Remove or reduce increases in payment
z .. and in deferment
z Amend spouses pension proportion / remove it altogether...
z Could be pre retirement, post or both.
z Introduce member contributions
z Change definition of pensionable salary
z .. e.g. just to basic earnings*
z .. or cap earnings at fixed level*
z .. or cap earnings increases in future*
z ..or change basis of averaging
* Credit for one example only (including any other sensible suggestion)
z Could change format of accrual to DC at lower cost
z Or to career average earnings
z .. with or without revaluation
z Allow option for commutation of some pension into cash at retirement
z .. on terms beneficial to the scheme
z Increase the normal retirement age?
z Make the entry criteria tougher, e.g. longer period of service before being eligible
to join (keeps it open but cuts the cost of accrual on new members)
z Remove any beneficial early retirement terms, if they exist?
z Remove any discretionary practices e.g. additional pension increases
z Or amend other option terms e.g. terms for transfer values
Answered well by most candidates although some failed to make distinct points e.g. by
suggesting reducing pension increases to two different levels.
Page 4
(ii) Specific suggestions
z Reducing accrual to 80ths would reduce contribution rate by 25%
z Introducing members contributions would reduce company contribution rate by

the corresponding amount
z Removing pension increases in payment could reduce future costs by around 30%
to 40% (assuming inflation of ~ 3% per annum)
z Increasing retirement age by, say, 5 years (with any sensible indication of the
impact)
z Removing spouses benefit entirely to save 10-15%
z Change to DC saving dependent upon new contribution rate.
z Any other reasonable suggestion with explanation / illustration.
Credit was only given for changes that would result in a significant reduction, as specified in
the pre-amble to this part of the question. Whilst part (ii) was generally answered well, some
candidates failed to give approximate costings, or over-engineered their calculations, given
both the instruction to illustrate the approximate effect, and the limited number of marks
available.
3 Initial calculations
Annuity certain for 10 years at 4% = approx 8.3 (continuous)
12 * 1,000 * 8.3 = 99,600
Hence 100,000 is approximately the present value of the next 10 years benefit
payments at the risk-free rate
And represents around 8 years of benefit payments ignoring interest (100,000 /

12,000)
Allow similar marks for calculation of 20 years payments and comparing that to
100,000.
Key financial considerations
A key factor for the man to consider is how long he expects to be receiving the
benefit
He may be in a better position to estimate this than the insurance company...
...particularly if circumstances have changed over the last five years.
Page 5
This will depend in part on any views he may have on his life expectancy
(mortality)
If he considers his life expectancy to be seriously impaired (i.e. likely to die

within the next few years) then the offer would represent very good value...
...and would enable the mans dependants to inherit some of the benefit after his
death
If the mans life expectancy is not impaired then it is likely that he will survive
until age 65.
In which case how long he expects to receive the benefit will depend on his views
about how much longer he will remain unable to work due to ill-health
(morbidity)
If he foresees being able to return to work within the next few years then the offer
will represent good value for money.
Otherwise he would be giving up a benefit for up to 20 years
And would need to invest the lump sum and achieve a high return to extract
equivalent value
So his views about future investment returns and attitude to risk would be
important
Consider what earnings would be available in alternative employment he is fit for
Other considerations
The members preference for cash now vs. income later...
...for example, the possibility of using cash to pay down debts or make a large
purchase
His views about future inflation, which would erode the real value of the income
stream
Other assets/sources of income, and the importance of this benefit to his standard
of living
His attitude to work, i.e. the state of health at which he is prepared to seek
employment
... in relation to the strictness of the insurance companys unfit to work

disability criterion for continued payment of the benefit
The offer may enable him to take the lump sum and return to employment earlier
than he otherwise would...
Page 6
...whereas continued receipt of the benefit might encourage him to remain out of
work when he could, in fact, seek employment which would cause the benefit to
stop
Risks
Poor estimation of future mortality / morbidity prospects
Lump sum option: poor future investment returns leading to reduction in income...
...or loss of capital
...or failure to adequately manage personal finances over time
Lump sum: risk that he spends it quickly on discretionary items e.g. cruise/car
etc.
Monthly income option: default of the insurance company
Monthly income option: erosion of real value of income due to high inflation
This was the first question on the paper where the majority of candidates struggled, and it
appears that many candidates tried to answer this purely by recalling bookwork, without
applying their knowledge to the particular circumstances of the question. Students often
listed factors but left the examiners to interpret their relevance to the question, which for a
discuss question, fails to demonstrate understanding of the subject.
The key issue is the length of time the individual expects to receive the monthly income for,
which depends both on his life expectancy and the likelihood of him returning to work.
Separately, he may also consider his immediate cash needs and the flexibility offered by a
lump sum. Stronger candidates coherently and concisely analysed the breadth of these
issues, using the numerical information in the question to demonstrate their understanding.
Setting out the calculations, and thus identifying all the assumptions that would affect any
comparison of value might have helped the weaker candidates generate a longer list of
considerations and risks to discuss.
4
For all approaches, assets taken at market value
Asset-based discount rate
An implied market discount rate is determined for each asset class
E.g. could use gross redemption yield for bonds
i.e. between 3.3% and 4.8% p.a. depending on term of bonds held
For equities, more judgement needed
Page 7
Assuming inflation of 3% p.a., historic real equity returns might suggest 9% p.a.
A weighted average of the individual discount rates based on the proportions

invested is used to discount the liabilities
That would give .8 9.0 + .2 4.0 say i.e. ~ 8% p.a.
Alternatively a notional portfolio intended to match the liabilities could be used to

determine the weighted average of the individual discount rates
Perhaps more like .6 9.0 + .4 4.0 i.e. ~ 7% p.a.
Examiners gave credit for sensible variations on this, i.e. assumed inflation, argument that
6% real return on equities not realistic, gross redemption yield in range 3.3% to 4.8%,
different weights for notional portfolio (some bonds to match non-pensioners).
Mark to market approach
This is a replicating portfolio approach
Which compares to a portfolio of assets that closely replicates the duration and
risk of the liability measure
For the liabilities there is an implicit assumption that a set of bonds can be found
to match the liability cash flows
e.g. pensions with fixed increases, pensions with inflation linked increases
From each set of bonds it is possible to derive a yield curve
The yield curves can be applied to the corresponding projected benefits to

determine a value that is consistent with the value of the replicating portfolio
The appropriate yield curves are generally those relating to nominal government
bonds and inflation linked government bonds
Yield curve here curves upwards, suggesting a lower discount rate for pensioners
(towards 3.3%) than non-pensioners (4.8%)
In practice an average yield may be used as the discount rate
i.e. maybe value all liabilities using ~ 4% per annum
Bond yield plus risk premium
This is also a replicating portfolio approach
Where for the liabilities the discount rates are based on bond yields
i.e. 3.3% to 4.8% or average as under mark to market ~ 4% p.a.
Page 8
but then increased to take account of the returns expected on other asset classes
Often referred to as an equity risk premium
Historic data could be used to argue for (6.0 0.9) ~ 5% p.a. (1946 to date) or
(5.7 3.5) ~ 2% p.a. (1970 to date)
The level of the risk premium would depend on the actual assets held
So apply the .8/.2 weightings to give discount rate in range ~5.6% to 8.0%
{Marks were given for well argued 60/40 split based on split of liabilities backed by equities}
It may be constant over time or vary depending on the assessment of market

conditions
For both asset-based discount rate and bond yield plus risk premium approaches:
Must allow for the degree of prudence to be incorporated
any equity out performance is not guaranteed so the scheme is still reliant on the
strength of the employer covenant
Prudence / weak covenant might suggest lower end of ranges.
Whilst most candidates were very comfortable reproducing the relevant core reading, fewer
were able to demonstrate that they understood how to apply these in practice to derive
appropriate discount rates. Many did not take into account that historic real returns were
provided, so an inflation assumption was needed to determine a nominal discount rate. Very
few students mentioned the issues of prudence or the impact of the employer covenant, which
again suggests that many candidates struggle to bring together different parts of the syllabus
to produce rounded solutions.
5 Investments
Is there a range of investment options to satisfy members risk profiles?
And are there a suitable number (too many/too few?)
Is there a default fund and is it appropriate?
e.g. does default include lifestyling?
Extent to which any default fund is used or switched away from will provide an
indicator of member engagement
Are the fund choices suitably invested, monitored and managed?
Are the funds monitored regularly and are they performing satisfactorily?
Page 9
Is performance relatively poor or just in line with markets?
Are the charges acceptable?
Should any investment guarantees be offered?
Administration
Is the scheme receiving an efficient and user friendly service?
Are there agreed service standards?
Compliance with relevant regulations?
Are records and benefits calculations accurate?
Low cost (value for money, if outsourced)?
Communication
Need to decide what information should be given to raise awareness of scheme
Do members have simple access to information
And do they understand the risks they bear?
Are projections of prospective benefits available that are easily understand
And can they model different options easily?
Ensure all communication is up to date
including education / topical issues for members
Use of different forms of media e.g. on-line
Should a helpline be available
Encourage feedback from members
And ensure processes are in place to act upon feedback
Compliance with legislation
Company considerations
What were the original objectives?
Does it aid attraction and retention of employees?
Page 10
provide adequate benefits (to allow retirement when company wants)
with employee and employer flexibility
Valued by staff
Low cost
Simplicity of design
Tax efficient structures
Minimal effort by company and trouble free
Compliant with relevant law e.g. age, gender discrimination
Are they obliged to provide the scheme
... and if so, are they providing the minimum level of contributions or more?
Does contribution structure target company expenditure at those members that
value them most?
... e.g. by matching sponsor contributions for members paying more
What are other companies providing
Member considerations
Maximise benefits
easy to understand and operate
Affordable (low contributions)
What are the tax benefits of membership
Are members offered independent benefit advice and support
Suitable investment choice
With investment advice
Flexible
Good communication process in place
Security especially for dependants
Page 11
...if there are protection benefits offered as well
There was a wide spread of marks, with some candidates scoring full marks. The stronger
candidates:
used the structure in the question (as obvious as this may be, some candidates solutions
did not appear to be organised under the headings requested);
made several points under each section and then moved on (note that the solution above
includes many more points than required); and
focused on the higher-level objectives of the review, for the sponsor (and members where
requested) rather than minor practical issues.
6 (i) Use of Actuarial Control Cycle
Need to consider the commercial and economic environment
And apply any professional guidance/requirements
Specify the problem
First step of Actuarial Control Cycle is to analyse what the risks are
... and quantify the financial consequence of the risk events occurring
Main risk to company is higher costs than expected
... failure to anticipate predictable increase in long term costs as scheme

matures
... unexpected increases due to changes in employee turnover
... periods of high inflation combined with pressure to continue past policy
of increasing awards
Other risks include timing and volatility of payments
Including requirement to potentially make payments at commercially

unattractive times
Analysis may conclude that problem is not as significant as FD considers
But if the risks are not felt to be acceptable then ...
Develop the solution
Consider reduction of benefits
Consider and quantify appropriate methods of managing risks
Page 12
Consider actuarial models to project the contributions to and outgo of the

scheme
Make appropriate assumptions i.e.
... how many employees qualify for benefits each year?
... how much benefit (allowing for inflation)?
Interpret results and consider implications
Determine solutions and consider alternatives
... is PAYG appropriate or some form of funding?
... if funded need to consider appropriate reserves and contributions
... and investment strategy
Consider sensitivities and scenario testing (stochastic models?)
And communicate the solution in an understandable way
Monitor experience
Identify causes of departure from expected outgo
i.e. number of employees receiving awards more / less than expected
... and impact of inflation / discretionary increases to awards
Particularly if scheme is relatively new so impact on employee behaviour

is uncertain
... is the structure and level of awards appropriate given objectives of

scheme?
Feed experience back to the specifying problem / developing solution

stage as appropriate
Whilst most candidates were familiar with the actuarial control cycle, only a minority
recognised the issues that needed to be addressed. Specifically, the problem was not just the
affordability of the awards, but also the sponsor having sufficient liquidity to pay the awards.
Many candidates did not put sufficient emphasis on the key risks, nor did they apply the
stages of the control cycle to the specific situation.
(ii) Establishing an actuarial value
Need appropriate employee data
... including age/qualifying service/contribution information
Page 13
Full details on rules of long-service award scheme
Any documentation on how/when awards are increased
... and any employee communications on either of the above
Past turnover experience
Company indications as to expected future changes
Need to determine an appropriate model to allow for level and incidence of

cash flows
May extend to a stochastic model to assess variability/range of outcomes
What is an appropriate funding method?
... given criteria such as security, stability, realism, flexibility
Economic and demographic assumptions will be needed
... withdrawals, retirements, deaths, new entrants
... assumed rate of increase in awards
... investment return on invested assets
Companys objectives are key to determining appropriate strength
... prudent if want to minimise risk of unexpected calls on company funds
... best estimate if want to minimise costs in short term
Consider how company wants to pay contributions (e.g. % of monthly

salary etc.)
Treatment of any surpluses that build up may be important in this decision
... particularly as employees leaving shortly before completing a service

milestone may result in a significant release of reserve
Need to consider any relevant legislation on funding
Company may also need to consider any relevant accounting rules
This was relatively straightforward, but few candidates scored well and many failed to state
the obvious. A basic explanation of determining the benefits to be valued, selecting an
appropriate measure, identifying appropriate assumptions, projecting the benefits, etc.,
would have scored well. Many candidates, however, provided detailed formulae, or simply
listed the economic and demographic assumptions that would be needed. Given the
instruction to discuss, and the context of this question, the examiners encourage
Page 14
candidates to consider what they would discuss in a meeting with or brief paper to a Finance
Director who had expressed a wish to fund an arrangement, before they started carrying out
detailed actuarial calculations.
7 (i) Covenant issues
the trustees would be less worried if the scheme was well funded and/or
well matched
Need to understand the reasons for the trading difficulties
Need to meet the company to discuss the reasons behind the trading
difficulties and future plans to increase profitability
Together with the reasons for the suggestion to cease future benefit accrual
Will the savings be re-directed to the pension scheme for example.
Professional covenant advice is needed
Role of overseas parent should be investigated
Need to understand the structure of the business and the group.
More regular monitoring of covenant is required
Need to understand the differences between short and long term covenant
Analyse the possible impact on existing deficit reduction plan
Consider the use of alternatives to cash payments
Consider any legislative impacts e.g. debt on employer on business

failure event
Some students did not restrict their answer to this part to covenant assessment issues i.e.
information they would seek, from who, why they would need it, rather than e.g. considering
specific investment strategy changes, or listing at length the various approaches in the core
reading for assessing covenant.
(ii) Security
Third party guarantees will increase member security without the need for
immediate cash payments
e.g. a guarantee from the company to underwrite the current recovery plan
payments
or a guarantee from the overseas parent
Page 15
depending upon the covenant of the parent itself
or alternatively a bank guarantee could be put in place
A fee is paid to the bank to arrange this guarantee
Other alternatives to cash payments include:
A charge on the sponsors fixed assets
whereby the scheme has a legal claim on specified assets of the sponsor
However this may impact the sponsors borrowing capacity
and /or require permission from banks / other creditors
Assets might not be worth much if company is in difficulties,
...but if the parent is unwilling or unable to provide support, theres a bit

more security
may seek higher priority for pension liabilities
may apply limits to self investment
could ask company to alter investment strategy if the company holds the
power to select funds
could apply limits on additional company borrowing
Arranging for ratchets in contributions so that if the sponsors financial

position improves then the scheme shares in this improvement
Or introduce contingent contributions based upon changes in funded status
As the company is experiencing trading difficulties they may be unwilling

or unable to give any company or bank guarantees
Similarly they may be unable to give greater security for the pension debt
over other creditors
again theres the point of refinancing that might mitigate this problem
Might consider insolvency insurance if not prohibitively costly
Generally well answered candidates that did not score well did not cover a sufficient range
of options, or listed them without any further discussion of their possible value or otherwise.
Page 16
(iii) Key issues regarding one-off payment
Trustees need to ensure they minimise the risk of scheme being unable to
pay benefits as they fall due
So need to decide whether the one off payment solution is the best option
for members
For the solution to work really need cessation of accrual to be completed
Buy-out deficit should be targeted if company is in distress
What is the current deficit when securing the liabilities with an insurance
company (buyout deficit)
Need to get quotes from different insurance companies if the business is

competitive there might not be a real deficit at all
How large is the one-off payment
and will it eliminate the buyout deficit
The current funding target may be inappropriate
Could consider running the scheme as a closed fund using a very prudent
(self sufficiency) funding basis
Expert covenant advice needed
together with details of the refinancing package
If the payment is below the full buyout deficit, could the full amount be
reasonably afforded by the company and / or the overseas parent company
Or could a revised deficit payment schedule be put in place over a longer

period to eliminate the full deficit instead
If not could the one-off lump sum be increased at all?
Is the offer of the lump sum preferable to probability of the sponsor failing
with realistic likelihood of no further payments to the scheme
... and loss of jobs for active members as well as benefit reductions
Legal advice is needed
Legislative & regulatory guidance to be determined
Investigate impact on members benefits if one-off payment is accepted
Page 17
Are reductions to accrued benefits permitted in legislation (if scheme later

falls into deficit)?
Given there would no longer be a scheme sponsor and the scheme would
enter wind-up
Consider appropriate 3rd party guarantees
and /or other alternatives to cash payments
Transfer into parents scheme if one exists and run off from there may be
cheaper for parent in the long run?
Need to consider implications of business failure on the fund
For example is there access to any form of central discontinuance fund
Whilst a minority of candidates scored well on this part, many failed to score half the marks
available. Many missed key points such as the size of the payment relative to the deficit (on
different measures), didnt consider alternatives or the risks to members of accepting the
payment, or circled at length on minor issues.
Page 18
8 (i) Data requirements
Item Reason
Information relating to past and current operation of scheme
Trust Deed & Rules / schemes legal Powers and responsibilities of parties
documentation involved (sponsor, actuary)
Benefit levels
Member booklets, announcements etc. May include further information on benefit
Trustee minutes levels not in main documentation
Details of past discretionary practices Past policy and practice may not be
explicitly covered in rules and booklets etc.
Pre-funded or not?
Factors in use for member options such as So options can be valued appropriately,
early retirement, commutation etc. particularly if not cost neutral on one or
more sets of assumptions
Scheme report accounts Confirm value/breakdown of assets
or And data for analysis of surplus
o Asset statement Appropriate allowance for expenses
o Cash flows in and out
Information relating to the future operation of the scheme

View of relevant parties on future Assist in deciding whether to (continue to)
discretionary practices make allowance and to what extent
... and possible changes to benefits Impact on cost of future accrual (if
prospective) or accrued liabilities
(retrospective)
... and future investment strategy May influence assumption setting if liability
valuation basis is linked to scheme assets
... and salary increases Assumption setting particularly around
allowance above general levels of earnings
inflation, and promotional allowances
... and turnover / hiring strategy For demographic assumptions e.g.
withdrawals, new entrants, early retirements
including one-off changes
Likely / potential changes in legislation Allow for known improvements to benefits,
particularly retrospective, or
Might restrict funding flexibility e.g.
assumption setting, deficit/surplus
Sponsor covenant Determining appropriate degree of prudence
in funding assumptions
Industry / professional information on Setting appropriate mortality assumptions,
longevity experience / projections particularly allowance for future
improvements
Other information
Previous Valuation Report To allow analysis of changes and as
...subsequent actuarial advice reference point for validation of results
Economic data To help set valuation assumptions
Purpose and objectives of Valuation To ensure assumptions/method/results are
appropriate
Timescale for valuation To assist in planning of work requirements
Page 19
Most candidates scored well on part (i), particularly those who used clear headings to
structure their solutions and ensure they provided the appropriate explanation for each item.
A few candidates wasted their time, however, by including inappropriate detail (e.g. itemised
contents of the accounts) or by listing membership data that the question stated had already
been provided.
(ii) Membership data checks
z Membership reconciliation
z separately for actives, deferreds and pensioners
z compare to scheme accounts and/or employer data
z Reasonableness checks
z Basic validation that fields contain valid entries
z e.g. check that there are new members since the last valuation for an open
scheme.. or blank data in a field which should have information for
particular members
z Compare average benefit levels, ages, salaries with previous valuation
z .. e.g. average salary increase with expectations or average pension

increase with rules / inflation
z Consistency of totals in membership data with information in accounts
z e.g... total salaries for actives with member/company contributions

received or .. total pensions in payment in membership data and accounts
z Consistency between investment income and assets
z Minimum and maximum levels for benefits, ages, salaries
z Spot checks e.g. comparing last times data with this times data for an
appropriate set of individual members
z Check data for individuals with highest liabilities separately
The better candidates covered the principal types of checks, with one or two examples of each
to show they understood what this meant in practice.
(iii) Data for cash equivalent
z The funding valuation is a long-term planning exercise
z ... calculating an aggregate liability
z ... and determining future funding requirements at regular intervals
Page 20
z Individual inaccuracies can cancel out over whole membership
z .. as long as approximations are not inadvertently biased
z E.g. using latest salary as basis for projection even if pensionable salary is
averaged
z .. ignoring minor complexities in benefits that are not material for funding
purposes over the whole membership
z Allow for revaluation not salary increases in calculations
z A cash equivalent is likely to involve a settlement of a liability
z ... and is an individual calculation
z E.g. transfer to another arrangement, divorce settlement
z Approximations might over or understate transfer value
z Respectively penalising the scheme or the member
z With no opportunity to correct things at a later date
z Transfer value may also take account of further demographic information
z E.g. actual marital status at time of leaving service (or date of quotation)
z So additional information might be needed.
The question specifically asked why the membership data might differ for the two types of
calculation (which as the examiners hoped candidates would explain, involved ongoing
funding and the settlement of a liability). A number of candidates wrote at length on the
different assumptions that would be made and therefore failed to score any marks. Other
candidates did explain how the membership data might differ, but not why, thus missing out
on the opportunity to pick up a few straightforward marks.
END OF EXAMINERS REPORTS
Page 21
EXAMINATION
20 April 2012 (pm)

booklet.
supervisor.
sheet.
question paper.

1 (i) List the Technical Actuarial Standards issued by the Board of Actuarial
Standards in the United Kingdom (UK). [3]
(ii) Outline the issues that a UK actuary should consider when deciding whether
actuarial work done for an overseas pension scheme should comply with the
various Technical Actuarial Standards. [4]
[Total 7]
2 A pension scheme sponsor is seeking to reduce investment risk by purchasing

investment products from an insurance company.
(i) Outline the options available. [4]
(ii) Discuss the financial implications of taking this approach. [4]

[Total 8]
3 A defined benefit pension scheme provides members with a single life pension at age
65, which increases each year in line with price inflation. At retirement, members can
choose either or both of the following options:
Exchange up to 25% of the pension for an immediate lump sum, calculated as 15

for every 1 per annum of pension given up.
Swap the remaining pension that increases with price inflation for a non-
increasing pension that will be 30% higher.
Discuss the issues that members should consider in making their decisions regarding
these two options. [12]
4 A defined benefit pension scheme currently has 80% of its assets invested in equities
and 20% in bonds. The scheme sponsor wishes to reduce the investment risk when
market conditions allow.
The scheme is proposing to put in place a strategy to reduce risk over the longer term
by establishing a process whereby the percentage equity holding is automatically
reduced in stages when pre-arranged funding levels are reached.
(i) Discuss the advantages and disadvantages of this proposed strategy. [5]
(ii) Outline the issues that need to be considered before adopting the process. [4]
(iii) Outline three other high level approaches that could be considered in order to
reduce risk for the scheme generally, without reducing the pension benefits.[3]
[Total 12]
ST4 A20122
5 A defined benefit pension scheme has just completed a funding valuation using a
prudent actuarial basis. The scheme is now considering a review of the following
items:
the transfer value basis;

the factors used for exchanging pension for cash at retirement;
the early retirement reduction factors; and
the late retirement factors.
(i) Discuss whether it is appropriate to use best estimate or prudent actuarial

assumptions, for each of the items listed above. [6]
(ii) Outline the relative advantages of using fixed or market related factors. [4]
(iii) Set out the other issues that should be considered when determining
appropriate factors for actuarial calculations. [6]
[Total 16]
6 (i) List the main sources of surplus or deficit in a defined benefit pension scheme.
[4]
The latest funding valuation of a small defined benefit pension scheme has revealed a
significant surplus. The previous valuation had shown a small deficit. An analysis of
the experience between the valuations has revealed that the surplus arising in the
latest valuation was almost entirely due to the death of one pensioner with no
dependants, the value of whose benefits was a significant proportion of the schemes
liabilities.
(ii) Discuss the options available to the scheme trustees in respect of this surplus,
including examples of how it could be used. [10]
The analysis also revealed that salary increase experience over the inter-valuation
period reduced the surplus available by a small amount. The Finance Director of the
sponsoring employer believes that average salary increases over the period were
broadly equal to the actual inflation experienced over the period. The previous
valuation had assumed that salary increases would be in line with inflation. He has
asked the actuary to explain why there has been an experience loss in respect of salary
increases.
(iii) Suggest the points that the actuary might make in her response to the Finance
Director. [6]
[Total 20]

7 Currently, the government of a developed country imposes a requirement for its
residents who have defined contribution (DC) pension provision to use the whole of
their DC funds to purchase an annuity with an insurer at age 65. This policy is
unpopular with residents of the country because annuities are viewed as expensive
and inflexible.
(i) Discuss the options that the government may consider in order to address
residents concerns. [5]
A working party appointed by the government has proposed that the requirement to
purchase annuities is relaxed. Under this proposal, residents with DC funds would be
able to retain some (or all) of their DC funds in their own personal investment
account. Residents would be able to withdraw money from these accounts to meet
their ongoing needs.
(ii) Discuss the factors which may affect whether a resident chooses to take
advantage of this increased flexibility. [8]
The government currently provides a state pension on a means-tested basis. Residents

over age 65 who have a total income of less than $100 per week are provided with a
state pension of $100 per week. The means test is carried out on an annual basis and
looks at the residents income over the month before the date of each test. The
government has reservations about the working partys proposal, as it wishes to avoid
an increased number of residents becoming dependent on state pension provision.
(iii) Explain how the proposed system could lead to an increase in the number of
residents who are eligible to receive a state pension. [2]
(iv) Discuss safeguards that could be built into the proposed system to ensure
residents are adequately provided for in retirement. [10]
[Total 25]
END OF PAPER
ST4 A20124
EXAMINERS REPORT

Purpose of Examiners Reports
candidates, both those who are sitting the examination for the first time and who are 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. Although
Examiners have access to the Core Reading, which is designed to interpret the syllabus, the
Examiners are not required to examine the content of Core Reading. Notwithstanding that,
the questions set, and the following comments, will generally be based on Core Reading.
this report. Other valid approaches are always given appropriate credit; where there is a
commonly used alternative approach, this is also noted in the report. For essay-style
questions, and particularly the open-ended questions in the later subjects, this report contains
all the points for which the Examiners awarded marks. This is much more than a model
solution it would be impossible to write down all the points in the report in the time allowed
for the question.
T J Birse
July 2012

Subject ST4 (Pensions and other Benefits Specialist Technical) Examiners Report April 2012
Comments on the April 2012 paper
The Examiners were pleased to see a much improved pass rate for this paper, with many
candidates showing that they understood the underlying syllabus by producing concise,
logically structured solutions that addressed the specific context and instructions provided in
the questions.
Relatively poor performance on Q1 demonstrated a bit of a collective blind-spot on some

relatively new core reading (the Technical Actuarial Standards). Whilst candidates are
generally right in thinking that SA4 is where UK-specific pension content is examined, they
should not conclude that any parts of the core reading can be dismissed.
As in previous sessions, questions which required more analysis or application of knowledge

to slightly unfamiliar situations proved more challenging. Question 3, 4, 5(i), 6(iii) and 7 are
examples.
Finally, questions 6 and 7 constituted half the marks available, but it seemed clear to
examiners that candidates had not given them a proportionate amount of time. Whilst we
make no comment on the order in which candidates attempt questions, we do suggest that
candidates plan their answers to the whole paper at the beginning of the examination, in
particular identifying the important information in each question, and the specific instruction.
Also, candidates may wish to avoid over-refinement or repetition of points on earlier shorter
questions (which might at best score an extra mark) at the expense of time spent exploring the
longer questions (which might identify a more productive seam of several marks).
Page 2
1 (i) Technical Actuarial Standards

Generic Standards
z Data
z Reporting
z Modelling
Specific standards
z Pensions
z Transformations (Core reading refers to Business Transformations)
z Insurance
z Funeral plans
(ii) Application to overseas pension scheme

z TASs apply to work done in relation to the UK operations of entities and
any non-UK operations which report in to the UK, so it depends on
whether the overseas scheme (or its sponsor) reports in to the UK
z Even if it doesnt, wider adoption of the TASs is encouraged by BAS.
z (...So) The actuary may wish to comply with the TASs anyway...
z ... but should consider the benefit to the client of TAS compliance i.e. how
will it affect their decision-making?
z ... are their local regulations or actuarial standards which cover this work
anyway?
z ... is the work being done in scope of the TASs?
z The client might ask the actuary to comply with TASs.
Somewhat surprisingly, this was the worst answered question on the April 2012 paper (in
terms of the average marks scored as a percentage of the total available), despite it being
very closely aligned to the core reading on this topic. It appears that many candidates
thought that because they generally only apply to UK actuarial work, they are also out of
scope for ST4 examination purposes. Some basic awareness of them is, however, required
for all members of the Institute and Faculty of Actuaries, hence their inclusion (at a very high
level) in the ST4 syllabus.
2 (i) Options available
With profit arrangements

Contributions are set which will meet a given level of benefit given a
prudent set of assumptions for investment returns
If investment experience is better than assumed, bonus returns are
credited to the fund.
These bonuses may be used to reduce future contribution needs or to
increase benefits.
Deposit administration
Contributions are accumulated with a mixture of guaranteed and bonus
rates of interest.
Managed funds
a pooled investment vehicle where funds are usually unitised
there may be a choice of funds and so underlying assets
Page 3
no investment guarantees are provided / return reflects underlying

assets
Annuities
Purchased to insure all or part of a current or deferred pension
Non-profit annuities should provide a guarantee that the insured
pension is paid.
Other investment products with guarantees
Various contracts may be available which offer minimum returns or
guarantee that the policy value cannot fall below a certain level
Derivatives / swaps (not in core reading, but acceptable alternative)
E.g. longevity swaps offered by insurers for largest schemes
The instruction in (ii) was to outline, so credit was only given for examples that showed
that the candidates understands the item they named. Candidates that simply listed products
did not gain credit.
(ii) Financial implications

Key points
In all cases, an investment product will incorporate management charges
and profits, (either explicitly or implicitly) within the terms offered.
there will also be further costs in relation to the premium for any risks
transferred to the provider (e.g. longevity in annuities)
If a product provides guarantees, this may restrict investment freedom and
hence reduce return / funding levels
Which would increase the cost of providing benefits and require additional
contributions from the company
Further implications
different tax treatments which may or may not be beneficial
insurer may provide cheaper add-on services (admin, insurance)
managed funds may give access to investment specialists
security for other members may be reduced if particular liabilities are
secured by guaranteed investments e.g. annuities
liquidity may be an issue for some e.g. annuities
inflexibility e.g. some contracts may incur early surrender penalties (with-
profits)
competitiveness of market will affect the level of costs discussed above
risk of insurer default
loss of upside risk
Question 2 was generally answered well it was reasonably straightforward bookwork, but a
few candidates covered products which address non-investment related risks (e.g. group life
assurance).
Page 4
3 Issues members should consider
General issues which are relevant to both decisions (and should only score once)
the members underlying preference for cash or higher benefits (flexibility / his
time value of money)
does the member have any immediate need for the cash / higher pension e.g. to
pay off a mortgage or meet specific financial commitments?
health if good and expects to live a long time, may prefer pension vs cash and
inflation protection (or same point expressed in converse way but not both)
extent and nature of other wealth in terms of liquid assets and longer-term sources
of income
possible loss of future discretionary increases
Cash versus pension:

What level of alternative income could be achieved by taking cash and purchasing
a pension elsewhere (open market option)
... or by reinvesting in some other vehicle
... consider yield/risk of other vehicle against certainty provided by pension
any sensible numerical analysis of the value of cash vs pension

are there any restrictions on the use of the cash?
can the member survive on the residual pension?
taxation are cash and pension taxed at same rate?
if the member takes the cash he is effectively accepting investment and longevity
risks
need/desire to provide for dependants (pension is single life unclear what would
happen if the member died shortly after the pension started)
If member is concerned about solvency of pension scheme and sponsoring
employer, taking cash is a way of diversifying wealth
Level vs increasing pension:

outlook for future inflation
if inflation is 3% per annum, it will take 9 years for index-linked pension to
exceed the level pension (or other sensible analysis)
and longer for total pension received to exceed that under the level option
also need to consider possibility of short-period of high inflation
inflation-linked pension can be seen as insurance against erosion of standard of
living due to longevity / high inflation
so the decision depends on the members attitude to these risks
level pension means the member is accepting the inflation risk
again, this attitude may be affected by whether other sources of income have
inflation-protection
higher level pension may mean loss of means-tested benefits/in higher tax-band ?
Members attitude and likely spending profile in retirement is important
would the member prefer higher real income in the early years of retirement
when still active (e.g. to go on holidays)
Page 5
or is it important to maintain real level of income for later in retirement (e.g. to

meet long-term care costs)
Many candidates scored well on this question. Those that did not score highly often just
listed criteria for decision making without discussing their implications for this member in
the context of this question, or using the figures in the question to help illustrate the
comparison of options. While there was no specific instruction to calculate examples,
numerical comparisons would normally feature in good client advice, as the stronger
candidates appreciated. This is, after all, an actuarial exam!
4 (i) +s and -s
Advantages
Investment risk is only retained for as long as is needed
Gradually moving to a lower risk strategy
... so more practical / less likely to affect market prices
As and when the Scheme can afford to do so
Potentially reducing need for regular investment risk reviews
Can lock into a stronger funding position
With good investment return locked in and not lost again in the future
... which turns market volatility to the Schemes advantage
Likelihood of future cash calls / dependency on the sponsor is reduced
Strategy can be aligned to other risk management opportunities e.g. buy
out
Disadvantages
Any allowance in the valuation basis for equity outperformance will need
to reduce over time due to the revised asset mix...
... which would increase the measure of liabilities and may in turn require
higher contributions
May require equities to be sold when their prices are low and/or bonds
purchased at times their prices are high (i.e. sub-optimal returns)
Lose opportunity for future good equity performance
And prevents any re-risking opportunities where risk is increased to meet
certain targets
If already in deficit, the highest investment risk is being taken when
scheme is worst funded.
(ii) Considerations
The strategy needs to centre around a long term end game target (i.e. set
objectives) e.g. buy out or a fully matched bond portfolio
... the maturity of the scheme (when /what is the endgame)
A detailed governance process is needed to implement the strategy which
could be complicated and may involve significant expense
Much more regular monitoring of the funding level (and assets) is needed
Page 6
... and will need to check the success of the strategy itself from time to
time
The move to bonds needs to consider the correct bond portfolio (nature,
duration etc. ) to reduce mismatching risk
... sufficient suitable bonds may not be available
The process could be delegated to a third party e.g. investment house or
actuarial advisers
Details of the trigger process need to be determined in advance i.e.
... design of funding level bands
... specified rules on assets to trade when triggers are met
Need to consider the downside impact of falling equity markets and/or
increasing bond prices (i.e. what if triggers are never met?)
Consider views of the sponsoring employer and appetite for risk
Taxation issues (with appropriate example e.g. CGT if equities sold)
(iii) Three other approaches
Reduce investment (and longevity risks) e.g.

annuity purchase
longevity hedging
a fully investment strategy immediately e.g. LDI
Liability management e.g.

incentive exercises (ETVs, PIE)
modifying benefits (switch to CARE, break salary increases)
encouraging options on terms that lead to an increase in the schemes
funding level
transfer scheme to another fund
Alternative security provided by the sponsor e.g.

Charges on assets
Parent company guarantees
... etc.
More conservative approach to funding

Stronger assumptions
Higher employer (and member?) contributions
Mismatch reserve as buffer against adverse experience
Credit was given in parts (i) and (ii) for other reasonable suggestions.
Given the instruction in the question, (high-level) the examiners were looking for three
distinct options in part (iii), with a brief explanation or example for how they reduce risk.
Page 7
5 (i) Best estimate vs Prudent
Best estimate means the use of a set of assumptions which we expect to

fall at the median of future outcomes (i.e. 50% of results fall below and
50% above)
Prudent means the assumptions are stronger than best estimate (experience
is more likely to be more favourable than assumed than not)
The use of prudent assumptions will result in higher transfer values and
cash commutation at retirement (for a given amount of pension)
If prudent funding assumptions (e.g. a lower discount rate, other things
being equal) are used to determine early and late retirement factors, this
will result in higher early retirement pensions and lower late retirement
pensions (than the use of a best estimate discount rate)
...whereas setting early or late retirement terms in a prudent manner
might be expected to produce a lower pension, to avoid reducing security
for other members
Transfer Value basis

A cash sum representing the expected future cost of providing the
promised benefit will be paid to the member in settlement of the liability
Therefore it is not appropriate to pay out greater than this expected amount
As it would disadvantage remaining members
Therefore a best estimate set of assumption is more appropriate
Unless enhanced transfer values are being offered as a de-risking exercise
and then prudent assumptions could be used.
Cash Commutation factors

Use of prudent assumptions would be consistent with the funding basis
... and might be used to encourage take-up and the transfer of risks
But this is likely to exceed the expected cost of the benefit
Therefore best estimate assumptions are more appropriate
Particularly as there may be the possibility of selection against the scheme
E.g. members with shorter life expectancies might be more likely to
exercise the option
Early and late retirement factors

The pension is paid earlier or later than the normal retirement age so the
financial impact is less significant and spread over a period (the
calculation involves the ratio of two annuities)
Therefore best estimate or prudent assumptions could generally be used
without creating a significant strain on the fund.
(ii) Fixed vs Market-related
Market related
The terms reflect the actual market conditions when the payment is made
For example, they will be similar to the cost of buying an annuity with an
insurance company / transfer-in terms of receiving scheme
Page 8
They reflect changing market conditions automatically, so reducing the

possibility of selection due to market movements
So the underlying methodology need not be reviewed frequently to ensure
they remain appropriate
A market-related basis may be necessary where cost neutrality on some
basis is the primary objective
... to mitigate the impact on scheme (vs funding)
... to give members an appropriate chance of reproducing benefits (TV to
DC)
Fixed factors
These are consistent with the view that actuarial factors are an integral part
of the schemes benefit structure
Therefore the expected benefit should be known in advance...
... and member perception is that factors are fairer (as they dont see other
members shortly before/after them getting what seems a better deal)
This is particularly helpful for members determining their benefits in the
run up to retirement therefore appropriate for cash commutation, early and
late retirement factors
Administration is greatly reduced
Communication is made easier as the member can be told what benefit
they will actually receive on retirement for example
(iii) General/actuarial issues
Requirements of the scheme rules (e.g. who sets the factors?) /compliance
with any relevant legislation and guidance
The current funding position of the scheme and strength of sponsor
covenant
Communication to members / ease of understanding / perceived vs actual
fairness
Employers objectives e.g. encouraging members to leave employment
through use of generous ERFs / encouraging risk transfer (commutation)
Whether or not consent is required for the option to be exercised
However, a general aim is usually cost neutrality
What is done by competitors and other pension schemes?
Consider member expectations / existing factors and take-up rates
Ease of administration / complexity and cost of making the relevant
calculations
Theoretical factors may be smoothed for practical purposes
The degree to which factors should reflect individual member
characteristics (e.g. unisex or sex-specific factors, marital status)
Timing of the change to any of the factors
E.g. would it be appropriate to reduce transfer values to reflect an
underfunding position?
How long are the factors likely to be in place for the future hence will
fixed factors still be appropriate until the next review?
Consideration of any possible selection against the scheme
Page 9
Allowance for any discretionary increases e.g. in transfer values

The relative tax treatment of options
Whilst this question was often answered well, a significant number of candidates failed to
demonstrate that they understood the underlying issues.
In part (i), despite the fact that they werent defined in the question, some candidates neither
defined best estimate and prudent, nor demonstrated that they understood what each
meant in the context of the question. The list of types of actuarial factor should have acted as
a strong hint to consider whether the answer is the same in each case.
In (ii), some candidates answers looked more like recalled lists rather than an outline that
demonstrated understanding of the two approaches.
For part (iii), many solutions were simply too sparse to score significant credit.
6 (i) Sources of surplus/deficit
Equivalent credit was given to candidates who either (1) structured their
answers in accordance with core reading and provided one or two examples
to illustrate the different items i.e.
The probability of providing the benefit

(decrements, longevity, options, ...)
The cost of the benefit
(inflation, salary growth, expenses, ...)
The amount of contributions in the funding period
(actual ER+EE contributions relative to cost of benefits accrued)
The amount of investment proceeds during the funding period
... or (2) provided a list of typical Analysis of Surplus items, e.g.
Surplus or deficit carried forward from last valuation

Investment return
Contributions
Retirement and other member movements
Salary growth
Options e.g. early/late retirement / commutation / transfer values
(Post-retirement) mortality
Inflation (as it affects pension increases / revaluation)
Administration and other expenses met from scheme assets
Changes to market conditions / basis / funding method
(ii) Options available w.r.t. surplus

Need to take account of legislation and the Trust Deed and Rules ...
... either of which may restrict how surpluses should be used
Sponsor may have control of surplus not Trustees
Strength of sponsor covenant should also be considered
Page 10
consider industrial relations

is there any precedent / how have past surpluses been dealt with?
Note that this appears to be a one-off source of surplus so it may be
appropriate to deal with it in a way that doesnt create an ongoing
commitment (and so anticipates future similar gains)
If sponsor has to bear future deficits then may expect to have the benefit
of surplus (and be encouraged to continue to support the scheme)
If members have made contributions they may feel entitled to at least a
share of the surplus
Possible uses of surplus are:
Retain surplus in scheme as reserve against future volatility
... particularly if scheme is small / sponsor covenant an issue
... could allow a higher-risk/reward investment strategy
De-risk by buying out some liabilities (pensioners / deferreds)
De-risk by offering enhanced transfer values for a period
De-risk by strengthening funding basis (if weak) and/or switching
investments
... perhaps investing just the surplus in growth-seeking assets
Refund to sponsor
...but note possible tax implications
Reduction of future member / employer contributions
Enhancement of benefits e.g.
service credits
one-off pension increases
discretionary increases...
(credit was given for any two sensible enhancements)
(iii) Response to FD
Salary increase assumption is a long-term item set consistently with other
items...
... what was inflation assumption in valuation?
If actual inflation more than expected then loss would occur in absolute
terms (but may better have been allocated to the inflation item in AoS)
Note impact was small / these assumptions are not generally the most
important ones.
What measure of inflation is FD using? Is it same as valuation
assumptions?
Is there a timing difference? ...actual salary increases often based on
inflation from previous year.
Promotional increases?
Basic salary may have increased in line with inflation
... whilst pensionable salary may include overtime, bonus etc.
How did FD calculate average salary increase?
... Possibly just increase in total payroll over period
... Could include employees who arent members of scheme
Members of scheme with larger liabilities could have had higher salary
increases
Page 11
Meaning average salary increase weighted by liability would be higher

than inflation
Note the parallel to the effect of one significant pensioner on surplus
Significant change in active membership over valuation period could have
affected analysis
e.g. large salary increases in first year, then a reduction in membership
followed by smaller increases
This was the best answered question on the paper, with many candidates scoring 14 or more.
Stronger candidates focused on the source of the surplus, i.e. its one-off nature, and made
appropriate suggestions, noting possible constraints. Weaker candidates did not discuss
their suggestions, say why they might or might not be appropriate, and even failed to
consider the possibility of retaining the surplus. In part (iii), stronger candidates considered
a wide range of issues, rather than focusing on one or two possibilities at length.
7 (i) Government options
Change the requirement so residents only have to use a proportion of their

DC funds to purchase an annuity
Increase the age from which members must purchase an annuity
Remove the requirement to purchase an annuity, leaving residents to invest
their own DC funds (i.e. income drawdown)
Encourage insurers to increase flexibility in their annuity products
through legislation or voluntary participation
e.g. by allowing people more choice over the form of their annuity
or potential to vary the payments
or share in the investment return/risk
Allow residents to purchase annuities in phases
this may appeal to people who wish to semi-retire
Encourage insurers to reduce the cost of annuities
E.g. through tax breaks
Regulating expense loadings to drive efficiency
Or reducing the barriers to entering the market to increase competition
Or reducing any compliance burden (while still maintaining security
for residents)
Introduce a government-run annuity provider which can:
Offer the flexibility residents want
Insure at a lower cost
as could be non-profit
and would be government-backed so no need to build in extra
reserves for security
Encourage employers to provide defined contribution to defined benefit
conversion for employees
Education to tackle the perception that annuities are expensive.
Page 12
(ii) Factors
Level of financial sophistication; residents with a high level of

understanding are more likely to feel confident in investing their own DC
funds.
Attitude to risk; if residents are risk averse they are unlikely to take
advantage.
Other sources of income or assets:
If a resident has other pensions/assets to meet their income needs they
are more likely to want to take a risk with their DC funds.
Or if their spouse has a stable income they may be willing to take on
risk.
Some residents may prefer the flexibility as they would prefer to have a
higher income early in retirement
when they are more able to enjoy it
or to pay off a continuing liability such as a mortgage
Residents with lower life expectancy than average are more likely to take
advantage
as the cost of an annuity will factor in a certain life expectancy and if a
resident lives less long they could potentially fund a higher income
Members characteristics versus how annuities are priced e.g. unisex
annuities may be less attractive to males
If the annuity must include a spouses pension and the member is single
they are more likely to take advantage.
What will happen to the personal account after the residents death?
If the fund passes to the dependants to use as they please, residents
who expect to have a greater fund than required to pay their own
pension until death are more likely to take advantage.
The simpler the process for managing the personal account, the more
likely residents is to take advantage.
Any difference in tax position between purchasing an annuity and
investing in a personal account:
on income
after the residents death
The residents personal view of future investment returns
achievable in a personal investment account
... and inflation
If there is a state safety net if the personal investment account is
exhausted (e.g. a state pension) residents are more likely to take advantage
How the new flexibility is communicated to residents
if residents are unaware or do not understand they will not take
advantage of it,
... whereas supportive press comment may encourage participation
... and availability / cost of good financial advice may be a factor
Size of DC funds
those with small funds may face prohibitively large management
charges
...due to admin costs of regular drawdown.
Page 13
How well the existing market meets the residents needs.

If the resident wishes to semi-retire and take some income from their
pension fund while still working they are more likely to take advantage.
Any restrictions on how much residents may withdraw money from their
personal investment accounts may reduce take-up
(iii) Increase in numbers eligible?
Under the proposed system there is a risk that residents will underestimate
the cost of providing an adequate income in retirement.
Without safeguards, residents may exhaust their personal investment
accounts and become dependent on the state pension.
The way in which the means test is performed means residents could
potentially manipulate their income stream to receive a state pension
by dropping their income to $100 per week in the relevant month
If the residents spouse has no pension provision of their own, the spouse
could fall onto the state pension.
(iv) Safeguards
Impose a maximum amount that can be withdrawn from the residents

personal investment account each month.
This could be an amount expected to last for the residents whole
retirement, so would need to take into account:
o Expected investment returns
o Expected inflation
o Expected longevity
The level of spouses pension required and likelihood this will be paid
The government could set and publish factors, perhaps annually.
This is likely to be unpopular with residents who want more flexibility
from their personal investment account.
This mimics an annuity from an insurer to some extent.
Introduce a test such that if the residents personal investment account is

expected to produce an income of at least $100 per week for the whole of
their retirement, the member can withdraw as much as they want above
this level.
This may be more palatable to residents with large personal investment
accounts who value flexibility.
Set a minimum amount that may be withdrawn from the residents

personal investment account.
Would need to be at least $100 per week to meet the means test
Unlikely to impact on residents with large personal investment
accounts
Need to consider how to tackle residents with insufficient funds to
provide this
Page 14
For these residents, the lowest cost burden on the state would arise if
the member must take $100 per week until their personal investment
account is exhausted
but this doesnt seem to be in the spirit of ensuring adequate
provision in retirement.
Change means test

so it looks at income over the previous year rather than the previous
month to avoid manipulation of income.
This may disadvantage low income residents who have had a recent
drop in income
To avoid cliff-edge element (some sort of graded test)
Only allow residents to change the level of income from their personal
investment account once per year
to avoid manipulation to meet the means test.
May be unpopular as it would reduce flexibility
Take into account residents income from other secured sources to

determine how much they may withdraw from their personal investment
account.
e.g. a defined benefit pension from an employer
or annuities already secured with insurers
So if the member can prove they have $100 per week income from
these sources they may withdraw as much as they wish from their
personal investment account.
Or use the same method to determine how much of their personal

investment account the resident must use to secure an annuity
So they must have income of $100 per week from secured retirement
income before being permitted to invest any DC funds in a personal
investment account.
The government should consider if an income of $100 per week is

adequate to provide for residents in retirement when considering the
proposal.
Restrictions on choice of investments in personal account

To reduce risk of poor returns by investing too cautiously
To reduce risk of default by investing too riskily

Requirement to purchase annuity once fund reduces to a given level
i.e. the level that purchases the minimum $100 per week
Change means test to allow for assets as well as income

Which could include the value of the DC fund itself
May disadvantage residents whose wealth cannot (easily) be disposed
of
Page 15
Unsurprisingly, there was much evidence of time pressure in the answers to this question,
with many candidates failing entirely to discuss and explain in their solutions, or show
that they had carefully read the question. There were many points of detail that could be
used to add breadth to solutions, simply by listing the features of proposals, and making
salient observations about their impact on individuals in different circumstances, ands
whether or not they would help achieve the stated objectives.
In part (i),many candidates only covered cost issues, even though the question stated that the
policy was also unpopular due to inflexibility (and the preamble to part (ii) was all about
flexibility issues).
Again in (ii), stronger candidates discussed the factors they identified, rather than just listed
them candidates should note that writing your list in the form of a series of questions does
not demonstrate understanding on its own (or, indeed, constitute a discussion).
In part (iv), many candidates considered other aspects of post-retirement provision, rather
than safeguards to be applied to the specific proposal in the question.
Page 16
EXAMINATION
1 October 2012 (pm)

booklet.
supervisor.
sheet.
question paper.

1 (i) Set out the key reasons why a defined benefit pension scheme should make
regular membership data checks to ensure a high degree of data quality. [3]
(ii) Outline the data checks that could be made. [4]

[Total 7]
2 The government of a developed country wants to increase the proportion of the

population that has adequate pension provision. It is not sure whether it wants to
introduce compulsory pension contributions, either onto private pension schemes or
into an alternative pension arrangement to be set up by the government.
(i) List the options available to the government to increase pension scheme
membership, other than compulsory contributions. [3]
(ii) Discuss the advantages and disadvantages of making it compulsory for

individuals and employers to make pension contributions. [5]
[Total 8]
3 A large defined benefit pension scheme is undertaking a general risk reduction

exercise. As part of this, the scheme is considering using insurance contracts to
reduce the risks associated with:
the lump sum benefit payable on a members death before retirement

the spouses pension payable on a members death before retirement; and
the pension paid to a member on retirement.
The scheme does not currently use any insurance contracts.
(i) Outline the key features of the insurance contracts that may be considered. [6]
(ii) Describe how the insurance contracts could reduce the risk associated with
each of the three pension benefits listed above. [4]
[Total 10]
4 A large company has an income replacement scheme for its employees. If an

employee is unable to work due to ill-health, after a six months waiting period, the
scheme provides an income of 75% of the members salary at the date he fell ill until
he reaches age 65 or recovers sufficiently to return to work. The benefit increases in
payment by 3% per annum compound.
The benefit is insured on a group basis. The finance director has expressed concern
about a recent increase in the insurance premium.
(i) Suggest reasons why the premium is likely to have increased. [6]
(ii) Suggest possible ways to reduce the premium. [6]

[Total 12]
ST4 S20122
5 An employer currently offers its employees a benefit package (in addition to salary)
that includes a pension scheme, life insurance and private medical care. The
employer is considering introducing a flexible benefits scheme for its employees.
(i) Explain what is meant by a flexible benefits scheme. [2]
(ii) Suggest the key reasons why an employer might offer a flexible benefits
scheme. [2]
(iii) Discuss the main issues that the employer should consider in designing the
flexible benefits scheme. [8]
[Total 12]
6 A defined benefit pension scheme completed a funding valuation as at 1 April 2011,

using the basic form of the Projected Unit Method. The results and main assumptions
are shown below:
Active liabilities 150m

Standard Contribution Rate (SCR) 20% of pensionable salary
Normal retirement age 65
Average age of Actives 45
Pre-retirement discount rate 6% per annum
Earnings increases 4% per annum
Pre-retirement decrements None
The scheme closed to new entrants on 1 April 2012. One of the schemes trustees has
heard that a different funding method should now be used to calculate the Standard
Contribution Rate (SCR).
(i) Discuss the suitability for this scheme of each of the four main funding
methods used to determine the SCR. [6]
The standard formula for the SCR is as follows:
r65 65 x Y Y 65 x r (1 + e)Y (1 + r )Y (i e )
f .Y .S . (1 + r ) (1 + e ) v a65 + AL. SaY .
lx (1 + r )Y
(ii) Define f, Y, S, r and e, including how they may vary for each method. [6]
(iii) (a) Suggest the most appropriate funding method, based on your answer to
part (i).
(b) Calculate the new SCR using this method.

[3]
[Total 15]

7 A funding valuation for a large defined benefit pension scheme is about to be
performed. It has been suggested that in addition to presenting the valuation results on
a set of prudent funding assumptions, the results should also be shown using the
following three additional sets of valuation assumptions:
best estimate assumptions
insurance company buy-out assumptions
self sufficiency using low risk assumptions with all the investments in
government bonds
(i) Outline the key features of all four valuation bases. [4]
(ii) Discuss the purpose of the results under each of the four bases, explaining how
each could be used as part of the funding valuation and the schemes financial
management analysis in general. [12]
[Total 16]
8 The funding valuation for a medium sized defined benefit pension scheme has just
been completed. The deficit has increased significantly from the previous valuation
three years ago. The sponsoring employer continues to have a reasonably strong
covenant with a large holding of fixed assets shown on the balance sheet. However,
trading conditions are more difficult and there are signs that the sponsoring employer
may experience cash flow problems in the near future. The pension scheme has an
investment strategy of 25% equities and 75% bonds.
The sponsoring employer has formally proposed to the trustees of the pension scheme
that the investment strategy be moved to 75% equities and 25% bonds. The reasoning
is that this move would improve the funding position of the scheme and require
reduced deficit payments over the longer term.
(i) Discuss the points that the trustees should consider in their response to the
sponsoring employers proposal, outlining the potential impact on the funding
valuation basis. [8]
The sponsoring employer has also suggested that, until its cash flow issues have
improved, it would like to consider alternatives to cash contributions. These
alternatives include, but are not limited to, the use of contingent contributions and a
charge on the employers fixed assets, with these assets reverting to the ownership of
the pension scheme on default of future promised cash contributions.
(ii) Outline the range of alternatives available and the effects of each option for
both the sponsor and the pension scheme. [8]
(iii) Outline any other ways the trustees might react to the companys situation. [4]
[Total 20]
END OF PAPER
ST4 S20124
EXAMINERS REPORT

Introduction
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.
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.
D C Bowie
December 2012

The examiners therefore look for candidates to apply their knowledge of the Core Reading to
parts). Time management is important so that candidates give answers that are roughly
proportionate to the number of marks available, for all questions.
Whilst we make no comment on the order in which candidates attempt questions, we do

suggest that candidates plan their answers to the whole paper at the beginning of the
examination, in particular identifying the important information in each question, and the
specific instruction. Also, candidates may wish to avoid over-refinement or repetition of
points on earlier shorter questions (which might at best score an extra mark) at the expense of
time spent exploring the longer questions (which might identify a more productive seam of
several marks or more).
The Examiners were pleased to see a second successive high pass rate for this paper, with
many candidates showing that they understood the underlying syllabus by producing concise,
logically structured solutions that addressed the specific context and instructions provided in
the questions.
Candidates generally scored very well on questions 1 and 2, reasonably on questions 3 to 7,

but particularly poorly on question 8. The relatively poor collective performance on the final
question seemed, at least partially, to be a result of poor planning and time-keeping this was
a question that required some reasoning and explanation.
Page 2
1 (i) Reasons for member data checks
Incorrect benefits may be paid to members

Legislative requirement to ensure benefits paid in accordance with the
schemes rules
Can add significant costs
E.g. error correction, future buy-out
Uncertain assessment of financial liabilities / actuarial valuation
May lead to inappropriate advice
Incorrect contributions may be made
Insufficient funds may be held by the scheme as a result
Fines may be imposed
Or removal of tax status resulting from non compliance
(ii) Range of data checks
Membership reconciles with previous valuation

Missing data
Common sense checks
E.g. no new entrants recorded
Comparison with other sources of data
E.g. from group life scheme or employment data
Data consistency
E.g. average salaries at current and previous valuation
Data validation
E.g. min & max ages
Random spot checks and benefit calculations
Focus on members with largest liability and items that have the greatest
impact
Answered well by most candidates. Those candidates that didnt score well typically focused
on only one type of data check or considered the impact on just one of the stakeholders.
2 (i) Options available to the government

Educate/ require education about the importance of providing for the
future (e.g. providing advice)
Provide tax relief for
employers contributions
employees contributions
investments
benefits
Direct cash incentives
Capping charges on pension products
Provide minimum pension benefits to all directly from the government
Or means test benefits and top up for those who do not reach the minimum
Create value for money pension products
With a simple standardised product
Page 3
with low costs and administrative efficiencies

introduce legislation to regulate private benefit arrangements / instil
confidence in the system
introduce auto enrolment
increase pension flexibility e.g. pension age
(ii) Compulsion
Advantages
To ensure adequate pension provision is made by all the population
Prevents future reliance on the State
May reduce the Governments long term budgets
Promotes awareness of future pension provision
The alternative arrangement set up by the Government could be used by an
individual for all employments
Could encourage greater trust in pension providers / ensure greater security
of invested contributions
Positive macro-economic impact (giving a suitable example)
Disadvantages
may be unpopular with employers & individuals
As may be perceived as an additional tax
Employer profitability may reduce and employment reduced
The low paid may be unable to afford
Unemployed are unable to make contributions
Wealthier individuals may have other demands for contributions
May be significant costs in setting up the alternative pension arrangement
May be poor value for money if charges are passed on
Difficulties in setting minimum contribution to ensure adequate pension in
retirement / the minimum becomes the standard rate
And ensuring contributions are made by all the population
Existing private pension schemes may need greater State regulation
This was the best answered question on the paper, at least in terms of the average proportion
of the marks available. A few candidates, however, failed to read the question carefully,
including compulsory contributions in their lists for part (i), or ignoring the instruction to
discuss pros and cons of compulsion in part (ii) e.g. by simply stating this would be
unpopular, this would be unfair etc., without explaining why.
3 (i) Key features of contracts
Group Life Insurance

Covers lump sum payments on death in service
Typically a very competitive market, so minimal profit margins in pricing
Usually charged for on a recurrent single premium basis
A unit rate is determined at inception according to age and gender
distribution
And is applied to the total sum assured during the period of the guarantee
Page 4
A free cover level is usually offered

i.e. insurer will provide cover for individuals in the group without medical
evidence
Experience / profit sharing is common for larger schemes
For the spouses death in service pension the insurance cover may be
achieved by insuring a larger lump sum out of which the spouses pension
will be paid
Alternatively the death in service spouses pension could be insured
Stop - loss / catastrophe insurance (with an example)
Non profit annuities

A lump sum is generally paid at retirement to an insurer to match a
members retirement benefits
May be an immediate or deferred annuity
The annuity may be level, increasing at a fixed rate or in line with an index
to match the promised scheme benefit to the member
Payable for life
With for example a guarantee period and / or widows benefit
The cost will include loadings for insurance company profits,
administration and contingencies
The liability is transferred to the insurance company
But can be purchased in either the schemes or the members name
With-profit and unit linked products may also be available
Which would enable the pension scheme to benefit from experience that is
better than assumed in the annuity terms
Reasonably competitive market/pricing may exist
... and may not be able to match increases in scheme rules (e.g. LPI,
discretionary increases etc)
(ii) Risk reduction
Lump sum insurance

There is greater predictability in the cost of the death benefits with
insurance
Reducing the potential for large variability in claims if there is no
insurance
And very large individual claims relative to the size of the assets
Avoids adverse mortality experience
The resultant investment strategy does not have to allow for variability and
size of death claims
E.g. reduced requirement to hold liquid assets
Spouses pension
The value of accrued benefits may be relatively small so an insurance
contract will remove the risk of the claim exceeding the reserve held
Reduces unpredictable cash flows but as the dependants pension is paid
out periodically rather than in one large lump sum this is less an issue
compared to lump sum death benefits
Page 5
Or if benefit is based on prospective service removes the longevity risk
Pensions on retirement Immediate annuities

Removes the mortality risk in retirement
Removes the investment risk in retirement
Removes the inflation risk if the benefit is linked to an index
Removes risk of expenses of paying out pension being greater than
expected
Generally answered well, but it appeared that some candidates neither read the whole
question first, nor followed the instruction in part (i), so covering material that was
specifically relevant to part (ii) in place of the relatively straightforward solution required
for (i).
4 (i) Reasons for increase

Reasons may be specific to our companys experience, or due to the
overall experience of the insurer (or both)
Previous loss leading rates may have now expired
There may have been a large number of recent claims leading to the
premium rate being increased.
e.g. people fell ill for longer / improving longevity might have
increased the average length of claim
Current provider may no longer be competitive.
Salary roll increases
Number of members increased
Changing age profile of membership
Changing sex profile of membership
Change in insurance pricing structure
e.g. due to regulation or competition in market
Changed market conditions have made insuring income replacement
benefit a lot more expensive
e.g. lower bond yields
The benefit of an income of 75% of salary may have been a disincentive
for the member to go back to work
Tax changes
(ii) Ways to reduce premiums

Suggest market review may be possible to find cheaper insurer
Or negotiate with the current insurer to reduce premiums
Tighten up (or enforce more strongly) ill-health definition to reduce claims
Introduce active return to work or rehabilitation programme to shorten
length of claims
Reduce benefits, for example
Consider scope to reduce 75% benefit level
...e.g. percentage applied, salary definition used, or introduce a salary
offset
Increase waiting period e.g. from 6 months to 12 months
Page 6
Review 3% per annum escalation rate

Consider time limit on claims, e.g. 5 years, rather than to age 65 (or reduce
age 65 limit)
Examine self-insuring
but self insurance increases risk to the Company
Have members meet part of the cost
perhaps on a flexible benefits basis
Reduce number of members eligible for benefit
This question invited candidates to consider all the reasons for a premium increase. A full
answer required candidates to consider all the stakeholders involved. Some candidates
focused on one party in great detail, missing some more obvious possibilities elsewhere e.g.
covering the insurers business at great length, but not mentioning increases in the
employers membership or salaries (or vice versa). A full answer to both parts was also
easier to generate if candidates considered factors that affect the incidence, size and
persistence of claims.
5 (i) What are Flexible Benefits?

employees are offered the option to revise the level of an existing benefit
or to choose different benefits
which the employee buys either by reducing their pay
or by giving up part of their existing benefits
(ii) Why provide them?

Ensuring best VFM for their expenditure by targeting benefits that
members appreciate
Targets benefits that members appreciate
recruiting, retaining, motivating and empowering employees
(... or competitors provide them)
recognises that employees needs change over time
feel that it is inappropriate to provide all employees in an organisation with
the same benefit package
(iii) Main issues to consider

What benefits should it offer?
What are its competitors doing
What is common practice in the country
What do the employees want?
Are there any tax advantages for certain benefits?
Whether there is a state benefit to integrate with?
Eligibility criteria
Choices include
Permanent disability benefit (e.g. pension)
Different levels of life insurance
Subsidised health care: medical, dental, opticians
Buy/sell holiday
Savings: profit sharing, share plans
Page 7
Subsidised goods: e.g. food, housing, telephone, travel insurance,

bicycles
Administration of the benefits,

does it need additional staff or will it outsource (cost)
pricing of options benefits, i.e. how much salary should be given up
Cost neutral to company or at a profit e.g. should the company pass
on any tax benefit?
There will be a trade-off between attractiveness (many options)
and simplicity (few options)
Including how often members can review their choices
And how often the terms should be reviewed
Online administration will allow employees to self-administer and
reduce costs
Maximum and minimum of any benefit

Legislative requirements (e.g. statutory minima / maxima)
Whether to insure with third party e.g. life insurance
(will depend on size of company and/or pension scheme)
Communication of benefits to staff
HR manpower planning considerations
Which options is the employer looking to encourage / discourage
Decision to insure or self insure the benefits
For parts (i) and (ii), some candidates solutions made only one distinct point and could not
possibly score the full marks available. For example many candidates only mentioned
choosing different benefits from a selection, but not the impact on earnings or having
different levels of benefit.
For part (iii), the examiners noted that the better-scoring candidates structured their answers
with a number of sub-headings (which need not have been those in the specimen solution
above). Candidates that scored relatively poorly often listed items without giving examples
or explanations this will not score well when the instruction is to discuss an issue.
6 (i) Funding methods
General points
Scheme sponsor will probably prefer a stable SCR
...but any method is appropriate as long as all involved understand likely
future changes to SCR
Attained Age funding method

Average future contribution rate for current membership
Which may be suitable given scheme is closed to new entrants
Allows for salary growth to retirement
No change to accrued liability
Page 8
Entry Age funding method

Sum of the average rate for all service that would have applied to each
member at the age they joined
Inconsistent with existing PUM accrued liability?
Unlikely to be suitable
Projected Unit funding method

Cost of benefits built up in the next year (or longer control period)
Will increase given no new entrants / stable only if average age of
active members remains the same
May not therefore be appropriate for long term planning
Current Unit funding method

Doesnt allow for future salary growth in accrued liabilities.
Reduces the accrued liability
Contribution rate will increase significantly as membership ages
(ii) Definition of terms

f = pension accrued per year of service as a percentage of final salary
Y = number of years service to be included in the calculation
S = current salary
r = inflationary revaluation (other than salary growth) of the pension
before payment starts
e = inflationary revaluation (due to salary growth) of the pension before
payment starts
Under the basic form of the Current Unit method: Y = 1 and r = 0.

Under the revaluation adjusted form of the Current Unit method: Y = 1 and
r 0.
Under the basic form of the Projected Unit method: Y = 1 and r = e.

Under a Unit method using a control period: Y = length of the control
period.
Under the Entry Age method: r = e and Y = all potential service from
assumed entry age,
x is the entry age.
Under the Attained Age method: r = e and Y = all future service from
age x.
(iii) New SCR
Most appropriate method is Attained Age

Should provide stable contribution rate if assumptions are borne out
Converting PUM with 1 year period to AAM ...

...assuming 20 year average period to retirement
20% * 20 / (20 year annuity at (6% 4%) i.e. 2% = 16.35)
Page 9
So revised SCR is 24.5%
Part (i) Many candidates had a fair attempt at part (i) but some seemed determined to
methodically work through all of the criteria in the Core Reading (stability, realism,
durability, etc.) for each of the four funding methods. This approach led to a lot of repetition
and points which were not specific to the scheme - it was clearly not appropriate given the
marks available and the instruction to discuss the suitability of each method for the
scheme.
Part (ii) The above solution was taken from the Core Reading, but it did not need to be
reproduced in full for candidates to score the six marks available. The examiners wanted to
see that candidates understood how the funding methods worked, and in particular, where
they differ. Many candidates demonstrated this by defining each variable, the value it took
under the PUM, and explaining for which methods it took a different value. This was a good
approach that gained equivalent and, where appropriate, full credit.
Part (iii) If a candidate simply named a method without explanation, partial credit was only
given if the method selected was consistent with their discussion in part (i). For the
calculation, credit was also given for other (often much longer!) derivations of an SCR that
produced a plausible result, but many candidates lost their way doing calculations that were
clearly disproportionate to the marks available (which hinted at around two to three minutes
work).
7 (i) Key features of valuation bases
Prudent Funding
The prudent assumptions allow for the uncertainty surrounding the future
benefit costs
Allowing for the assessed strength of the employer covenant
Assumes the Scheme is on-going
And supported by the employer over the long term
The basis allows for the actual investment strategy being followed
Best Estimate assumptions

Uses the expected outcome for each of the valuation assumptions
With any contingency margin removed from the assumptions
Hence subject to greater short term experience fluctuations
Provides a more realistic cost of the future benefits
Buy-out
The valuation assumptions are likely to be very prudent
Often allowing for significant margins e.g. life expectancy
including implicitly the insurance company profit margins, cost of capital
etc.
The assumptions will mirror those used by an insurance company
But are unlikely to involve actual insurance company quotations or
assumptions
Assumes all active members will be treated as early leavers
Page 10
with no allowance for future salary increases

Assumes the scheme will no longer be supported by the sponsoring
employer
Wind-up / buyout expenses can be significant
Self Sufficiency
Assumes the scheme is still on-going, but not dependent on the sponsor to
underwrite risks taken
Assumptions will be prudent
And may be similar to buy-out assumptions
But do not allow for insurance company profit margins etc
May not reflect the actual investment strategy followed
Typically assumes Government bonds are held to match liabilities
(ii) Purpose of results
A particular valuation basis may be a legislative requirement
Prudent Funding
To determine the future level of contributions that are needed
Either payments to remove the deficit and / or the future service
contribution rate
Comparison of assets & liabilities assesses the degree of security for the
accrued benefits
Could be used to determine a suitable investment strategy
To review the financial progress since the previous valuation
To assess the cost of the level of current benefits provided and their future
viability
Best Estimate assumptions

Provides a more realistic cost of the future benefits
But is subject to greater short term fluctuations
May be used by the employer for the Companys financial reporting
requirements
And in the assessment of the financial significance of the benefit
obligations
Buy-out
Provides an estimate of the cost of securing the benefits with an insurance
company
Comparing the assets to the buyout cost provides an assessment of the
underlying security of the benefits if scheme is wound up
Self Sufficiency
Mirrors the cost of buying out with an insurance company
But assumes the scheme is still ongoing
Provides a financial assessment assuming the investment strategy has been
de-risked
Page 11
Use of alternative valuations
Best estimate
Allows an appropriate contingency margin to be determined
(or helps illustrate the degree of prudence in the prudent funding basis)
In line with the strength of the employer covenant
Allows the sensitivity to the valuation assumption to be analysed
The best estimate cost of future benefits can be analysed to determine
any benefit improvements or possible reduction in future service benefits
Buy-out
Allows an assessment of the security of members benefits
And hence the reliance on the continued support of the employer
Used to aid understanding of the fully de-risked position of the pension
scheme the end game
Self Sufficiency
Aids long term financial planning if buyout does not happen
Mirrors the scheme acting as its own insurance company over the longer
term
Without allowing for insurance company profit margins etc
Aids understanding of some of the risks in the pension scheme
E.g. investment risk
Could be used as part of a de-risking investment strategy with a movement
from return seeking assets to a safer matched position
Candidates generally did well on this question, and it should be noted that the length of the
solution above goes well beyond that which was required for a passing standard, but reflects
the wide possible range of points that could reasonably be made. Further, given the inter-
changeability of the points in the solution above on key features, purpose of the results,
and how each could be used, candidates were given credit (once) for relevant points made
anywhere in their solution to Q7.
8 (i) Trustees response

The investment strategy needs to considered alongside the strength of the
covenant
Unless the liability profile is very immature (e.g. mostly young active
members)...
... the suggested change to the investment strategy will increase the risk to
the scheme significantly
Any future adverse investment experience will need to be met by the
employer
The employer and trustees attitude to risk needs to be determined
The covenant overall is less strong with potential cash flow problems
This is not consistent with the proposed change to the investment strategy
Scheme rules may determine who has the power to set the investment
strategy
Page 12
It may be that the employer does not determine the investment strategy
The Trustees will need to meet with the employer to discuss the full
reasons for the suggested investment strategy change
Or if any contingent assets are being offered if the funding position falls in
the future
More information is needed on the current and future trading position in
general
The valuation discount rate may reflect the assets held
And hence we would expect a lower liability if the discount rate increases
But also will take account of the employer covenant
With greater prudence possibly being needed in the valuation assumptions
to reflect the possible change in the covenant
So the value placed on the liabilities may actually increase and the funding
position worsen
Investment issues
Matching of assets and liabilities needs to be considered
Need to consider the alternative to equity investment (even if Trustees
willing to increase the level of investment risk)
Or alternatively, for example, moving from government bonds to corporate
bonds
(ii) Alternatives to contributions
Charge on fixed assets

This is a legal agreement that the Scheme can claim specified assets of
the employer in the event of insolvency
(or other specified circumstances)
Noting there are significant fixed assets available
Increases security for the pension scheme
Depending on the quality of the assets and the ranking of the charge
To the detriment of shareholders
Which may restrict the future borrowing capacity of the employer
To cover adverse experience (e.g. investment performance)
Or employer defaulting on payments
Company guarantee / credit default swap

A legal agreement to underwrite any debts from the sponsor to the
scheme
The impact for the scheme depends on the strength of the guarantor
e.g. a parent company
Invest in assets that pay on the employer default e.g. credit default
swaps
Bank Guarantee
Paying a lump sum to the Scheme if the employer fails to do so
Gives a high level of security to the Scheme at the expense of other
lenders and the shareholders
Page 13
May be expensive for the employer and increase cost of capital if

required
Other
Consider buying more bonds
Consider insuring some of the benefits
Contingent contributions
With the sponsor making up the deficit more quickly if the schemes
financial position deteriorates
Alternatively there could be ratchets in contributions so that if the
employers financial position improves then the scheme shares in this
improvement
(iii) Other issues
Consideration of the underlying reasons for the more difficult trading

conditions and possible cash flow problems
An analysis and current valuation of the fixed assets on the balance sheet
Consideration of the employers other creditors
Instigate a more regular review of the covenant e.g. quarterly
Consider bringing forward the date of the actuarial valuation
Consider undertaking a detailed investment strategy review to better match
the schemes assets and liabilities
Consider level of future benefits (with an example)
Part (i) Somewhat troublingly, many candidates seemed all too ready for the Trustees to
accept the employers proposal without any further debate, notwithstanding the questions
clear implication of a weakening of the employer covenant at the same time as a significant
increase in the scheme deficit. Whilst the question didnt specify the maturity of the scheme
and hence the matched position, the shift to equities clearly increases investment risk, yet
many candidates solutions never mentioned the words risk or covenant at all, and went
off on tangential discussion on the possible reasons for the increase in deficit, or the detailed
process for switching investments.
Part (ii) Candidates familiar with the relevant Core Reading, and with time to structure
their solutions, scored well on this question.
Part (iii) Credit was given for any four plausible outlined suggestions, excluding any that
would be clearly an over-reaction to the circumstances, and those which would only follow
after the sort of analysis above first being carried out.
Page 14
EXAMINATION
19 April 2013 (am)

booklet.
supervisor.
sheet.
question paper.

1 A non-contributory final salary pension scheme only has active and deferred
members. The funding valuation is due as at 1 January 2013. The results from the
previous valuation as at 1 January 2010 were as follows:
m
Liabilities:
Actives 50
Deferred pensioners 20
Total liabilities 70
Assets 65
Surplus/(deficit) (5)
Standard Contribution Rate: 24% of pensionable salaries
The Standard Contribution Rate was calculated using the Projected Unit Method with
a three-year control period.
Total pensionable salaries as at 1 January 2010 were 8m.
The key financial assumptions used for the valuation as at 1 January 2010 were:
Interest rate = 6% per annum

Salary increases = 4% per annum
Pension increases = 3% per annum
(in deferment and payment)
The following additional information is available regarding the schemes experience

during the three year period to 1 January 2013:
Average salary increase = 3% per annum

Average investment return = 7% per annum
Average deferred revaluation = 3% per annum
Employer contributions paid = 5m per annum
No membership movements
(i) Estimate the actuarial gain/loss arising over the inter-valuation period in
relation to active member liabilities, stating any further assumptions that you
make. [4]
(ii) Estimate the surplus or deficit in the scheme as at 1 January 2013, stating any
further assumptions that you make. [4]
[Total 8]
ST4 A20132
2 In a developed country, investment income and capital gains from savings are subject
to tax. The government of the country operates the following method of taxing
pension schemes:
Employee and employer contributions are exempt from income tax.

Investment returns within pension schemes are exempt from tax.
Benefits taken from pension schemes are subject to income tax.
(i) Explain why the country might have adopted such a system of pension
taxation. [3]
The country has a progressive income tax system whereby income (from both
earnings and pensions) is taxed at the rate of:
20% of income up to $100,000 per annum, known as the higher income

threshold; and
40% of income above $100,000 per annum
(ii) Set out the advantages and disadvantages of contributing to a defined

contribution pension scheme, compared with the alternative of saving taxed
income, for an employee earning:
(a) $70,000 per annum

(b) $140,000 per annum [3]
The government wishes to reduce costs and is considering restricting the tax relief
currently enjoyed by citizens earning more than $100,000.
(iii) Discuss four different methods by which the government could control this
cost, including the practical advantages and disadvantages of each. [8]
The government has now changed the taxation system so that pension contributions
will no longer be exempt from income tax; however future benefits accrued in
pension schemes will be tax-free. The governments president states that the change
will raise a considerable amount of extra tax revenue.
(iv) Comment on the presidents statement in relation to future contributions and

accumulated pension funds. [4]
[Total 18]

3 A large defined benefit pension scheme holds 100% of its assets in equities.
(i) Outline the possible impact of poor equity returns on the scheme members
benefits. [4]
The managers of the scheme wish to reduce investment risk. They are considering
moving a significant proportion of the scheme assets into a fixed interest bond fund
which invests in global government bonds.
(ii) Set out the reasons why this bond fund may not be the most appropriate
investment for the scheme. [3]
The managers have yet to agree on a particular bond fund but have asked the actuary
advising the scheme to determine an appropriate proportion of the fund to be invested
in bonds.
(iii) Describe how an asset-liability modelling exercise could be carried out to

assist the managers in deciding the proportion to be invested in bonds. [5]
In light of the asset-liability modelling exercise, the scheme managers have decided to
move 50% of the schemes assets into bonds.
(iv) Discuss the practical issues that the managers should consider in making the
switch to the chosen bond fund. [5]
[Total 17]
4 A final salary defined benefit pension scheme provides an option for its members to
take a retirement benefit at a date earlier than normal retirement age. The following
information is available:
Normal retirement age: 65

Benefits payable on death: nil
Funding assumptions:
Discount rate: 7% per annum
Pension increases in payment: 3% per annum
Revaluation of deferred pensions: 4% per annum
Mortality table: PMA92C20
The early retirement factor at age x is expressed as a percentage of the members

accrued pension revalued to age x.
(i) Calculate, using an equation of value, the early retirement factor for a deferred
pensioner aged 58, stating any additional assumptions that you make. [5]
(ii) Discuss why different early retirement factors may be adopted for active
members compared with deferred pensioners. [5]
[Total 10]
ST4 A20134
5 An actuarial valuation for a defined benefit pension scheme is now due. The
following market yields are prevailing as at the actuarial valuation date:
Long dated fixed interest government bond yield 3.0% per annum
Long dated index-linked government bond real yield 0.5% per annum
Long dated investment grade corporate bond yield 4.0% per annum
Equity market dividend yield 3.5% per annum
The schemes assets are invested 25% in government bonds, 25% in investment grade
corporate bonds and 50% in equities.
(i) Suggest, with reasons, assumptions for the discount rate and price inflation
under the following approaches:
(a) mark to market method

(b) asset-based discount rate
For each approach, you may assume that the same single discount rate is to be
used both pre-retirement and post-retirement. [6]
The scheme provides annual pension increases in line with price inflation, subject to a
cap of 3% and a floor of 0%.
(ii) Discuss how the pension increase assumption may be derived from the price
inflation assumption. [4]
(iii) Discuss whether the sponsoring employer might prefer the scheme to be
funded using best estimate funding assumptions or prudent funding
assumptions. [4]
[Total 14]
6 The regulator of a country requires sponsors of pension schemes to disclose

information to members of pension schemes. This includes publishing audited
scheme accounts including information about the schemes investment strategy and
funding level, and the provision of annual benefit statements to members.
(i) Explain why the regulator may require this information to be disclosed. [5]
A sponsoring employer of a defined contribution scheme is preparing benefit

statements for its members. Under the provisions of the scheme, both employer and
members contribute and members can choose from a range of funds in which to invest
the contributions. Each year, the benefit statements will include a single projection of
the pension that the members fund accumulated to date is expected to provide at
normal retirement age. The projection is based on an assumed investment return of
7% per annum and current annuity rates.
(ii) Outline the shortcomings of this approach to benefit statements. [4]
(iii) Suggest improvements that could be made to the benefit statements to

overcome these shortcomings. [4]
[Total 13]

7 A defined benefit pension scheme has assets of 100m and an accounting deficit of
45m. The scheme is managed by a board of trustees.
The balance sheet position of the sponsoring employer can be summarised as follows:
Assets Liabilities
Intangible assets 50m Debt 90m
Property 25m Pension deficit 45m
Cash 5m Trade creditors 15m
Stock 40m Shareholder funds 5m
Debtors 35m
Total 155m Total 155m
Last year, the sponsoring employer made pre-tax profits of 10m.
(i) Discuss whether the sponsoring employer should be assessed by the trustees as
viable ongoing or in distress. [10]
As a result of further information received, the trustees have concluded that the
sponsoring employer is in distress.
(ii) Describe the courses of action that the trustees should consider as a result of
their conclusion. [6]
Pensions in payment are currently increased annually in line with inflation. The
sponsoring employer is proposing to offer members, at the point of retirement, the
option of exchanging their inflation-linked pension for a higher pension without
pension increases. Current pensioners will not be included in the exercise. The
conversion factors are determined so that the actuarial value of the uplift to the
pension is expected to be 90% of the value of the pension increases surrendered.
(iii) Outline the advantages and disadvantages to the sponsoring employer of this
proposal. [4]
[Total 20]
END OF PAPER
ST4 A20136
EXAMINERS REPORT

Introduction
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.
D C Bowie
July 2013

The overall standard of scripts was broadly as expected, and this was reflected in a similar
pass rate to the norm. There was no indication that candidates consistently found any one of
the questions tougher than the others average total marks were similar for all questions.
More detailed feedback is provided on each question below.
Page 2
1 (i)
Salary increases are assumed to be awarded uniformly over the inter-
valuation period
The valuation assumptions include no allowance for pre-retirement
mortality
Or other decrements, e.g. withdrawal, early retirement
No change to valuation assumptions (if candidate assumes a basis change
and gets the resulting calculations correct, award this half mark)
Expected Actives Liability at 1 January 2013

= 50 * 1.063 + 24% * 8 * 3 * 1.063
= 59.55 + 6.86 = 66.4 million
Estimated Actives Liability at 1 January 2013

= 66.4 * (1.03 / 1.04)3
= 64.5 million
Estimated Gain on actives liability = 1.9 million
(ii)
Investment returns are assumed to be earned uniformly over the inter-
valuation period
Contributions are assumed to be received uniformly over the inter-
valuation period
Estimated Deferred Liability at 1 January 2013

= 20 * 1.063
= 23.8 million
Estimated Total Liabilities at 1 January 2013

= 64.5 + 23.8 = 88.3 million
Estimated assets at 1 January 2013 = 65 * 1.073 + 3 * 5 * 1.071.5

= 79.63 + 16.60 = 96.2 million
Estimated Surplus at 1 January 2013 = 7.9 million
(Give credit for alternative methods e.g. estimating actuarial gain / loss on
other elements and summing.)
Examples of other methods:
(i) 50 1.063 + 0.24 8 (1.040.5 1.062.5 + 1.041.5 1.061.5

+ 1.042.5 1.060.5)
= 66.2m
Although averaging could be used in the latter part e.g.
0.24 8 3 1.041.5 1.061.5
And the actual liability is:
50 1.063 (1.03)3/ (1.04)3
Page 3
+ 0.24 8 (1.030.5 1.062.5 + 1.031.5 1.061.5+ 1.032.5 1.060.5)

= 64.4m
This gives a gain of 1.8m (66.2 64.4)
Numerical questions often result in candidates scoring either well or badly, with little in
between. This question was no exception. It is important for candidates to be able to
demonstrate an understanding of the theory in such a question, and a methodical approach
will always pay dividends.
(ii) Using an analysis of surplus
Investment gain
Expected assets = 65 1.063 + 5 (1.062.5 + 1.061.5+ 1.060.5) = 93.8m

Actual assets = 65 1.073 + 5 (1.072.5 + 1.071.5+ 1.070.5) = 96.3m
Investment gain = 2.5m (96.3 93.8)
Contribution gain
Actual contributions = 5 (1.062.5 + 1.061.5+ 1.060.5) = 16.4m
Expected contributions =
0.24 8 (1.040.5 1.062.5 + 1.041.5 1.061.5+ 1.042.5 1.060.5) = 6.7m
Contribution gain = 9.7m (16.4 6.7)
Surplus
Deficit brought forward = 5 1.063= (6.0m)
Investment gain = 2.5m
Salary gain = 1.8m
Contribution gain = 9.7m
Current surplus = 8m
As for (i), results were variable.
2 (i) Reasons why the country might adopt such a system of pension taxation
The government wishes to encourage private pensions saving
from both employees and employers
in order to ensure an adequate level of pension in retirement
and reduce the requirement for state support in retirement
for example to reduce the need for means tested benefits
The system adopted provides a tax incentive to pay into a pension
scheme
to the extent that other forms of saving are subject to tax on investment
returns
Without an incentive workers may be unwilling to lock away savings for a
long period
The tax system is broadly cost neutral regarding the taxation of
contributions and benefits
assuming that the tax rates on the income paid whilst contributing and
that received during retirement are the same
Page 4
The public finances of the country may make a more generous tax
incentive unaffordable
Fairness earnings are only taxed once either on receipt of income or on
receipt of pension
This bookmark question was relatively well answered.
(ii) General Advantages (apply to both workers)

Tax-free investment returns
Income tax could be lower in retirement (if a different rate for pensions is
applied or tax rates change)
General Disadvantages (apply to both workers)

Money locked away and cannot be accessed until retirement
Risk that income tax rate may be higher in retirement
Key advantage for Worker earning $140,000

If worker has income less than $100,000 in retirement, 40% tax saving
is received on contributions and only 20% tax payable on pension
Relatively well answered by all most candidates.
(iii) Ways to reduce costs
Restrict the tax relief on contributions to 20%

+ Will result in less tax relief for given amount of contributions
+ Removes the loss of tax revenue that occurs when high earners receive
40% tax relief on contributions and pay 20% tax on benefits
+ Fairness e.g. perceived as fairer all citizens get the same rate of tax
relief
- Could result in double taxation for some high-earners: 20% relief on
contributions but 40% tax on benefits, resulting in overall tax rate of
more than 40%
- Could discourage pension saving by high-earners, adversely affecting
the pensions industry
- Could encourage employers to remove / reduce pensions for workers if
they cannot benefit from them to the same extent, resulting in lower
pension provision all around
- Administering different rates of income tax and pension tax relief
could cause administrative difficulties
Place an upper limit on the annual amount of contributions that can be paid
+ Will reduce tax relief where citizens currently pay more contributions
than the cap
- OK for citizens with long, stable earnings, but makes it difficult for
citizens with short, volatile earnings to save sufficient funds
- Difficult for older citizens to make up a shortfall in pension saving,
e.g. due to poor investment returns close to retirement
- Complications over indexation of limits
Page 5
Place an upper limit on the accumulated value of an individuals pension

savings
+ Caps the tax relief given over the working lifetime of an individual
- Citizens who have control over their earnings and pension
contributions can aim to avoid higher rate tax altogether later in their
career
- How should the limit be administered for members with benefits in
several pension schemes drawn at different times?
- What to do about citizens already over the limit risk of retrospective
taxation?
Place limit on the value of fund eligible for tax-free investment return
+ Reduces the cost of tax relief on investment returns
+ Encourages workers not to over-fund pensions, hence reduces tax
relief on contributions
- Difficult to administer
- E.g. if a fund is over the limit, which assets returns within it should be
taxed?
Reduce state-funded benefits for retirees with an income above a certain

level (means-testing)
+ Saves money as state benefits directed to those who need them the
most
- Complex to administer
- Some less well-off pensioners may be discouraged from applying for
means-tested benefits and be worse off
- Assuming there is a fixed amount of state benefits to offset, this hits
moderately affluent citizens harder than the super-rich
Will need to give credit for any other sensible, distinct suggestion (though
limit to four). Note some advantages / disadvantages may apply to more than
one suggestion credit only if well-argued and clearly relevant to the option.
Tended to be well answered by those with a structured approach to the solution. Many did
not cover sufficient breadth, however. To score well on this type of question, candidates must
identify four clearly different methods, giving sufficient discussion of all of them, not just the
first two, say.
(iv) Presidents statement
Future contributions
In the short term the presidents statement is correct
Current tax revenues will increase because there will no longer be tax
relief on pension contributions
However in future tax revenues will be lower because benefits from
pension schemes will no longer be taxable
Therefore the change will bring forward tax revenue in time rather
than generate additional tax revenue
Page 6
Although this depends on the overall net effect. If the pension system
doesnt balance (say is a net cost to the government) then this position will
reverse (i.e. become a net gain to the government)
To the extent that higher earners will no longer be able to claim 40% tax
relief on contributions and will not pay 20% tax on benefits, the change
may have a net effect of raising tax revenues
If fewer people are encouraged to save, there may be a saving on
investment income relief
Accumulated funds
The change should only apply to benefits taken in respect of future pension
contributions
Otherwise it would amount to a tax giveaway in respect of pension funds
accumulated at the date of change, which will escape tax altogether
Separating accumulated and future pension benefits will add
administrative complexity
Particularly for defined benefit schemes, where the timing of the
contribution may not be the same as the timing of the benefit promise
Unfunded pension schemes would be a particular problem
Candidates need to produce a structured response to score well on this type of question.
3 (i)
The benefits are defined, hence benefits payable should be unchanged
However, security of benefits is reduced due to lower funding level
Sponsoring employer will be required to make good funding shortfall
This may lead to a reduction in future benefits
or cessation of benefit accrual altogether
Accrued benefits are normally better protected by law so less likely to be
affected
But if employer is unable to make good funding shortfall then accrued
benefits may be reduced as well
Reduces chance of discretionary benefits
Possible reduction in transfer values paid out
Possible impact on member options (e.g. early retirement) if consent
required
Relatively well answered, but needs sufficient breadth to score well.
(ii)
The bond fund may not be a good match for the Schemes liabilities
For example:
Currency risks mix of currencies in global bond fund may not be similar
to currencies of liabilities
Inflation risks Scheme may have inflation-linked liabilities not matched
by conventional bonds
Page 7
Duration / reinvestment risk if the term of the liability exceeds that of the
bonds (or if bonds to not provide income at same time as liabilities)
Other:
Government vs. corporate bonds do government bonds offer a high
enough yield to meet the funding assumptions or should corporate bonds
be considered?
Security / credit risk does the fund invest in the bonds of countries with
low credit ratings
A single bond fund may not provide sufficient diversification
Lower expected return on bonds vs. other asset classes may adversely
impact liability calculation and contribution rate
Relatively straightforward for those candidates who focused on the specifics of the question.
(iii)
The precise objectives of a particular ALM exercise need to be set so that
appropriate data can be applied to the model
These objectives may indicate the acceptable level of risk, the funding
target against which the risk is to be considered, the secondary objectives
given that the first is met and the investment strategies that are to be
considered
The time period over which these probabilities apply and the number of
simulations to be run will also need to be set
An ALM study projects the schemes asset and liability cashflows
usually using a stochastic model for the economic cashflow elements and a
deterministic model for the demographic elements. For a given investment
strategy, an ALM study will allow estimates to be made of the
probabilities of future events in the lifetime of the scheme
For example, the probability that funds will be sufficient to meet
benefits
or the probability that additional financing will be required
These projections are carried out for a range of investment strategies
Any suitable stochastic investment model will require a large number of
input parameters covering the expected returns and standard deviations of
return on each asset class, the degree of correlation (for example equity
returns and price inflation), etc.
A typical assumption will be that bonds are a lower risk investment than
equities...
but with a lower long-term expected return
Hence, for different equity:bond asset allocations, the ALM study will
illustrate:
The reduction in risk obtained by holding fewer equities and more bonds,
and
The additional cost (contributions required) arising from the lower
expected returns
The output will depend on the parameters used for the stochastic
investment model of the asset class returns used in the ALM
Page 8
Given that the particular parameters chosen will not be borne out in
practice, it is important to test these investment policies for robustness
under alternative assumptions. The sensitivity to assumptions about
expected returns and risks should be explored to test the robustness of the
conclusions
To score well, candidates need to apply the bookwork to the specific scenario too many
candidates simply regurgitate bookwork lists about asset-liability modelling.
(iv) Practical issues

Which equities will be kept and which will be sold?
What will be the overall timeframe for the switch?
Will it be done in one go?
Or over several smaller switches?
Can the cashflow of the Scheme (net positive or net negative) be used to
accomplish some of the switch?
Is the intention to switch assets and move to a lower-risk investment
strategy as soon as possible?
Or will the managers seek to pick an opportune time for the switch?
Based on equity and bond market levels / yields
Or the Schemes funding level
Accepting the risk that they might switch at a poor time
Or that the switch may not happen for a long time
What are the transaction costs?
How can these be minimised?
Are there any liquidity issues affecting the sale of the equities or the
purchase of the bonds?
Can an investment manager / adviser be appointed to effect the switches
(or is there one in place?)
How should the changes be communicated to members?
Less well answered, requiring some application of knowledge to the scenario.
4 (i) Equation of value
Eax = P * v(NRAx) * aNRA * lNRA / lx
where:
x = age at the point of early retirement

NRA = normal retirement age
E = early retirement pension
P = the pension that would be payable from NRA
(This is the formula from the Core Reading. Credit can be given for an
alternative correct formula provided that the terms are defined.)
Page 9
The formula can be adjusted to allow for any pre-retirement benefits that
are also surrendered by taking early retirement and for any additional post
retirement benefits.
Calculation:
Assume pensions paid annually in advance

Assume annual pension increases on anniversary of retirement
From tables, l65 = 9,648 and l58 = 9,865
a65 = 13.666, a58 = 16.356 at net 4% (7%3%)
E / P = 1.07 (7) * 13.666 / 16.356 * 9,648 / 9,865 = 0.509
Expressed as a percentage of accrued pension revalued to age 58, early
retirement factor
= 0.509 * 1.047 = 67%
Note: Tables work with annual in advance pensions. Give credit if candidate
assumes pensions paid continuously (for example) but says the effect/error is
minimal as were looking at a ratios of annuities.
Alternative equation of value, based on ERF applied to pension at date of

retirement
ERF * Eax = P * (1+r) (NRAx) *v(NRAx) * aNRA * lNRA / lx

then
ERF = (1+r) (NRAx) *v(NRAx) * aNRA / ax* lNRA / lx
As for many numerical question, this did separate candidates quite well.
(ii) Different active / deferred factors
If the scheme is being funded on a basis that projects future pensionable

salary increases then the equation of value differs for the two groups
For deferreds, the NRA pension includes future deferred revaluation
For actives, the NRA pension includes future pensionable salary growth
Funding bases normally include a higher assumed rate of salary growth
than deferred revaluation
So using the equation of value method would give a higher early
retirement pension to an active member than an equivalent deferred
pensioner
This would effectively mean that the withdrawal profit that would occur
when an active member becomes a deferred pensioner is used to enhance
the members pension if, instead of becoming a deferred pensioner on the
date of leaving, he instead takes early retirement from active status
rather than being a source of surplus for the scheme as if he were
becoming a deferred pensioner
Arguably a member should not benefit from assumed future pensionable
salary increases if he is retiring from service and will not receive them
Page 10
The employer may wish to have the flexibility to provide greater early
retirement pensions to some employees for commercial reasons (to
manage workforce numbers)
Perhaps using early retirement factors based on the deferred pensioner
equation of value if the member is taking early retirement at his own
request, and early retirement factors based on the active member equation
of value if the member is taking early retirement at the employers
request, e.g. redundancy
Although for redundancy it depends on the package and whether the
employer wants to use enhanced scheme benefits or other employment
benefits (e.g. cash)
For active members, also need to consider whether an allowance for future
benefit accrual should be included in the equation of value
For example, if the employer wishes to provide special ill-health
retirement benefits
The allowance or expectation of discretionary benefits may differ for
actives and deferred pensioners and this may be reflected in the factors
Some benefits may differ for actives and deferred pensioners and these
may be reflected in the factors e.g. death benefits
The assumptions may differ for actives and deferred pensioners and these
may be reflected in the factors e.g. post-retirement mortality
The ERF for deferred pensioners may take into account the value to the
alternative transfer value deferred pensioners may take
There were many points to be made here, and candidates sometimes struggled to use the
breadth available.
5 (i) (a) Mark to market

Liabilities are discounted at bond yields
The bond yield may be based on government bonds
Or corporate bond yields adjusted for any credit risk
The market rate of inflation is derived from as the difference
between the yields on fixed interest and index linked bonds
Suggested assumptions:
Discount rate = 3% (give credit if corporate bond yield used
adjusted for credit risk e.g. 3.6%)
Inflation rate = 3% 0.5% = 2.5%
(b) Asset-based discount rate

An implied market discount rate is determined for each asset class
E.g. for fixed interest securities this is based on the redemption
yield
Or for equities the expected dividend income and sale proceeds
The discount rate used is the weighted average of the individual
discount rates based on the schemes asset allocation
Page 11
Suggested assumptions:
Inflation assumption = 2.5% as above
Discount rate for government bonds = 3%
Discount rate for corporate bonds = 4%
Discount rate for equities = dividend yield + inflation + real growth
= 2.5% + 3.5% + 1% (say) = 7% (no marks for silly numbers)
Weighted average discount rate = 25% * 3% + 25% * 4% + 50%
*7% = 5.25%
(Give bonus if credit risk adjustment explicitly included in
corporate bond yield)
A structured comparison was easy to achieve here, and those with a simple approach did
well. It is important to clearly demonstrate understanding of the differences.
(ii)
Deriving the pension increase assumption will require a probability
distribution for the inflation assumption
rather than just the expected value
With the probability distribution we can calculate the expected value of
price inflation subject to the floor and cap
Algebraically or stochastically
The variance (or standard deviation) of the probability distribution will be
important
as the greater this is, the more likely price inflation is to reach the cap
and floor
An assumption for the variance can be made by considering the historic
volatility of price inflation
or looking at option prices which may give a market view
If there is a market in Limited Price Indexation bonds then the yield on
these can be used
In practice, because the price inflation is towards the upper end of the
pension increase range, a simple deduction may be made to the price
inflation assumption
say 0.25%...
as more detailed methods may be considered spurious accuracy
(Give credit for a comprehensive description of a replicating portfolio

method.)
Candidates need to give sufficient detail to score well.
(iii)
The preference would depend on the sponsors attitude to financial
obligations and risk in the short, medium and long term
Opportunity cost: the employer may prefer not to pay more to the scheme
than is strictly necessary in the short term
As it may have other things it wishes to do with the money
For example investment projects or dividend payments
Hence it may have a preference for more realistic assumptions.
Page 12
However, to the extent that this would then risk an unexpected increase in
the future level of contributions this may not be acceptable
Prudent assumptions result in greater stability and predictability of
contributions:
If the risk of overpaying in the short term is viewed as being preferable to
the risk of having to find extra resources in the future, there will be a
preference for a prudent approach to the setting of the assumptions
It will also be affected by the ability of the sponsor to benefit from any
overpayment.
E.g. a refund of surplus
Or offsetting against the cost of future benefit accrual
Scheme members / trustees may prefer prudent assumptions to improve
security (and apply pressure for prudent assumptions)
Best estimate assumptions are more consistent with accounting
assumptions
This offered an opportunity to demonstrate deeper understanding of the issue, which was not
taken by all candidates.
6 (i)
It might be an attempt to improve the security of non-state pension benefits
For example, members will be able to challenge the sponsor in the event of
a poor funding level
or risky investment strategy
To enable members to plan and make informed decisions regarding their
pension
e.g. changing contribution rates, investment strategy
It encourages good pension scheme governance
Audited accounts reduce the scope for fraud
The state may want to encourage the take-up rates of private sector
pension schemes
In order to reduce the reliance on state benefits
Consumer protection the state may wish to ensure via benefit statements
that members understand their benefits
and are not misled
for example regarding the impact of fees and charges
Poor disclosure can lead to problems for providers if members are given
unrealistic expectations
such as over-optimistic defined contribution projections
or defined benefit statements that do not highlight the risk of reduced
benefits in the event of discontinuance or sponsor insolvency
Relatively well answered care needed not to be too UK specific if working in the UK.
(ii)
Different members may have different investment strategies
7% may not be a suitable assumption for the various funds available
Page 13
after allowing for the impact of fees

A fixed 7% each year will not take account of varying market conditions
The projection could be misleading as it does not allow for the impact of
inflation on the purchasing power of future income
giving members an unrealistic expectation of what their pension can buy
Using current annuity rates does not allow for expected improvements in
longevity before the member retires
Providing a single projection may give the impression that there is a high
degree of certainty regarding the members benefit
but the investment return achieved could be very different from 7%
and annuity rates can change
Basing the projection on the members current fund does not illustrate the
impact of future contributions
Annuity rate does not take account of the options the member has at
retirement (e.g. indexation, spouses pension, retirement age)
Many candidates gave too sketchy answers.
(iii)
Show projections using a range of assumptions
To highlight that the outcome is unknown and illustrate sensitivity
Adjust the 7% return assumption to allow for market conditions
and investment strategy (different assumptions for different funds)
taking into account the charges on the funds
Discount the result by a price inflation assumption to show the amount of
pension in todays money
Show separate results for current fund and future contributions
Include an allowance for longevity improvements in the annuity rates used
Include caveats that the result is uncertain and could be greater or less than
the range shown
Illustrate both the expected fund value and pension amount at normal
retirement date to highlight the importance of the annuity rate
Include caveat that annuity rates can change
Upgrade to an interactive, web-based system that allows members to test
scenarios
This tended only to be answered well by those who gave a good solution to the previous
question.
7 (i) Viable ongoing / In distress

The sponsor can be described as viable ongoing if the deficit is financially
manageable
with a reasonable likelihood of it being paid off over an appropriate
period
The sponsor can be described as in distress if the deficit is financially
unmanageable given sponsors resources
with no realistic likelihood of removing deficit over appropriate period
Page 14
In practice, there is a range from clearly viable to clearly distressed

sponsors and an element of subjectivity may be required to assess the
financial strength a sponsor lying in the middle of this range.
Discussion
Need to assess the employers covenant, i.e. its ability and willingness to
pay sufficient contributions
To meet benefit payments as they fall due
The trustees may wish to seek additional help, including perhaps the
appointment of an independent expert, to assess the covenant as they may
not feel sufficiently experienced for this task
Consider extent to which employer is legally obliged to fund the deficit (if
any)
The deficit of 45m could be regarded as loan to sponsor
Consider size of deficit relative to size of employer
its assets (which could be realised to repay the loan if required)
its earnings (which can be used to meet regular repayments to the
scheme)
consider other measures of deficit as well, i.e. funding or buyout
Particularly if scheme were discontinued
Consider other company debt does it rank above the pension scheme
deficit in the event of insolvency?
For example, is it secured on the property?
Investigate value of intangible assets on balance sheet is the figure given
realisable on insolvency?
The same for the debtors are these all expected to pay
Review cashflow statement are profits reflected in cash which can be
used to fund scheme?
Consider if there is a parent company which would make good any
shortfall
Various ways to assess credit risk, e.g.
o Business outlook
o Financial metrics
o Implied market default risk
o Credit ratings
o Other risk-based measures e.g. levies
o Probability of default using Merton-type model
o Independent business review
o Meet regularly with finance director or board of sponsoring employer
to discuss financial position and plans for the future
Conclusion
In this instance, the balance sheet of the employer appears able to
support the pension deficit
And the employers annual profit is more than 20% of the deficit
Which indicate that the employer should be considered more towards
the viable ongoing end of the range
Page 15
Other points
However, the pension scheme has a similar size to the employers balance
sheet
And the position could change, for example if the scheme has poor
investment returns
Could explore actual numbers, e.g. value of assets if we wrote off debtors
and intangible assets = 70m
Comment on liquid assets, e.g. level of cash at 5m, how liquid is the
stock at 40m will depend on nature of business
This should be relatively straightforward with a small degree of application. Answers tended
to be light on detail with insufficient depth.
(ii) Actions considered

Move to a more matched investment strategy, e.g. a higher weighting in
bonds
to reduce the risk of the funding level getting worse
Invest in assets that pay out in the event of sponsor default
such as derivatives including credit default swaps
Consider alternatives to cash payments if the sponsor is unable to afford
them
such as a charge on the sponsors fixed assets
or parent company guarantee / bank guarantee / letter of credit
Include ratchets in contributions so that if the sponsors financial position
improves
then the scheme shares in this improvement
Set up contingent contributions so the sponsor has to make up the deficit
more quickly if the schemes financial position deteriorates
although this could cause problems if the employer cannot afford the
contributions
it may be better to permit a weaker employer to defer contributions to
ensure it stays in business
Close to future benefit accrual or reduce future benefits
in order to protect accrued benefits as much as possible
Suspend discretionary benefits
Continue to monitor covenant and put into place procedures such that the
sponsor must inform the trustees of certain things e.g. restructuring debt
Review the use of insurance e.g. buy out the pensioners
Review any member option terms or consent requirements with regard to
options which are costly
Reasonably well answered.
Page 16
(iii) Pension increase exchange
Advantages
Deficit reduces as liabilities lower in both actual terms and as
measured on funding basis
With no additional up-front cash contribution requirement
beyond the costs of administering the exercise
Transfer of inflation risk (above a certain level) from employer to
members
Reduced longevity risk as pensions less back-end loaded
Possible lower investment risk if new pensions easier to match with bonds
Easier matching may lead to an even bigger saving relative to the buyout
cost
Option may be popular with some members who would like higher initial
pension
Disadvantages
True extent of saving will depend on the assumptions used
loss of upside risk if inflation is lower than expected
Despite expected 10% saving, risk of selection against the scheme
for example, members in ill-health taking up offer
Risk of mis-selling if terms of offer poorly communicated / not understood
Reputational risk if perceived to be poor value due to expected 10% saving
Risk that cost of exercise could outweigh reduction in liability if take-up
rate is low
Reasonably well answered, but often insufficient points made to gain full marks.
Page 17
EXAMINATION
27 September 2013 (am)

booklet.
supervisor.
sheet.
question paper.

1 The actuarial profession in a developed country has an overall objective of ensuring a
high level of professional expertise, good practice and reliability of advice from its
membership.
(i) (a) Outline approaches that could be followed to achieve the overall
objective of the profession.
(b) Indicate how the approaches might achieve the professions objectives.
[4]
The profession is now considering introducing a mandatory requirement for specified

types of actuarial work to be reviewed by another qualified actuary.
(ii) (a) Outline the advantages of this requirement.
(b) Set out the general areas that the reviewer may consider as part of his
review.
(c) Give two possible examples of pensions work which may be required
to be reviewed.
[3]
[Total 7]
2 An employer currently sponsors a defined benefit pension scheme. The employer has
decided to replace the scheme with a hybrid pension scheme. It is considering
adopting one of the following two benefit structures:
a defined contribution scheme with an investment return underpin; or
a defined contribution scheme with no investment return underpin but with pre-
determined factors to be used to convert members funds into a pension at
retirement.
(i) Outline how each of the two hybrid schemes may operate in practice. [6]
(ii) Discuss the issues that the employer should consider for each option. [6]
[Total 12]
ST4 S20132
3 (i) List four distinct types of actuarial valuation that may be carried out for a
defined benefit pension scheme. [2]
(ii) For each of the valuations in part (i):
(a) List the various parties that would be interested in the valuation.
(b) Outline the purpose and key features of the valuation.

[8]
(iii) Describe the issues that the actuary must consider when setting the discount
rate assumption for an actuarial valuation. [3]
[Total 13]
4 The scheme rules of a large final salary pension scheme in a developed country allow
members to take a number of options.
(i) (a) Outline the general principles that should be considered in setting the
terms:
to allow members to take early and late retirement; and

to exchange some of their pension for cash at retirement.
(b) Comment on how frequently the terms should be reviewed.

[6]
The scheme also has a defined contribution additional voluntary contribution (AVC)
facility.
(ii) Discuss the potential ways in which the scheme may convert members AVC
funds to pensions at retirement. [3]
The scheme currently uses sex-specific factors for the early and late retirement and
cash commutation options. Following an amendment to legislation, the countrys
government has ruled that pension schemes are no longer permitted to use factors
which differ for men and women.
(iii) Discuss the implications of this ruling for the scheme. [3]
[Total 12]

5 The sponsoring employer of a final salary pension scheme is a large company with an
overseas parent. The scheme is managed by a board of Trustees. Only a small
proportion of the total workforce are members of this pension scheme.
(i) Outline the information that the Trustees may use to determine the strength of
the employer covenant, considering the following areas:
balance sheet financial strength

profitability
cash flow
size and funded status of the pension scheme
[8]
The trustees are currently deciding whether they should appoint an external adviser to
assess the employer covenant or make the covenant assessment themselves.
(ii) Outline the issues that the trustees should consider in deciding when making
their decision. [4]
[Total 12]
6 A large defined benefit pension scheme has recently had a number of members of the
sponsors senior management team appointed as trustees of the scheme. The schemes
global pension advisers have suggested that a trustee sub-committee be established to
work closely with the employer to oversee a risk management framework.
The majority of the schemes liabilities are in respect of its current pensioners. The
majority of the schemes assets are invested in equities. The scheme currently has an
in-house pensions administration team.
The sub-committee will be responsible for implementing a framework to reduce the

incidence and impact of risks that could affect the pension scheme. The sub-
committee will work closely with the sponsoring employer.
(i) Set out the high level stages of the process that the sub-committee might
follow, with reference to the actuarial control cycle. [4]
The sub-committee has decided to look at the following areas:
Trustee knowledge and understanding

Scheme advisers
Conflicts of interest
Record keeping
Employer covenant
Investments
(ii) Suggest how the key risks under each of the areas above may be controlled or
reduced. [12]
(iii) Outline the regular procedures that the sub-committee should put in place as
part of its risk management framework. [6]
[Total 22]
ST4 S20134
7 A company with a large multinational parent is in the process of replacing its current
defined benefit scheme with a defined contribution (DC) pension scheme. The local
pensions manager has asked the actuary advising the scheme for a report outlining the
key features of a good quality DC scheme and the risks associated with DC schemes.
(i) Outline the points that the actuary should make under the following headings:
ensuring the DC scheme is fair and offers good value for members
governance
the duties of the parties running the scheme
administration
communication to members
[11]
(ii) Set out the key benefit design considerations that the company will need to
make in respect of the DC pension scheme. [11]
[Total 22]
END OF PAPER
ST4 S20135
EXAMINERS REPORT
September 2013 Examinations

Introduction
D C Bowie
January 2014

The overall standard of scripts was broadly as expected, and this was reflected in a similar
pass rate to the norm. The marks for all questions were broadly similar, with no questions
standing out as particularly hard or straightforward compared to expectations. More detailed
feedback is provided on each question below.
Page 2
1 (i) Expertise Examination, CPD

Good Practice professional guidance (ethical / technical)
Reliability of advice compliance checklist, supervision
Aims
Sets a minimum level of competence, interpretation of relevant legislation,

adapting to changing circumstances, adherence to integrity, competence and
care, impartiality (e.g. Actuaries code), disciplinary process
(ii) (a) Advantages
Focuses on significant pieces of work

Ensures compliance with relevant legal and regulatory requirements
Ensures consistent approach
Identifies any material inaccuracies or inconsistencies
Identifies any suspected non compliance with broad aims of profession
Should provide a minimum level of competence / consistency
Promotes professionalism
Easy to document and monitor
(b) Check on appropriateness and reliability of actuarial methods and

assumptions used
Technical skills, ethics and professionalism
Understandable to end user / appropriate communication / users can
have confidence in the informations relevance, transparency of
assumptions, completeness and comprehensibility
Check any potential conflicts of interest
Consider any limitations / potential danger areas
(c) Report on scheme funding

Report on member options
Accounting for pension benefits
Any other sensible and distinct suggestion
This was a relatively straightforward bookwork question, and was answered as expected. It is
important for candidates to ensure in such questions that their answers are wholly relevant to
the question, and not to fall into the trap of simply reiterating lists.
2 (i) General points
Members and employer contribute into individual investment funds

The member may have the choice of a number of investment funds
DC with investment underpin
If the total return of the funds is below a specified amount then the funds are
topped up by the employer
Page 3
This could be done at the members retirement (or on leaving the scheme, if
earlier) or on an annual basis
The specified minimum may be linked to an investment index e.g. yield on
government bonds
Or be an absolute amount e.g. 3% p.a.
Different underpins could be used for different investment funds
The members fund is then used to purchase an annuity at retirement
So the scheme and members share the investment risk pre-retirement.
the extent of investment risk shouldered by the employer being dependent
on the nature of the guarantee
and the members take on post-retirement risks (e.g. cost of pension annuity
or other risks if alternative approaches are taken, e.g. income drawdown)
DC providing an income at retirement using the schemes own conversion

factors
The actual amount of the members fund at retirement is determined by the

contributions paid;
... and the performance of the investment funds
The members individual funds at the members retirement are then converted
into a pension determined by the schemes own conversion factors
rather than buying an annuity from an insurance company
The factors could be fixed or market related
The pensions are then paid from the scheme.
..So the scheme takes on the investment and longevity risks post retirement
..but the member will have taken on the investment risks pre retirement
The employer may consider the pace of funding of the actual cost of the
underpin
(ii) DC underpin
The employers contributions will be affected by the estimated cost of the

investment underpin
This will not be known until the member reaches retirement date/leaves the
scheme
And the cost of the guarantee will be variable over time
The employer could use derivatives to mitigate some of the underlying risk
The format of the underpin may result in members choosing more risky funds
because members know that the employer will make up any shortfall
which will increase the amount/value/cost of the guarantee
The employer could restrict the choice of investment funds accordingly,
e.g. not allowing investment in very risky funds
It may be possible to incorporate the underpin directly into some of the
investment funds
If the investment guarantee is set at a low level it will reduce the potential
overall cost
But may not be valued or even understood by the members
depending on complexity (e.g. fixed 3% p.a. vs index tracking)
guarantee can be applied annually or on an overall basis,
Page 4
the latter being less costly and easier to value/implement with less risk of
selection from members switching funds strategically
DC conversion factors
General points
Costs / legislative compliance

Administration costs need to be allowed for
Understanding of the risk involved
Funding a funding / reserving strategy needs to be put in place
Communication / understandable / demonstrating the value
Practicalities
The factors will vary depending on the amount of dependants pensions

And any pension increases in payment
Need to regularly review conversion factors
..in particular consider market-related factors
The employer retains the longevity risk in retirement
So not protected against unexpected improvements in life expectancy
But will gain if members die soon after retirement
The employer also retains the post retirement investment risk
But can invest accordingly to minimise this risk i.e. matched to annuity
payments
Selection effects e.g. those in ill health may opt to transfer to secure a better
annuity rate elsewhere
This question was generally well answered in the first half, with better candidates drawing
out more relevant points in the later part. Again it is important to ensure that answers are
relevant to the actual question asked. It is also important to consider the split of the questions
and to offer proportionate weight to the different parts of the question to maximise
opportunities to obtain credit
3 (i) On-going funding valuation
Solvency / discontinuance valuation

Best estimate valuation
Accounting or Regulators valuation
Self sufficiency / risk free real returns valuation
Transfer Value basis valuation
A statutory valuation basis
Page 5
(ii) Funding valuation
(a) members / trustees / employer / regulator

(b) to determine on going funding level and future contribution
requirement
assumes scheme is on-going

and supported by the employer over the long term
uses prudent valuation assumptions
allowing for assessed strength of the employer covenant
Solvency
(a) members / trustees / employer / insurance company/ Regulator

(b) assesses the cost of securing liabilities with an insurance company
valuation assumptions are very prudent

mirroring the terms offered by insurers
assumes the scheme will no longer be supported by the employer
Best estimate
(a) trustees / employer

(b) provides a realistic cost of future benefits
uses the expected outcome for each of the valuation assumptions

i.e. with prudence margin removed
Accounting
(a) employer / shareholders / potential investors

(b) provides a realistic value of liabilities
in accordance with any prescribed accounting regulations

uses best estimate / prescribed assumptions
Subject to short term fluctuations in disclosed results
Self Sufficiency
(a) members / trustees

(b) purpose is similar to buy-out
but assumes scheme is still ongoing though will not be supported by the
employer
uses prudent assumptions
but excludes insurance company profit margins etc.
assumes government bonds are held as safe investments
Page 6
(iii) The choice of the discount rate is dependent on the purpose and objective of
the valuation
E.g. to provide the cost of a benefit augmentation or to provide a long term
estimate of funding (the contribution rate)
The valuation method will also determine the choice of the discount rate
It is important to ensure that the the assets and liabilities are valued in a
consistent way
The discount rate may be fixed by the market or regulation or prescribed
The form / structure of the discount rates may differ
For example split discount rates, use of yield curves etc
The consistency of the discount rate over time should also be considered
Those candidates who approached this question in a methodical way scored by far best.
Where a question can be broken into easily managed bitesize chinks the ability to meet the
requirements of the marking schedule is made much more straightforward. Some candidates
clearly understood the different approaches, but by answering without structure failed to
obtain the marks available.
4 (i) General principles
Consider any requirements in the scheme rules

E.g. who has the power to set the factors
and / or any legislative requirements / practice
Consider if the factors are to be actuarially neutral
and on what valuation basis
If not actuarial profits / losses may result
The significance / materiality of these should be considered
For example early retirement terms may be generous as part of redundancy
programmes etc.
Some options may be encouraged / discouraged
Consider the reasons why this may be the case
Need to consider the fairness between those that take the options and those
that dont
Could consider adopting the same or different terms for active and deferred
members
Investment and longevity risk is impacted by the take up rate of the option
E.g. Cash commutation at retirement removes the longevity and investment
risk for this part of the benefit.
Need to consider what allowance if any would be made for discretionary
benefits / increases
Consider any potential selection against the scheme
E.g. commutation when the member is in ill health
Communication of factors and any change to members
Consider member expectations
Should the funding position be allowed for e.g. cash commutation reduced if
scheme poorly funded
Should sex dependent or unisex factors be used
Theoretically calculated factors may be smoothed for practical purposes
Administrative considerations e.g. ease of calculation, cost of calculation
Page 7
Are factors to be market related or fixed

Market practice what are other similar schemes doing
Frequency of review
Factors are usually changed infrequently

If they are robust they can be used for a reasonable period of time without
change (e.g. a few years)
Depending on whether they are fixed or market related
This allows for member retirement planning
However, the factors need to be reviewed periodically to see if they continue
to meet the objectives
For example they do not create a funding strain for the scheme.
Often the review follows an actuarial valuation
(ii) Pensions (annuities) may be purchased from an insurance company

However minimum purchase prices may apply
And /or poor terms are quoted for small benefits
The inclusion of a profit margin means the annuities will be more expensive
Purchasing the annuity is transferring the risk from the scheme to the
Insurance Company
There will be more flexibility for the member as they can choose the shape of
the benefits
Or pensions paid through the scheme

With the scheme setting appropriate terms / assumptions
These may eventually turn out to be too generous or too pessimistic
With a cost / gain to the scheme
Or through an income drawdown facility

With the funds remaining invested and the member withdraws an amount each
year
There will be a risk of running out of money
The costs of administering this arrangement may be significant
(iii) The scheme will need to revise its factors as they are currently sex-specific
Could use unisex factors that reflect the schemes membership profile
If the split is based on the split of liabilities then on average the impact would
be broadly neutral on the scheme funding basis
But the actual take up rates of options cannot be predicted accurately
Could use factors which result in the lower/higher of the male or female
benefit being provided
This implies adopting male/female life expectancy in setting commutation
factors for example
This may increase / decrease take-up rates of the options

Consider possible selection risk
Need to consider the administrative requirements of the change
Communication with members
Page 8
This question required somewhat more application of the basic points and those candidates
who were able to demonstrate a little more depth of thought were able to score better.
Candidates should clearly review the instructions in the question (i.e. list, describe, discuss
etc.) to help them assess the level of detail and higher skills application required to obtain the
marks available.
5 (i) Definition of employer covenant e.g. the ability of the employer to support
the pension scheme
Balance Sheet
From statutory accounts

And management accounts if appropriate
Analysis of current capital structure
Level of liquid assets
Level of tangible assets / value of assets in distress
Level of free reserves
To assess coverage of any pension deficit
And whether the employer could cover the buyouts deficit in the event of wind
up
Amount of borrowings
Including secured and unsecured creditors / rating of the debt
Management presentations / views
Trends how has it changed over time
Publicly available information
Such as broker briefings, press reports etc.
Reports from external credit advisory specialists
Confirmation of compliance with banking and other creditor covenants
Benchmark analysis against other employers/schemes in a similar position
Profitability
Current declared profits

Before and after tax
And projections of future profits
Including future business plans
To determine ability to pay current and future deficit recovery contributions
Cashflow
The amount of cash the business generates (EBITDA)

Projections needed to assess the ability to make future deficit contribution
payments
And to determine what contributions the employers cash flow can support
and how this might change in difficult trading conditions
Interest payable as proportion of cash flow (interest cover)
Page 9
Size and funded status of the scheme
The materiality of the covenant will be influenced by the funding status and
size of any deficit relative the Companys free assets
The company is large and the pension scheme is relatively small so there
should be sufficient security for any potential buyout deficit
But this will depend on the size of the deficit on different valuation bases
A well funded scheme would require minimum reliance on the sponsor
Only a small proportion of the workforce is in the scheme so its financial
importance to a large company should diminish over time
The legal responsibility for the overseas parent to support the pension scheme
is an important consideration
(ii) Financial skills of the trustee board

Objectivity of the trustees i.e. not conflicted
Time resource for trustees to make the covenant assessment
Understanding of the key factors that affect the employers financial position
And understanding of the information that predicts future changes to company
performance
Understanding of the group structure of the employer
And the legal obligation of the overseas parent
The materiality of the covenant assessment / degree of importance
For example, how well funded is the scheme?
Cost of using an external covenant adviser
External adviser might help with robust negotiations with the employer
Any legal requirements to have an external adviser
Openness of the employer in sharing their financial position
This is a relatively straightforward question on a regularly examined subject. It is critical,

however, that candidates answer the question asked and not a similar one they have
encountered before.
6 (i) Specify problem

Develop solution
Monitoring experience
Professionalism
Economic / commercial environment
Set Objective
Identify risks
Assess risks
Produce / implement action plan
Monitor and review
Repeat process
(ii) Knowledge and understanding
Do the new Trustees have the required knowledge

E.g. schemes legal documents, knowledge of funding, investment etc
Page 10
Trustees should regularly assess skill base

And determine any knowledge gaps
and undertake regular training
Assess overall effectiveness
Personally and collectively
Take professional advice (e.g. Independent Trustee) / delegate as appropriate
Scheme advisers
Risk of bad advice

Appropriate process for appointment of advisers
And evaluating quality of advice
Conflict of Interest
Are the global advisers working for company & trustees
Potential conflicts involved for the senior manages appointed as trustees
Ensure variety of members on trustee board, e.g. minimum proportion of
MNTs
Develop a conflicts policy
Actively manage known conflicts
and potential conflicts
Including those of advisers
Record keeping
Do the In house admin team having sufficient resource / up to date skills &
knowledge
Controls in place to ensure member records are present and correct
Checking / auditing
Accurate and securely stored
Controls to ensure prevention of scheme funds being misappropriated
Employer covenant
Ongoing assessment of the strength of the employers covenant
Consider independent assessment especially if board members are trustees
Have controls to identify events that may impact on it
Measures to reduce risk e.g. Company guarantees etc.
Investment
Ensure security and safe custody of assets
Moving to a better match of assets and liabilities
i.e. size of equity holding compared to pensioner liability
and impact of market volatility on funding & security
Regularly review investment performance
And review long term asset allocation
Review liquidity issues
(iii) Risk register

Including assessment of risks on impact and likelihood
Conflicts policy
Training logs of knowledge and understanding
Page 11
Planned strategy / Action plan to have responsibilities and timescales

Regular monitoring and review process in place covering
Investment issues (safe custody and security)
Record keeping,
Regular dialogue with employer

Agree joint objectives with employer
Disclosure to members
Seeking advice as appropriate
Regular review of covenant
This was a straightforward question and well prepared candidates scored well.
7 (i) Fairness & value for money
Costs & charges are transparent

And communicated at point of selection to the employee
To allow value for money comparisons to be made
Expenses minimised
Age related benefits offered
Impact on members of sponsors business / commercial risks are minimised
Flexible contribution and benefit structures are offered
...which are expected to provide an adequate level of benefit at retirement
A process is provided to maximise members income at retirement (e.g. finding
suitable annuity providers)
Comparison with the former DB Scheme
Governance
Trust v Contract considerations

Sufficient time and resources are available for maintaining the on-going
governance of the scheme
The importance of providing accurate information on a timely basis to
advisers and service providers is understood and carried out
Accountability of all the elements of running the scheme are identified,
documented and understood
Procedures & controls are in place to ensure the effectiveness and
performance of services offered by scheme advisers & service providers
Internal controls are in place to mitigate operational, financial,
regulatory and compliance risks
Regular review of investment options
Availability of investment funds
Ensuring assets are invested in appropriate vehicles e.g. with regulated
investment managers
People
The people running the scheme understand their duties

The duties include governance, Investment, communication etc.
Page 12
And are fit and proper persons

And act in the best interests of all beneficiaries
Any potential conflicts of interests and recorded and managed
Administration
All member data is complete and accurate

An audit process is in place
All transactions are processed promptly and accurately
A complaints procedure is in place
Disaster recovery systems are in place
Communication to members
Members are educated on how DC pension schemes operate

Including an understanding of the relevant DC risks
And the requirement to purchase an annuity at retirement
All costs and charges to members are disclosed at least annually
Members levels of contributions are regularly communicated
Regular benefit projections provided to members
Scheme communication is accurate, clear, timely and understandable
There is regular communication from date of joining to retirement
The risk profile of Investment options must be communicated
Members are encouraged to regularly review investment choices
(ii) Comparison with any existing companys global pension provision

Any potential economies of scale savings using existing global pensions
provision
E.g. existing fund managers
Comparison of DC offered by competitors
Analysis of reasons for switch from DB to DC influencing future design

E.g. cost savings, risk mitigation
Consistency with overall benefits package offered
And possible HR / employment issues with the change / member appreciation
Any legal / regulatory restrictions / considerations
Eligibility
E.g. all members to be offered access to scheme, a waiting period etc.

Payment of initial and ongoing running costs
Including governance costs, professional adviser fees etc.
Contract based or occupational schemes
Existing and future employee profiles
E.g. existing employees, new hires, seniority etc.
Investment options
Range of investment options to be offered

And frequency of review of the options
Page 13
Default investment options

Lifestyling options towards retirement
Contribution Rates / benefits to be provided
Level of member contributions / employer contributions

With different scales for executives for example
Flat contribution rates or company matching
Contributions to be based on basic salary or total remuneration
Benefit Options
Annuity purchase at retirement or pension purchased through the scheme

Member communication interface e.g. web based
Income drawdown
Cash v pension
Integration with State benefits
Risk benefits e.g. death in service cover

Use of insurance to cover the risk benefits
Well prepared candidates who broke the question down well, heeding the instruction of each
question, could score well here. Again, a structured relevant answer is very important to be
able to score against the schedule.
Page 14
EXAMINATION
2 May 2014 (am)

booklet.
supervisor.
5. Attempt all six questions, beginning your answer to each question on a new page.
question paper.

1 An insurance company provides annuity contracts to defined benefit pension schemes
in respect of current pensioners. In return for a one-off premium, the insurer makes
regular payments to the scheme, equal to the pensions payable to members covered by
the contract and their dependants.
(i) Set out the advantages and disadvantages to the sponsor of a defined benefit
pension scheme of purchasing an annuity contract covering all its pensioners.
[5]
The insurer has recently introduced a medical underwriting option. Where a scheme
has chosen to take up this option, the insurer will assess individual members
expected longevity and adjust the premiums charged, based on insured individuals
medical histories and lifestyle indicators (such as smoking and exercise). Schemes
can still choose for the premium to be calculated without medical underwriting.
(ii) List the other factors, in addition to medical history and lifestyle indicators,
that the insurer might take into consideration in assessing an individual
members life expectancy. [3]
(iii) Discuss whether the sponsor of a pension scheme might want to take
advantage of the medical underwriting option. [7]
[Total 15]
2 The Trustees of a defined benefit pension scheme are currently reviewing the
Schemes investment strategy. The Scheme remains open to benefit accrual. The
Scheme Sponsor has proposed that the Trustees switch a significant proportion of the
assets from bonds to equities.
(i) Outline the investment characteristics of bonds compared with equities. [5]
(ii) Explain the possible impact of the proposed switch to equities on members
benefits. [3]
(iii) Outline the factors the Trustees should take into account in setting an
investment strategy. [5]
[Total 13]
ST4 A20142
3 The Trustees of a defined benefit pension scheme have decided to review the factors
used for the various options available to members within the scheme.
(i) List the main options that are likely to be available to members within the
scheme. [2]
(ii) Set out the general approach to setting assumptions to calculate the factors for
the options. [4]
An active member of the scheme is approaching normal retirement age, but is also
very ill and not expected to live for more than a year. He has asked the Trustees what
his options might be so that he can provide for his spouse after his death.
(iii) Set out the benefits and options that might be available to the member. [9]
[Total 15]
4 As part of the funding valuation, the Trustees of a defined benefit pension scheme
have decided to obtain an assessment of the strength of the sponsoring employers
covenant.
(i) Outline why the assessment of the employer covenant is important. [2]
(ii) Explain when is it not necessary to assess the covenant. [3]
The assessment has shown that the employers covenant has improved since the
previous funding valuation and is now very strong.
(iii) Explain how the improved covenant might affect the financing of the scheme,
including the current funding valuation. [7]
[Total 12]
5 The government of a developed country is proposing to require employees who are

not currently members of an occupational pension scheme and their employers to
contribute to a defined contribution (DC) pension arrangement that meets the
governments criteria.
(i) Suggest why the government might be planning to introduce this measure.
[3]
(ii) Outline the factors that the government might consider in setting the minimum
level of contributions that must be made under its proposal. [10]
(iii) Discuss the difficulties the government may face in implementing its proposal.
[6]
(iv) Suggest how the difficulties that you identified in part (iii) may be overcome.
[3]
[Total 22]


6 A Company is considering setting up a pension scheme for its employees and wants to
make sure that the administrative burden is minimised.
(i) Set out the possible eligibility criteria that the Company could impose. [2]
The Company wishes to set up a defined benefit pension scheme but wants to make
sure that costs are affordable and predictable.
(ii) Suggest how a scheme could be designed so that the Company can achieve its
aim. In your answer you should consider the key features of a defined benefit
scheme. [14]
The company has decided to provide benefits based on final pensionable salary with
the following design:
Normal Retirement Age of 65

accrual rate of 1/60th of pensionable salary for each year of service
no pension increases in payment
cap of 45,000 on pensionable salary
The Standard Contribution Rate (SCR) using the Projected Unit Age Method for a
member age 40 is 25%, which includes an assumption of 3% for increases to
pensionable salaries, and ignores the cap.
(iii) Calculate the SCR, allowing for the cap on pensionable salary, for a member
age 40 whose current pensionable salary is:
(a) 45,000
(b) 30,000
(c) 20,000
You should show your workings and state any other assumptions that you
make. [7]
[Total 23]
END OF PAPER
ST4 A20144
EXAMINERS REPORT

Introduction
D C Bowie
July 2014

Good candidates demonstrate that they have used the planning time well - an attempt to get a
enables candidates to use the later 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 later parts).
Time management is important so that candidates give answers to all questions
The overall standard of scripts was broadly as expected, and this was reflected in a very
similar pass rate to the previous sitting.
There was significant variation in marks that enabled a clear distinction between those
candidates worthy of a pass and those who needed more depth to their knowledge 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.
Page 2
1 (i) Advantages
The sponsor of a defined benefit scheme is exposed to a number of risks
If experience is poorer than expected the cost of the scheme to the sponsor
will rise
And its accounts will be impacted
If the scheme insures all its pensioners, then all the risk relating to them
will be passed to the insurer
i.e. longevity risk
investment risk
and inflation risk (if applicable)
The volatility of the scheme as a whole will be reduced
May be insuring pensioners only as they are typically less expensive to
insurer than non-pensioners
Disadvantages
The upside risks are passed to the insurer
The purchase price has to cover insurance company expenses and a
contribution to its profit
There is an immediate liquidity constraint when buying the annuity
Dealing with issues such as future addition of discretionary pension
increases becomes complicated
The scheme is still subject to volatility arising from the non-pensioners
The scheme is subject to the risk of the insurer defaulting
The solvency of the scheme might reduce placing increased reliance on the
employer covenant
(ii)
The individuals sex
The individuals postcode/address
The individuals size of benefit
Industry the scheme operates within
The individuals occupation or socio-economic group
The individuals year of birth
The mortality experience observed in the insurers population
Mortality experience observed in the countrys population
Expectations for trends in future mortality
Pension size/earnings
(iii)
The sponsor will aim to keep costs low and will therefore be more likely to
select underwriting if it thinks it will lead to a lower premium [1]
This may be the case if a significant number of members have a lower life
expectancy than the insurer would expect without underwriting
For instance if they have poor medical history
Or a less healthy lifestyle
But to what extent are they already reflected into the insurers assumptions
by looking at other factors
such as occupation and postcode analysis?
Page 3
The extent to which the sponsor is familiar with members health is likely
to depend on the size of the membership
And only the sponsor of a very small scheme may have enough
knowledge of its members to have a view on their health
But a scheme with a few individuals with high liabilities and lower life
expectancy may be a suitable candidate
as the sponsor is more likely to be familiar with the state of health of an
ex-director for instance
and insuring them would remove a significant element of risk from the
scheme
If it approaches an insurer offering medical underwriting but does not opt
for it, will the insurer assume that members have a longer life expectancy
than average?
and charge a higher premium
There may be practical difficulties in arranging medical underwriting
and encouraging members to respond
The cost of underwriting large groups of members may be expensive
how will this affect the premium
It may not be the sponsors decision (may be the trustees)
And in any case should take in to account trustee views on the potential
member reaction.
This question was generally quite well answered, although the answers to part (iii) showed
significantly more variation. Those who scored well were able to cover sufficient breadth in
part (iii) to score well. Many candidates who did less well tended to go into too much detail
on one aspect of the answer without covering sufficient breadth, therefore limiting their scope
to score marks.
2 (i) Bonds
Government-backed bonds have low default risk
The default risk of company-issued bonds varies depending on rating of
the company
Income is fixed in monetary terms
or in real terms (e.g. index linked)
Defined levels of capital redemption on defined dates
High volatility in real terms (if fixed in monetary terms)
Bonds usually have a lower default risk than equities
Lower dealing cost
Lower expected return
Can be liquidity issues for company stock
Equities
Less certainty about the levels of income
Income (dividends) depends on the profitability of the relevant company
Do not provide any capital redemption proceeds
Capital can only be redeemed by sale on the open market
Market values of equities are generally more volatile than bonds
Page 4
Lower running yield than bonds
(ii)
The benefits are defined therefore benefits payable should be unchanged
But there may be reduced security of accrued benefits as returns will be
less certain
If equity returns are poor the sponsor may have to pay increased
contributions in the short term and benefit security will be impacted if the
employer defaults
But over the long term equity returns would be expected to be higher than
bond returns
So the scheme will be less costly to the sponsor
And it may be more likely to allow benefit accrual to continue
And job security may be increased for active members
Increased chance of discretionary benefits if returns are good
(iii)
The investment strategy should have regard to the liabilities of the scheme
o Nature of liabilities (fixed or index linked)
o Duration of the liabilities
o Currency
in order to reduce mismatch risks
and incorporate an appropriate level of diversification
The current funding position
Size of the fund and whether it is likely to increase or decrease
The expected cashflows of the schemed the sponsor
Likely changes to the liability profile in the short, medium or long term
Consider an ALM study
Attitude to risk of the trustees

and the scheme sponsor
and the impact on the employer s future contribution rate
Strength of sponsor covenant
Legislative constraints and guidelines
Liquidity and marketability considerations
Costs (of transition and ongoing)
Need to involve the employer (e.g. consult or obtain consent)
Adequacy of trustee governance arrangements to implement and monitor
new strategy
This question was relatively straightforward for well prepared candidates. Once again, in
part (iii) the better candidates were able to demonstrate breadth to their answers.
Page 5
3 (i) Transfer vales

Early retirement
Late retirement
Commutation
Additional spouses pension
(ii) General principle is that costs should not be significantly different

However, administrative simplicity is likely to be a consideration
So assumptions may not reflect individual circumstances (e.g. marital status)
And factors are often smoothed
Factors can be adjusted for current market conditions
Assumptions can be amended to reflect concerns about selection risk
Or to seek to improve the take up rate of the option
Discretionary benefits may or may not be considered
Assumptions used could be either realistic or prudent
[Additional point for a good example of the impact of using realistic or
prudent assumptions]
(iii) If the member is likely to die before retirement date then could either
Stay in employment and receive death in service benefits
These are likely to be a lump sum multiple of salary
Plus a spouses pension based on service to retirement date
Or the member could take an ill-health early retirement

Which could possibly be enhanced to take account of service to NRA
On retirement member could take a tax-free lump sum
Which would not affect spouses pension
So spouses pension would be very similar to death in service
On death would also receive balance of any guarantee for members pensions
This is usually 5 years but could be as long as ten
If likely to survive past retirement could work until then (if capable)
The retire normally receiving similar benefits to ill-health retirement above
There is an option to swap members pension for additional spouses pension
However, this could be at the Trustees discretion and they may not allow it
Or set terms based on members ill health so not worth it
The member might be forced to leave service with correspondingly lower

death benefits
Although he/she could always take a transfer value
And use it to buy a pension with much higher spouses pension
Or pass it on as a lump sum as part of the death benefits payable from a
personal pension scheme
This was relatively well answered. The best marks were secured by those who broke their
answer down in part (iii) to show different scenarios and gave proportionate depth on each
of these scenarios.
Page 6
4 (i) Shows the ability and willingness of the sponsor to pay sufficient
contributions to ensure the benefits can be paid as they fall due
Used to determine the key assumption and the level of required prudence
And the investment strategy
And general risk tolerance level
Affordability of future deficit funding plans
Can be used as part of a process to obtain contingent asset protection
(ii) The sponsors covenant is not an important issue if it is certain that the
sponsor will not default (e.g. some State sponsored schemes) or
the scheme is so well funded that no further contributions are required from
the sponsor or
the sponsor covenant is so weak as to be deemed nil or
the sponsor has no further liability to make contributions under the rules of the
scheme
(iii) Valuation
Assumptions
If previous valuation had allowed for the sponsor covenant by adjusting the
discount rate
then any reduction in rate could be reduced, or removed
(or possibly increased e.g. to target self-sufficiency/buy-out)
to take account of the strong covenant
the actuary could suggest the level of change based on the change in
probability of default
Deficit payments
A longer payment period could be acceptable
Resulting in smaller payments
Although if strong employer then they should be able to afford to pay more
And quicker
Investment
If company can support scheme then can move into riskier return seeking
assets
e.g. move from bonds into equities
This could have a knock-on effect onto valuation assumptions
As higher return could be allowed for
Reducing deficit (if any) and payments required
This was a relatively straightforward question, with well prepared candidates able to score
very well.
Page 7
5 (i)
To improve the prospect of adequate provision for citizens in retirement
Seems likely that currently a significant proportion of the population is
making inadequate provision
To encourage citizens to take ownership of their retirement provision
The government may believe that providing incentives to save for
retirement is not sufficient
Perhaps employers did not see any benefit in providing pensions
And citizens did not see their value
To reduce the reliance of citizens on the state to provide for them in
retirement
Under the proposal, employers and employees will instead meet the cost
The governments criteria will be in place to ensure that the DC
arrangements are adequate to meet the aims of the measure
such as providing adequate protection of individuals funds
Investment in pension funds could help drive economic growth
(ii)
Firstly the government will need to decide what level of benefit the
scheme should provide
Is it intended to entirely meet an individuals income needs in retirement?
Or to top up state benefits?
What age can individuals be expected to retire at?
Will dependants benefits need to be purchased?
Will the pensions need to increase in retirement?
Will any ill health
or death before retirement benefits be covered?
Will they be age dependent?
Or sex-specific or unisex?
Whether there is a requirement to buy an annuity
And if so, the expected cost of buying an annuity at retirement, which will
depend on future inflation and mortality rates
The more expensive this is the higher contributions will need to be
The types of investments available to members
And the expected return on the invested assets
The lower they are the higher contributions will need to be
Administration costs
The government should take into account the level of contributions made
by employers and employees who do currently have pension provision
And in other countries with similar schemes
And consider if these are adequate
What can employees and employers reasonably afford
Taking into account existing tax burdens
And the state of the economy
Contributions that are too high will be politically unpopular
Consider if they should be introduced at a low level and gradually
increased
Will a maximum level of contributions be set as well as a maximum
Page 8
The split between employer and employee contributions

Will the state offer any top-up or tax incentive?
Will the contributions be a fixed amount or a percentage of pay?
Whether any members should be exempt
(iii)
It may be unpopular with citizens of the country
and employers
Who may not understand the scheme and eg view the contributions as an
additional tax
Which may result in lost votes for the party in power
This may will especially be the case where citizens do not see the value in
pension provision
Employers may be unable to afford the contributions

Or the cost of administering a scheme
Which may put businesses under a strain
And possibly result in job losses or insolvency
Employees may be unable to afford the contributions

Which may leave them reliant on other state benefits
This will be particularly relevant to less wealthy individuals
There may not be sufficient suitable DC arrangements available

It would be disproportionately expensive for smaller employers to set up
their own DC schemes
Regulations will need to be introduced which might be complex

Together with an approach to enforcing compliance
(iv) Unpopular
Education and communication about why saving for retirement is
important
Education about what will happen to the contributions (i.e. not go into
general tax revenue)
Employers may be unable to afford

Tax breaks for employers on contributions
Enable administration costs to be met out of members funds
Employees may be unable to afford

Tax breaks for employees on contributions
Provide an exemption for the lowest paid workers
Who may qualify for state benefits at retirement
Phase in higher contributions over time
Page 9
There may not be sufficient suitable DC arrangements available

Provide a state-run DC arrangement so employers dont need to establish
their own
Encourage private provision of DC funds by financial institutions, perhaps
by tax incentives
Regulation and enforcement

Take a consistent approach to current tax based regulation
Introduce a regulator to enforce the new arrangements
This question had a wide variation in marks. Many candidates approached the answers
without any clear structure making it hard to identify separate ideas and therefore hard to
mark. By using a structured approach to the answer, it was relatively straightforward to
generate ideas and therefore score well. In part (ii) in particular, a breadth of ideas was
needed to score well and only the better candidates were able to do this. This question is a
very good example of one where candidates who took good notice of the number of marks
available for each section were able to score well by focusing their efforts on the areas where
marks were available.
6 (i) A minimum and maximum age limit on joining the scheme

A minimum service period to be served before joining
The pension scheme can be offered only to those types of workers that
company wishes to reward
The pension scheme could be offered just to full-time (not part-time)
employees
Although could be illegal
(ii) A defined benefit scheme will have some or all of the following features:
Fixed amount
Linked to service
Linked to price inflation
Linked to salary at or close to retirement
By their very nature, defined benefit schemes have an inherently uncertain

cost
Provide a benefit based purely on service with no link to salary

Predictable cost
More generous to lower earners
Level of benefit could be set to keep costs low
and adjusted in future to keep costs stable
If employer wants to provide final salary scheme then
Accrual rate a lower accrual rate will have lower costs
Salary linkage if based on final salary could impose a cap

The cap could be fixed
Or go up each year in line with an index
Page 10
Or just when funding allows

Have a maximum salary increase each year
Alternatively could be based on average salary over service period
Which is more predictable than a final salary scheme
Possibly revalued up to retirement in line with inflation
Leading to a less controllable cost
Pension increase no increases in retirement is cheapest and most predictable

If legislation allows this
Alternatively minimum statutory
Similarly for members that leave service again depending on legislation
Possibly have discretionary increases if funding allows it
Other benefits just provide members pension

No spouses pension
Or death in service benefits
However these are quite cheap, easy to insure and are valued by members
Members could have high contribution rate and employer pays balance
Alternatively cost could be split between employer and members
So if costs go up then members pay more
Introduce eligibility criteria

Ensure that options are priced on a cost neutral basis (or to make a profit)
Adopt a high retirement age
Simple benefit structure will keep administration costs low
Adopt a design where matching assets are readily available

Or it is easy to insure
Incorporate a process to reduce benefits if the scheme is not fully funded
Ensure the design is tax efficient
(iii) Assumptions contributions based on capped salary

Member remains in service until retirement
Cap remains at 45,000
Control period of 1 year
(a) Effectively assuming no increase in future salary

So would reduce SCR by factor of 1.0325 = 2.094
Gets SCR of 11.9%
(b) Either
Assume average salary increase over 25 years to get to cap is 1.635%
Then SCR reduced by (1.01635/1.03)26 = 0.716
Gets 25% 0.716 = 17.9%
Or
Page 11
Just need 13.75 years of 3% increases to get to cap

The SCR reduced by 1.03 (2513.75)
Gets 17.9%
(c) 20,000 1.0325 = 41,875

so never reaches cap
Therefore SCR is 25%
This question shows the typical result for a numerical part candidates either score well or
very badly. It is important to show full working in a numerical question, to enable the
examiners to identify the thought process followed and hence assess the level of
understanding of candidates. In part (ii), candidates needed to cover the full range of ideas
to score well.
Page 12
EXAMINATION
24 September 2014 (am)

booklet.
supervisor.
5. Attempt all seven questions, beginning your answer to each question on a new page.
question paper.

1 The trustees of a large defined benefit (DB) pension scheme are concerned about the
schemes data risks and operational risks. As a result, they have decided to compile a
risk register to formally record, score and control the underlying risks.
(i) Outline four key data risks and four key operational risks that might be
included in the risk register. [8]
(ii) Outline how the actuarial control cycle could be used as part of the proposed
risk register. [2]
[Total 10]
2 The sponsor of a large final salary pension scheme is exploring the possible options
for altering the scheme design for future service to achieve a better sharing of the
risks between the sponsor and the scheme members. The sponsor is considering
introducing either a revalued average earnings Scheme or a cash balance scheme.
(i) Outline the features of a revalued average earnings scheme. [2]
(ii) Describe how a move to a revalued average earnings scheme would affect the
sponsoring employer and the individual members. [7]
(iii) Outline the features of a cash balance scheme. [2]
The sponsor has also considered introducing a defined contribution pension scheme.
(iv) Describe the advantages and disadvantages to the sponsoring employer and
scheme members of introducing a cash balance scheme relative to:
(a) retaining the existing final salary scheme.

(b) introducing a defined contribution scheme.
[6]
[Total 17]
ST4 S20142
3 (i) Outline the implications of the strength of an employer covenant on the
funding and investment strategies for a defined benefit (DB) pension scheme.
[7]
The sponsoring employer of a DB pension scheme has a strong covenant. The scheme
currently has active members accruing future pension benefits. The employer has
been consistently profitable and has good future prospects but operates in a very
competitive business sector. For a number of years it has traded successfully and has
generated cash. This has enabled the employer to pay increasing dividends to its
shareholders. The employer also has a significant amount of wholly owned property
assets.
The 31 December 2013 actuarial valuation has shown that the scheme has
experienced a very large increase in its funding deficit since the 31 December 2010
actuarial valuation. The key reasons are a significant fall in interest rates and little
improvement in the value of the schemes assets. At the 31 December 2010 actuarial
valuation a relatively low contribution level was agreed between the employer and the
trustees because the employer planned to invest in its own business to further improve
the covenant.
(ii) Discuss the options that the trustees of the scheme and the employer could
consider to address the increase in the deficit. [7]
[Total 14]
4 A medium sized employer is considering setting up a defined contribution (DC)

pension scheme.
(i) Outline the key benefit design considerations the employer should take into
account before setting up the scheme. [4]
The employer has asked its advisers to produce a short report on the proposed DC
pension scheme covering:
the governance framework.

the investment strategy.
the monitoring requirements.
(ii) Set out the key points that the report should cover. [8]
(iii) Outline why in practice a very large DC pension scheme may have a more
comprehensive governance framework than a small or medium sized DC
scheme. [2]
[Total 14]

5 A company with a large defined benefit (DB) pension scheme has recently undertaken
a number of corporate acquisitions and disposals of different parts of its business.
One of the businesses purchased has a small DB pension scheme.
The trustees of the respective DB pension schemes have been asked to consider a
merger of the two schemes.
(i) Outline how the Company could potentially benefit as a result of merger of the
two schemes. [3]
(ii) Discuss the considerations that need to be taken into account by both sets of
trustees before they can agree to the merger. [8]
(iii) List the various documents that both sets of trustees should analyse as part of
the decision to proceed with the merger. [3]
[Total 14]
ST4 S20144
6 (i) Describe the key features of an Accrued Benefits Funding method. [1]
An actuarial valuation for a defined benefit scheme is about to be undertaken. The

schemes actuary is considering using one of the following funding methods to set the
contribution rate:
Entry Age funding method

Projected Unit funding method
Attained Age funding method
(ii) For each of the funding methods listed above describe:
The Standard Contribution Rate.

The Actuarial Liability.
The key features.
[12]
The schemes actuarial valuation has now been completed and the actuary has
produced the following results:
$ (000s)
Value of benefits for pensioners and deferred pensioners 170
Value of past service benefits for active members allowing for

future salary increases 380
Value of future service benefits for active members allowing for

future salary increases 800
Value of benefits accruing for all members in the year after the
valuation allowing for future salary increases 50
Value of future service benefits for members aged 30 allowing

for future salary increases 24
Value of future contributions by all members 300
Value of contributions by all members in the year after the

valuation date (members contribute at the rate of 5% of salaries) 20
Value of total future contributions for members aged 30

(new members are assumed to enter at age 30 and members
contribute at the rate of 5% of salaries) 10
(iii) Calculate (showing workings), for each of the three funding methods, the
Standard Contribution Rate and the Actuarial Liability. [3]
[Total 16]

7 The trustees of a large defined benefit scheme are about to start a review of the
schemes investment strategy.
(i) Outline the key issues that should be considered under the review. [5]
(ii) Discuss how an asset liability modelling exercise may help to determine an
appropriate investment policy. [5]
The trustees have instructed the schemes actuary to undertake an asset liability
modelling exercise.
(iii) Outline the information that the actuary will need before undertaking the
exercise. [5]
[Total 15]
END OF PAPER
ST4 S20146
EXAMINERS REPORT

Introduction
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
December 2014

Subject SA2 (Life Insurance Specialist Applications) September 2014 Examiners Report
The overall standard of scripts was broadly as expected, with a slightly higher pass rate to the
previous sitting.
There was significant variation in marks, demonstrating quite clearly to the examiners who
were the best prepared candidates who had sufficient depth to their knowledge to be able to
secure a pass. 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.
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
1 (i) Data Risks
Quality & accuracy of data

e.g. Financial & scheme records
Missing data / Gaps in data / out of date data
e.g. missing spouses date of birth
Security of data records
e.g. Storage , access restrictions and data protection
Reliance on third parties / data transmission to third parties
Operational risk
Failed internal processes / people / systems

e.g. ineffective peer review / checking processes
insufficient resourcing levels
lack of appropriate knowledge / experience
admin processes & procedures poorly documented
poor cash management / accounting
lack of effective audit trails
Dominance of a single individual
e.g. dominant chair of trustees
Reliance on third parties
e.g. advisers
Failure of plans to recover from external events
e.g. lack of disaster recovery plans
[8]
(ii)
Set Objectives
e.g. minimising risk
Identify risks
e.g. from a risk register
Use professionalism
To assess risks involved
Produce and implement action plan to remediate risk issues
Monitor and review against the chosen risk objective
[2]
[Total 10]
Relatively straightforward bookwork question and well answered. Important to cover both
aspects in part (i) equally.
Page 3
2 (i)
A scheme in which benefits accrue in relation to an individuals earnings
in a given year
indexed from the year of receipt to the year when the benefits become due
The indexation could be a fixed rate or linked to average price or salary
inflation
This offsets the eroding effect of inflation
Provides a link to career earnings (average rates of pay) rather than final
earnings
[2]
(ii) Employer
Schemes linked to average earnings generally have a lower cost than final
salary schemes
as final salary schemes include allowance for promotional pay increases
This reduces the exposure to the members increasing salary growth
so is useful as part of a risk mitigation plan
for future service only so the risk mitigation will take some time to be
realised
All benefits are increased by the same amount
So this reduces the cross subsidies that occur from some employees
receiving higher pay increases than others
Provides a more targeted scheme to certain groups of employees
e.g. part timers, flexible workers who tend to have a flatter pay progression
More difficult to reward high flyers / executives with higher pay
expectations
Other risks such as investment and mortality are unchanged
The revalued average earnings scheme is more complicated to explain to
members
and involves greater administration complexities (e.g. recording the
indexation each year rather than simple the salary at retirement)
May have adverse impact on recruitment / retention , manpower planning,
industrial relations
Members
Generally less attractive to employees than final salary schemes

However, different groups of employees are affected differently
The losers would be high flyers who receive large pay increases
throughout their careers
Conversely those with low pay increases gain compared to a final salary
scheme
However if the revaluation is based on national average earnings on
average there would be very little difference between the average earnings
scheme and a final salary scheme
If the revaluation is linked to price inflation lower benefits result as
average earnings generally increase faster than prices
Page 4
Average earnings scheme are better suited to part timers and flexible
workers who tend to have a flatter pay progression
More difficult for members to understand
More difficult for members to plan for retirement given the change
[7]
(iii)
A type of hybrid scheme
in which a percentage of salary is set aside each year for each member
The employer undertakes to ensure that the annual contribution will grow
at a specified amount
linked to prevailing interest rates or some other index
At retirement the members minimum accumulated fund will be
determined by the specified minimum rate of growth for each contribution
The accumulated fund value is used to purchase the required form of
benefits when those benefits become due
Cash Plan are similar to DC plans in that they target a lump sum benefit
[2]
(iv) Employer
(a) Relative to Final Salary
Advantages
More stable cost as a proportion of salary

Risk exposure controlled for mortality & post retirement
investment risk
Pre-retirement investment risk reduced
May be easier to explain to members
Disadvantages
A final salary type valuation is still needed

May be difficult to explain to members on early exit
Not as valued by employees as a Defined Benefit scheme might be
(b) Relative to Defined Contribution
Advantages
Employer can vary the pace of funding

Any surpluses are retained by the employer (e.g. on early
retirement)
More attractive to members
Disadvantages
Employer retains pre-retirement risk
Page 5
Higher compliance / admin costs

More volatile cost than defined contribution
Employees
(a) Relative to Final Salary
Advantages
Gives a choice of the shape of benefits at retirement
Disadvantages
Loss of mortality and post retirement investment guarantee

More difficult to understand
Cannot predict / plan for retirement as easily
(b) Relative to Defined Contribution
Advantages
Some pre-retirement investment guarantee
Disadvantages
Less pre-retirement investment choice

[6]
[Total 17]
Again, relatively straightforward and quite well answered. It is important for candidates to
consider the instruction in the question for parts (ii) and (iv) a more detailed answer is
required to meet the describe instruction. Again, need to cover both aspects of the
question in part (iv) to similar levels.
3 (i)
Employer covenant is a measure of the scheme sponsors ability and
willingness to fund the pension scheme
A strong covenant means:
Less prudence is required in the valuation assumptions

A lower funding target
A greater ability to withstand fluctuation in scheme assets & liabilities
so a riskier investment strategy may be followed
e.g. with an equity / growth element in the asset allocation
Generally greater security for members benefits
Greater flexibility on eliminating a funding deficit
An employer can afford to pay more into the scheme
Page 6
Or they may choose to do so to increase security and / or future funding

flexibility
A weak covenant means:
A higher funding target may be adopted

e.g. a solvency funding basis
A more cautious investment strategy may be adopted
With a more matched investment policy
De-risking strategies / buying out liabilities may be considered
Generally less security for members benefits
A longer period may be needed to eliminate a funding deficit
As available cash flow is likely to be limited
Alternative funding or additional security may be needed to guard against
sponsor default
e.g. use of contingent assets
More frequent monitoring of the covenant will be needed
[7]
(ii)
The scheme will require increased employer support
in the form of increased contributions
This should be feasible given the sponsors recent positive generation of
cash
and therefore would achieve a more equal treatment of the scheme relative
to shareholders
who have received increasing dividends
An extension to the current recovery plan may be appropriate
if it is mitigated by the property assets the employer holds
The Trustees may wish the employer to mitigate the downside risks of the
weak investment performance
with planned extra contributions based on pre-determined triggers
or extra contingent assets if the covenant weakens in the future
There should be no weakening of the valuation assumptions
or of the funding target
However if the covenant improves this may be possible
Further analysis of the investment performance / monitoring may be
appropriate
with perhaps greater matching of assets and liabilities going forward
More frequent monitoring of the employer covenant may be needed
perhaps with ratchets in contributions if the employers financial position /
profitability improves
More frequent monitoring of the schemes funding level
with contingent contributions if the funding level deteriorates
Risk reduction strategies e.g. buy-out, reduce benefits etc.
Page 7
Review of scheme design / member options / discretionary practices

[7]
[Total 14]
Relatively well answered in part (ii) better candidates gave a fuller discussion and not just
a list of points without any expansion.
4 (i)
Consider the level of benefits to be provided
subject to any cost constraints
Level of employer contributions
Level of employee contributions
Any employer matching employee contributions
Targeted population e.g. different scales for different parts of the
workforce or categories of membership
Range of investment funds to be offered
Default Investment funds
Employee profile, new hires etc
Death in service benefits
Any payroll constraints
Eligibility requirements
Availability of other benefits e.g. state benefits
Employee needs / expectations
Competitors provision
Tax efficiency
[4]
(ii) Governance framework
A comprehensive scheme governance framework needs to be established

with clear accountabilities and responsibilities
Key personnel (trustees / managers) need to understand their duties
And have sufficient time & resources available to do so
Train trustees
Establish and maintain adequate internal controls to mitigate risks
And ensure the effectiveness and performance offered by scheme advisers
& service providers
Act in the best interests of all beneficiaries
Manage any conflict of interest
Trust or contract based
Investment Strategy
Members will be offered a choice of investment funds

With a variety of risk tolerances
These need to be appropriate to the membership
Page 8
And take account members needs throughout their lifetime with the
scheme
The investment objectives for each investment option should be identified
and documented
The principles governing how decisions about fund selection are made
should also be documented
The potential benefits and risks of each of the funds should be clearly
communicated
Ensure that any default strategy is provided which is suitable for the
members
Monitoring requirements
Investment objectives are documented to allow them to be regularly

monitored
Use documented investment information to monitor fund performance
against the stated investment objectives
and ensure the strategy continues to remain suitable for members
Monitor the on-going suitability of the default investment strategy
Trustees and managers review their skills & competencies
to demonstrate they understand their duties
And are fit and proper to carry them out
Ensure that any delegated responsibilities (e.g. administration) are
documented, understood and reviewed regularly
Monitor Investment manager performance to ensure the funds chosen are
still appropriate
Monitor value for money in terms of conversion of funds to benefits on
retirement
Monitor the performance of the admin function
[8]
(iii) Likely to be related to the following key reasons:
Materiality
e.g. size of the scheme
Proportionality and cost of the governance process
Complexity
Practicalities
e.g. available management / trustee time
Much of the work involved with a governance framework is a fixed cost
as such for large scheme the cost per member may be significantly lower
Some activities such as reviewing the appropriateness of investment
objectives and investment performance may be viewed as a prohibitively
expensive exercise to carry out in a detailed and structured fashion for a
small or medium sized scheme
A very large scheme may have greater access to specialist advisers &
resources to assist them
Page 9
Smaller schemes may have smaller employers hence the availability of

management time might be lower
Economies of scale are greater for a larger scheme (with fixed costs spread
across a larger number of members resulting in a smaller cost per
member)
[2]
[Total 14]
Candidates showed good knowledge in this question, but it is important to have regard to the
number of marks available and to focus on the key points where there may be a longer list of
possible answers as, for example, in part (i).
5 (i)
Cost savings from running 1 scheme rather than 2 schemes
e.g. one set of advisers, one trustee board
Particularly as some of the scheme management overhead cost of running
a DB scheme are not correlated with the size of the scheme
May result in a reduction in management time
e.g. for any funding discussions
Improved governance easier to apply 1 policy than 2
Possible harmonisation of future scheme benefits
Increased investment opportunities for the smaller scheme
Decreased investment costs for the smaller scheme
Only one set of pension accounting disclosures for the company accounts
will be needed
The joint funding position may allow more flexibility for the small scheme
The small scheme may benefit from no longer requiring the use of
insurance
[3]
(ii)
Must act in accordance with the schemes trust deed & rules
The trustees should consider legal and actuarial advice
Need to determine which scheme will transfer into which
Or if a brand new scheme will be set up which is less likely
Trustees need to ensure they act in the best interests of their membership
Need to ensure that the rules of the transferring scheme permit a transfer
and the rules of the receiving scheme permit it to receive one
Past service benefits would need be transferred
This may require member consent
What are the respective funding levels of the 2 schemes
Is the security of benefits for one set of members diminished as a result of
the merger
Trustees should not accept a deterioration in the funding level
A cash injection may be needed to level up the funding positions on
merger
Covenant considerations
Page 10
What future service benefits will be provided by the new merged scheme
Considerations of any past practice of discretionary benefits
Or other member options such as early retirement or commutation
How does the balance of powers in the receiving scheme compare with
that of the transferring scheme
Investment considerations e.g. what assets will be transferred
The views of interested parties e.g. employers
Tax considerations
[8]
(iii)
Trust Deed & Rules for both schemes
Asset statement / trustee report and accounts
Members handbooks
And any recent member communication
Most recent actuarial valuations for both schemes
History of any discretionary increases
Summary of assets and investments
Employer covenant assessments
Details of any special benefit arrangements for individuals
[3]
[Total 14]
This question was less well answered. Better candidates were able to address part (ii) in
some more detail, giving a discussion of the points rather than a simple list without
commentary. To score well in these points, candidates need to demonstrate understanding as
well as knowledge.
6 (i)
The aim of an accrued benefits method is to target a given level of cover of
benefits accrued to date
The Actuarial Liability for members is based on pensionable service
accrued up to the valuation date
or the end of the control period as appropriate
[1]
(ii) Entry Age
SCR
Found by dividing the present value of all future benefits by reference to

projected final earnings for a member entering at a normal age by the
present value of their total earnings throughout their expected future
membership
Page 11
AL
Found by deducting from the present value of total benefits on projected

final earnings for all members the value of the SCR multiplied by the
present value if total projected earnings for all members throughout their
expected future membership
Key Features
Prospective method
Targets a stable contribution rate
Normal entry age is either estimated from actual membership or assumed
The contribution rate for a new entrant is generally insufficient to meet the
costs of the future service for the membership as a whole
Therefore the AL is greater than the present value of accrued benefits on
projected final earnings
Hence provides greater security than the PU or AA methods
For stability it is necessary that the new entrants, if there are any, should
have an entry age equal to the normal age which has been assumed
Therefore it is possible for the contribution rate to be stable even if closed
to new entrants
Projected Unit
SCR
Found by dividing the present value of all benefits that accrue in the year
following the valuation date, by reference to service in that year and
projected final earnings by the present value of members earnings in that
year
AL
Present value of all benefits accrued at the valuation date by reference to

Key Features
Accrued benefits method

Funds for a target level of the AL
Contribution rate will be stable if the age & sex distribution remains
constant
This implies a flow of new entrants
The value of the assets will equal the AL assuming the SCR has been paid
and all the assumptions are borne out in practice
As such all the benefits are fully secured by the assets held
Page 12
Attained age
SCR is found by dividing the present value of all benefits which will
accrue after the valuation date, by reference to service after the valuation
date and projected final earnings, by the present value of total projected
earnings for all members throughout their expected future membership
AL
Present value of all benefits accrued at the valuation date by reference to

i.e. the same as under PU method
Key features
Prospective method
Targets a stable contribution rate
SCR exceeds that under the entry age method
if the average age is greater than the assumed for entry
SCR exceeds that under PU method
if average period to retirement is greater than 1 year
No account is taken of new entrants
so if the scheme is closed to new entrants contribution rate required will be
stable
If the scheme is open to new entrants the AA method tends to overstate the
standard contribution rate required
[12]
(iii) Entry Age
SCR = 24 / (10 20) = 12%

AL = 170 +380 +800 12% (300 20) = 630
PU
SCR = 50 / (20 20) = 12.5%

AL = 170 + 380 = 550
AA
SCR = 800 / (300 20) = 13.3%

AL = 170 + 380 = 550 (same as PU)
Or 170 + 380 + 800 13.3% 300 20 = 550
[3]
[Total 16]
As is often the case with questions with a numerical aspect to them, candidates tend to either
do well, or rather poorly. In part (ii) those candidates who approached the question
Page 13
methodically, breaking it down into its constituent parts, gave themselves a better opportunity
to score well.
7 (i)
The liability profile of membership
In particular the duration of liabilities
Nature of benefits - are pension benefits fixed or increasing?
Expected future cashflows
E.g. amount of current pension payments
Forthcoming retirements etc.
The schemes funding target / position
Overall funding strategy
The amount of assets currently held by the scheme
The assessment of the employer covenant
A strong covenant will allow greater investment flexibility
The trustees / employers attitude to risk
Currency of liabilities
[5]
(ii)
ALM may help in assessing the risks & rewards
and in achieving an appropriate balance between the different asset classes
Helps value options & guarantees
Establishes a replicating portfolio of assets to hedge the liabilities
ALM looks at the possible impact on the financial strength of the scheme
under differing investment strategies
Will give an indication of future funding levels on various investment
strategies
Can model future cash injections from the employer
Derives the highest potential return for an agreed level of risk
Relative risks of different investment strategies can be modelled
Provides information on future cash flow requirements
Can assess the probability of funds being sufficient to meet funding targets
[5]
(iii)
Need to set the objectives of the ALM study
Indicating the acceptable level of risk and the funding target
The time period over which the probabilities apply
e.g. the acceptable level of risk may be set as a 90% probability of meeting
the funding target over the next 15 years
Need to use the data from the regular funding valuation
in respect of the assets & liabilities
Needs to include details of all options & guarantees
Funding method adopted
Assumptions used to determine the funding target
Assumptions with prudence margins removed
Page 14
Together with other demographic assumptions e.g. new entrants,

conversion terms which may have been ignored in the funding valuation
Rate of anticipated employer contributions
Stochastic investment model or economic model
[5]
[Total 15]
As for question 5, better candidates were able to address part (ii) in some more detail, giving
a discussion of the points rather than a simple list without commentary. To score well in
outline and discuss questions, candidates need to demonstrate understanding as well as
knowledge.
Page 15

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Faculty of Actuaries Institute of Actuaries

23 April 2010 (pm)

Subject ST4 Pensions and other Benefits

Time allowed: Three hours

INSTRUCTIONS TO THE CANDIDATE

4. Mark allocations are shown in brackets.

6. Candidates should show calculations where this is appropriate.

AT THE END OF THE EXAMINATION

A 60 year old employee has recently received an inheritance of 200,000 currently

(ii) Describe three options that could be considered to achieve an income in

(ii) Suggest possible alternative approaches to the CEOs pension arrangements.

6 The government of a developing country is setting up a State Pension scheme funded

ST4 A20103 PLEASE TURN OVER

(a) Employer information

April 2010 Examinations

Subject ST4 Pensions and other Benefits

Comments on individual questions

Q7 This question was meant to be an opportunity for candidates to score well by

Purchase of annuity from insurance company on terms fixed at outset

Salary on which pension based Base pension on basic salary,

(ii) Alternative approaches

No pension scheme at all

Defined contribution scheme

Improved defined benefit scheme

Or just usual scale benefits

Assess need for this cover

.. and its likely affordability

.. e.g. taking account of life cover currently available from private

Details of other state / National Insurance schemes providing same or

Likely costs of setting up and administering the scheme, depending on

How eligibility defined, e.g. is it by residency / nationality. How to deal

Assess appropriate ceasing age for cover provided

Start with historical mortality rates by age / sex

.. and any other subdivision on which it is reasonable to rate, e.g.

Allow for administration costs, if borne directly by those taking up the

Build in contingency allowance, e.g. against possible poor experience

Allow for return on any invested monies

If contributions will not be flat rate, determine suitable way of banding

Whether government will meet part of costs

Monitor experience on regular basis

Adjust premiums / cover as required to ensure scheme remains self

Consider possible administration issues, e.g. data base of participants,

It may not always be clear who to pay the benefit to

Communication issues, e.g. when rates / cover changes following a

Is advice to be provided, if so who can give it, who pays?

Is a separate fund to be maintained, requiring investment of premiums

Eligibility: starting and ceasing ages, is this determined by residency /

Consider what medical questions might be asked, if it is proposed to

.. e.g. recent serious illnesses, operations etc.

Selection issues if scheme voluntary

Could not allow future opt in after opting out

And the investment strategy

And general risk tolerance level

Affordability of future deficit funding plans

Can be used as part of a process to obtain contingent asset protection

What is the employers expected future financial performance?

What is the employers general attitude to supporting the Scheme?

Is he conflicted with a vested interest?

Is independent advice from specialists needed

Need to document an audit trail of how the covenant assessment will be

If the scheme is well funded the covenant is less of an issue

Need to consider scheme ranking against other creditors

(iii) Information from employer