ST4 2015

INSTITUTE AND FACULTY OF ACTUARIES
EXAMINATION
28 April 2015 (am)
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 new page.
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.
ST4 A2015 Institute and Faculty of Actuaries

1 A large Company provides a death-in-service benefit to each employee. The benefit
is a lump sum equal to twice basic salary on the date that the employee dies.
Currently the Company pays the benefit as a normal business expense, and does not
insure the benefit or fund for it in advance.
The Company is considering establishing a reserve at the beginning of each financial

year, which will be included in their accounts, equal to the expected cost of the death
benefit over that year. In addition, it would take out an insurance policy at the start of
the financial year to meet any costs in excess of this reserve from lump sums arising
as a result of death benefits over the year being higher than expected.
Outline the advantages and disadvantages to the Company of the proposed funding
arrangement compared with the current arrangement. [5]
2 The accounting standards board (ASB) of a particular country is considering the

introduction of new disclosure requirements so that investors can gain a better
understanding of the significance of the pension liabilities of a company.
Pension schemes in the country are not funded. Pensions are guaranteed by the
company and the company is required to purchase an insurance policy which would
provide the pension should the company become insolvent.
A group representing investors is intending to make representations to the ASB. They

would like to be able to rank companies based on the significance of their pension
liabilities.
(i) Set out the relevant information that could be included in company accounts
under the new disclosure requirements. [3]
(ii) Outline how this information would help investors to understand the
significance of the pension liabilities of a particular company. [3]
(iii) Explain how investors might rank companies according to the significance of
their pension liabilities when presented with this information. [2]
[Total 8]
ST4 A20152
3 A defined benefit pension scheme (the Scheme) provides a non-escalating pension
at a specific retirement age, together with a contingent spouses pension equal to a
fixed percentage of the pension payable to the member. The Scheme is set up under
trust and the trustees have decided that greater choice should be offered to members
when they reach retirement age.
(i) List the options that the trustees might consider offering to members,
assuming that there are no legislative constraints. [5]
The trustees have decided that members should be offered a transfer value at
retirement, as an alternative to the pension payable under the Scheme. The transfer
value would have to be used to purchase a lifetime annuity with an insurance
company.
(ii) Outline the issues that a member should consider when deciding whether to
accept this option. [5]
[Total 10]
4 A developing country has introduced disclosure of information legislation in relation

to defined benefit pension schemes operating in that country. Such schemes are
funded and are set up under trust. The legislation includes the requirement to issue an
annual statement summarising the current funding position within three months of the
start of each calendar year. A statutory body (the Regulator) has already been set
up by the government to regulate the operation of pension schemes. Penalties for non-
compliance of the new disclosure legislation, to be imposed on trustees, are at the
discretion of the Regulator.
The Regulator has become aware of a particular pension scheme (the Scheme)
where the disclosure requirement has not been met since the legislation was
introduced. The Regulator has contacted the Schemes trustees, and has received the
following response:
The membership consists entirely of low paid manual employees. We

consulted with relevant employee representative groups and agreed that this
information would not be meaningful to any of the members. Instead, it
would be likely to cause confusion and potentially alarm. We therefore took
the decision not to issue such statements to the members.
(i) Outline, with reasons, the different penalties that might be available to the
Regulator in relation to this breach. [2]
(ii) Discuss what you would expect the Regulator to take into account when
deciding whether any penalty should be imposed on the trustee board of this
Scheme. [8]
[Total 10]
ST4 A20153 PLEASE TURN OVER

5 The government of a developed country wishes to reduce the financial burden on its
State Pension Scheme, which is unfunded. It has proposed to make it compulsory for
all employers to enrol all employees automatically into a defined contribution pension
scheme. Employees may opt out.
The minimum member contribution rate to such schemes is to be 5% p.a. of basic

salary and the associated minimum employer contribution rate is to be 10% p.a. of
basic salary. In addition, members will have the right to pay additional contributions
not exceeding 5% p.a. of basic salary which employers will have to match.
It has also been proposed that the amount payable under the State Pension Scheme
should be reduced to a fixed amount intended to meet basic needs only, and that any
employee who opts out of a company pension scheme should lose the right to the state
pension entirely.
Outline:
(a) The potential short term financial implications for employees.
(b) The potential short term financial implications for employers.
(c) The potential longer term financial implications for employees.
(d) The potential longer term financial implications for employers.

[12]
6 A company currently sponsors a final salary pension scheme (the Scheme). It is

proposing to close the Scheme to future service accrual and to establish two new
arrangements, which are outlined below. Employees will be able to choose which of
these to join for future service benefits.
Option 1 is a shared cost targeted defined contribution scheme. Under this

arrangement, there would be no investment guarantees. The Company would
undertake a regular review of the joint contribution rate and change it as necessary in
order to try to reproduce the defined benefit at retirement that would have been
provided under the existing Scheme if it had continued.
Option 2 is a cash balance scheme which provides a guaranteed minimum deferred

cash sum at retirement based on the amount of Company and member contributions
paid. This is then accumulated on an annual basis in line with investment returns
generated by the scheme in the period up to retirement, and subject to a minimum
accumulation rate of 0% in any year.
(i) Set out, for each option, the features of the design that will need to be
determined by the Company before the scheme can be implemented. [12]
(ii) Discuss the issues that an employee should consider when deciding which of
the two arrangements to join. [8]
[Total 20]
ST4 A20154
7 A defined benefit pension scheme (the Scheme), which is closed to accrual, is
undergoing a formal actuarial valuation as at 31 December 2014. The investment
strategy is to invest 80% in return-seeking assets (such as equities and property) and
20% in matching assets (such as government bonds).
The Schemes trustee (the trustee) has just received the covenant assessment report
for the sponsoring company (the Company), which has ranked the covenant as
broadly satisfactory. However, the report shows that there are particular concerns
about the amount of debt on the Companys balance sheet, which amounts to 300m
of secured loans. The report also notes that the market capitalisation of the Company
at the valuation date was 200m, and that the pre-tax operating profits for the
preceding year were 35m.
On the valuation basis that the Schemes actuary has proposed, the value of the
Schemes liabilities is 400m on an ongoing basis and 600m on a solvency basis.
The market value of the assets is 400m.
The Company is proposing that it only pays the Schemes expenses (i.e. the costs of
administration, professional fees and regulatory charges) until the date of the next
valuation, which is due in three years time. In addition, the Company is proposing
that a financial management plan is agreed between the Company and the trustee
setting out actions which would be taken if there were a material deterioration in the
financial position of the Scheme before the next valuation is due.
(i) Discuss the risks that could impact the financial position of the Scheme,
including risks relating to the Schemes experience and the sponsor covenant,
were they to arise over the period until the next valuation is due. [14]
(ii) Discuss the monitoring arrangements that the trustee could put in place to
ensure that it has appropriate information in relation to the financial position
of the Scheme, including the sponsor covenant, over the period until the next
valuation is due. [7]
(iii) Discuss the actions that might be included in the financial management plan.
[7]
(iv) Discuss the suitability of insurance as a means of mitigating each of the risks
that you have identified in part (i). [7]
[Total 35]
END OF PAPER
ST4 A20155
EXAMINERS REPORT
April 2015 examinations

Introduction
The Examiners Report is written by the Principal Examiner with the aim of helping
candidates, both those who are sitting the examination for the first time and using past papers
as a revision aid and also those who have previously failed the subject.
The Examiners are charged by Council with examining the published syllabus. The
Examiners have access to the Core Reading, which is designed to interpret the syllabus, and
will generally base questions around it but are not required to examine the content of Core
Reading specifically or exclusively.
For numerical questions the Examiners preferred approach to the solution is reproduced in
this report; other valid approaches are given appropriate credit. For essay-style questions,
particularly the open-ended questions in the later subjects, the report may contain more points
than the Examiners will expect from a solution that scores full marks.
The report is written based on the legislative and regulatory context at the date the
examination was set. Candidates should take into account the possibility that circumstances
may have changed if using these reports for revision.
F Layton
Chairman of the Board of Examiners
July 2015
Institute and Faculty of Actuaries

Subject SA2 (Life Insurance Specialist Applications) April 2015 Examiners Report
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 April 2015 paper
The overall standard of scripts was broadly as expected, with a pass rate very similar to the
previous sitting.
There was a less significant variation in marks than in the previous exam, meaning that there
was not that great a distinction in marks between those who were able to demonstrate
sufficient depth to their knowledge to be able to secure a pass and those who were not quite
there. It is very important that candidates consider all aspects of the question, and read the
preamble fully. There is never superfluous information in the question, and by using all of the
information available, candidates can ensure they give a full answer. Giving just a little more
to clearly show depth can turn a close fail into a pass.
The questions are set so that it should take approximately twice as long to answer a 10 mark
question as a 5 mark one. Answers should therefore be similarly proportionate, as mentioned
in the general comments above.
In addition, candidates should carefully consider the instruction for example an instruction
to list points should be answered with a list without attaching discussion. Similarly, a
question asking for a discussion cannot be answered with a list of undeveloped points.
More detailed feedback is provided on each question below.
Page 2
1 Advantages of the proposed approach
Liquidity (with any valid reason why this is important)

However, company is large so liquidity may not be an issue
Will give a known cost for the insurance arrangements in any one year
So that any cost volatility that has been experienced under the existing treatment
will be removed
Noting that this might be quite small since the company is large
As will the potential for very high claims (e.g. arising from an accident involving
many staff)
There may be favourable tax treatment for the reserve
Any reserve that remains outstanding at the end of the financial year could be
released to fund the insurance premium for the next year
There is a competitive insurance market for mortality risks (in most countries) so
the cost of the insurance should be reasonable
And it is likely that the long term cost of the scheme will be less than if the benefit
were fully insured
Security a reserve has been set up
Disadvantages of the proposed approach
There is a cost to insurance so that in the long term the cost of the arrangements
will increase
Because insurance companies will include a margin to meet capital requirements
and want to make a profit
Any mention of opportunity cost
It may be difficult to deal with claims that are incurred but not reported at a
financial year end depending on how the insurance contract operates
The insurer may look to have exclusions (e.g. claims caused by Health & Safety
breaches) or to seek conditions on the policy which the employer would need to
satisfy in order for the insurance to be valid
It is likely to cost more to administer the arrangements with the insurance
company
Initial start-up costs
Cost of internal pricing setting up reserve, advice etc.
Counterparty risk default of insurer
Generally well answered it is important for candidates to clearly set out pros & cons, and
to make sure their answer is balanced across the two. Do not repeat points.
2 (i)
Details of the benefit design
And who has the power to change the benefit design
In relation to both future service and past service (if this is possible)
Membership information
Valuation of the liabilities
And how these have impacted the balance sheet and p&l account
For both past and future service
Page 3
On one or more prescribed bases

Show key assumptions where appropriate and
Scheme specific assumptions where appropriate
And method, approach etc.
Consistent treatment of discretionary benefits
And sensitivities relating to key assumptions
Information relating to the insolvency insurance premium
Expected cashflow
- current and future
(ii)
Details of the benefit design will allow investor to assess key risk areas
e.g. Inflation
And information on the extent to which benefits are discretionary
Membership data if complete, could be used to allow investor to do
own calculations
Or to assess concentration of risk e.g. If only a few members account for
significant liabilities
Valuation of liabilities will allow investor to produce key financial
metrics e.g. Value of liabilities as a percentage of market capitalisation
Which are comparable between companies
And over time
Sensitivity assessment will be helpful to understand the extent to which
liability values are dependent on key assumptions
Insolvency insurance premium indication of the insolvency risk
(iii)
Investors might be concerned with an absolute measure of liability or a
measure relative to the size of the company?
An absolute measure would be based on a valuation of the liabilities
Is an ongoing measure more appropriate or a measure based on insolvency,
such as the insurance premium?
The key assumptions could be prescribed or scheme-specific
A relative measure could give this valuation as a percentage of the assets
or earnings of the company
Or by considering the impact of the pension cashflows on profitability
Variability of ranking could be illustrated using sensitivity analysis or
scenario testing
Rankings will depend on the approach and assumptions used and so a
definitive ranking is unlikely to be possible
Book work sections were well answered, with better candidates able to apply their knowledge
to make a coherent argument in part (iii). Remember this is an unfunded arrangement!
Page 4
3 (i) The introduction of the following options could be considered:

Any changes should be cost neutral
To exchange part or all of the pension for a cash sum
To take a lower initial pension which increases during the course of
payment
To take a higher initial pension which reduces during the course of
payment
To take an alternative shape of payments e.g. U-shaped
To take a different level of initial pension with a higher or lower
percentage of spouses pension
To take part (or none) of the pension and to defer the remainder (or the
whole) of the pension
To transfer the pension to a third party pension arrangement
To capitalise the pension and permit the balance to be invested and
Allow the member to draw down an income from the balance every year
To take a lower initial pension with a higher bridging pension payable
until any state pension commences
To extend the range of beneficiaries entitled to a contingent pension
payable on the death of the member
Purchase extra benefit
Continue to accrue benefit
(ii) The member should consider the following initial points:

The member will want to choose the option which provides the
largest/most suitable benefits. This will depend on..
The amount of the pension payable under the scheme
And the lifetime annuity available in relation to the transfer value
On a basis with the same contingent benefits as payable by the scheme
On the best terms that are available in the market
Assuming that the trustees will offer the transfer value with an open
market option
The member should then consider any points that are specific to the members
situation such as:
Marital status and existence of any financial dependants (including
children)
Noting that the transfer payment will include an allowance for a
spouses/dependants pension based on proportions married/financially
dependent which are relevant to the population generally
And will probably not make any specific additional allowance for
childrens pensions
Their own life expectancy (particularly if they know this is impaired as a
result of ill-health)
Noting that the transfer payment will probably be based on average life
expectancy
Both the above considerations will serve to increase the amount of the
annuity paid by the insurer in comparison to the current pension
Page 5
How the benefits will be taxed
The member should then consider any preferences that might be available
under the insured arrangement but are not available under the current scheme
such as
Changing the shape of the pension (in the same ways as covered by part (i)
of the question)
Changing the amount and recipient of any contingent benefits payable on
death
Other miscellaneous points that the member should consider are:

The likelihood that the insurer will default, the protection available in such
circumstances and how this compares to the security offered by the current
scheme
Any restrictions that will arise by accepting the transfer compared to other
options that the trustees will also make available e.g. No cash sum if
member accepts the transfer
It is important to answer the question in full. For example, candidates often missed obvious
points about comparison of the actual benefits themselves not just the level of transfer value
etc.
4 (i)
Mandatory training sessions
To help educate the respondents on the issue
Fine the trustees
To remove them as trustees from this scheme
To prevent them from acting for any other scheme
And potentially to imprison them (although this would generally be
considered an extreme penalty for this type of breach taken in isolation)
To act as a punishment for the breach of legislation
(ii)
The regulator is likely to consider the purpose of the requirement to
disclose this information
When the disclosure requirement was introduced and how long non-
compliance has been going on
And the reasons that the legislation was first introduced
Such as any situations where members have had their benefits reduced
unexpectedly
Leading to pressure from trade unions and lobby groups for more
information to be provided about funding and security of benefits
The regulator is also likely to have regard to the extent that a compliance
culture exists in the country
And whether other schemes have also failed to comply
In which case, he would have regard to any penalties issued in these cases
Page 6
Noting that if this is the first such breach, the penalty issued will be a
precedent for future cases
The regulator is likely to check how well scheme is run and whether there
have been previous breaches of law by the same trustee board
And will probably impose a harsher penalty if the trustees have been non-
compliant in the past
Or if he discovers related breaches e.g. That the trustees have not finalised
the calculations required to determine the year end funding position
The regulator may take in to account whether benefits are at risk
Because the funding position is low
Or the employer covenant is weak
Or the investment strategy is risky
Or member misled over decisions
Materiality of non-disclosure
The regulator may consider the extent to which the trustees have made any
information about the funding position of the scheme available to members
The regulator may ask why it was not consulted in advance of the decision
not to disclose
Or take in to account whether the trustees are prepared to correct the
breach and issue the statement now
The regulator may take in to account the composition of the trustee board
Noting that higher standards might be expected if any of the trustees are
paid, particularly if they are acting in a professional trustee capacity
The regulator may take account of any planned changes to the law in this
area
Particularly if any plans to repeal the legislation are in the public domain
Or in contrast if there are plans to further develop the legislation so that
additional financial information is to be made available to members
The regulator is likely to require further information from the trustee board
To check factual points such as whether the entire membership does in fact
consist of manual workers
And the extent of the consultation with employee representative groups
And will also want to form a judgement on whether the employee
representative groups represent the whole workforce
And whether they may have any political motivation for taking a particular
position on this issue
If trustees took legal advice prior to non-disclosure
Relatively well answered best candidates simply showed a greater depth and breadth to
their answers with no repetition of similar points.
Page 7
5 (a) Potential short term financial impacts on employees

The short term financial impacts will mainly relate to changes to the
amount of pension contributions that workers are now required to pay
Compared to the pension contributions currently payable to State Scheme
and any scheme currently offered by the employer
And how this will impact take home pay
It is possible that contributions to the State scheme will be required at a
reduced level
Or that employers would change the terms of their current more generous
pension to the minimum level
Which would offset the introduction of mandatory minimum contributions
of 5% of basic pay for those with lower contribution rates currently
The impact on take home pay will also depend on the tax treatment of the
contributions
And whether employers decide to reduce basic salary to claw back the cost
of higher employer pension contributions
If take home pay reduces, then this will have a disproportionate impact on
very low paid workers
Unless other State benefits are available to support workers with income
levels below a minimum threshold
Although the member does have the opportunity to opt out of the scheme
entirely
By offering a matched contribution structure, the government is trying to
encourage workers to make do with less in the short term, in return for
more at retirement
In practice, this structure favours better paid workers who are able to
afford to pay higher levels of contribution
Cost of financial advice
Members close to or past retirement age will not have time to make up
difference due to reduction in state pension
(b) Potential short term financial impacts on employers

This will depend on the extent to which the employer currently pays
contributions to an occupational pension scheme and
The ability of the employer to pay a different (probably reduced amount)
to the current pension arrangement and
Any changes to the contribution rate that the employer is required to pay to
the State Scheme
It will also depend on the extent to which employees take advantage of the
matching facility
Noting that employers with well paid white collar workers will probably
pay more (as a percentage of basic salary) on average compared to those
with lower paid blue collar workers
In considering the overall impact, it is also necessary to understand the tax
treatment of any pension contribution payments
Depending on the date that the new scheme is to be introduced, it is
possible that any increase in cost will be unbudgeted causing cash flow
difficulties.
Page 8
No contributions will need to be paid in respect of those members opting

out
Transitional expenses between old and new schemes
(c) Potential longer term financial impacts on employees

These will relate both to the affordability of the rate of minimum
mandatory contributions throughout the workers career and
Any decisions that the worker makes in terms of paying higher voluntary
contributions or opting out of the scheme entirely
To the extent that the overall pension contributions are higher under the
revised arrangements, it is likely that retirement income will also increase
Assuming that the investments in the defined contribution scheme perform
satisfactorily
If the worker opts out of the new arrangements, they will lose the right to a
State Pension
Which is unlikely to have a positive financial impact on the workers
overall retirement pension
And could cause extreme poverty if the worker has no income at all in
retirement
For workers who take advantage of the matching facility, the maximum
rate of total contribution is 25% of basic salary
Which is likely to be sufficient to produce relatively high replacement
ratios at retirement (depending on the period to retirement)
Or to encourage early retirement assuming the benefits can be taken at
different ages
Ongoing expenses
(d) Potential longer term financial impacts on employers

This will depend to some extent on how many workers choose to take
advantage of the matching facility offered under the arrangement
But overall it is likely that there will not be a significant financial impact
in the longer term
Since any increase in the cost of pension provision is likely to be offset by
Reducing the cost of other parts of the workers compensation package or
by
Passing on the additional costs to customers
Candidates often failed to focus on the specifics of the question by making many points that
were not directly relevant to the actual question asked. This is an important point of exam
technique to prevent wasting time.
Page 9
6 (i) Design points relating to the targeted DC arrangement

Will review take account of accrued benefit
Or just future service
What are the eligibility requirements
Initial rates of company contribution
And the ratio of member and company contributions
Ensuring that they are sufficient to comply with any minimum
contributions legislation
And whether there should be any banding of the rates (noting that
individual rates by age/sex will be administratively complicated)
And whether members should be given the option to pay at a lower rate if
they accept that this means they are unlikely to reproduce the defined
benefit scheme outcome at retirement
And whether members should be given the option to pay additional
voluntary unmatched contributions
Whether accrued benefits should be taken in to account in the defined
benefit equivalence calculation
Noting that the final salary link might be lost if the existing arrangement is
a final salary scheme
Investment options during the accumulation phase
And in particular the various asset strategies that should be made available
Including any default arrangement
And any lifestyling opportunities in the period prior to retirement
Benefit options at retirement
Including the option to take part of the benefits as a tax free lump sum
Or by means of income drawdown
And any constraints on the type of benefits at retirement e.g. requirement
to provide a spouses pension if married
The options to be offered on leaving service with a very short period of
service
And generally whether benefits on leaving can be maintained within the
scheme, transferred to an insurer or taken as cash.
Treatment of contributions on death before retirement
The frequency of review of the joint contribution rate
And the actuarial assumptions and method that will be used to assess
whether the joint contribution rate needs to change at a review
Related to investment choice
Whether there should be any limit to the change in the joint contribution
rate after a review (e.g. the maximum increase is limited to 1%)
And the date that any such change should be implemented
Design points relating to the cash balance scheme

The amount and basis of calculation of member contributions
The initial company contribution rate
Noting that there is a capital value guarantee every year which will need to
be underwritten
So that the availability of funding from the company will need to be
established in order that the benefits can be provided
Page 10
Note that the same points as set out in relation to the targeted DC scheme
apply in relation to:
- At retirement options
- Withdrawal
- Death before retirement
Some general points:

Will the schemes accept transfers from the current defined benefit
arrangement?
Will members have the right to leave one scheme and join the other
scheme?
And if so, will they also have the right to transfer their accrued benefits to
the other scheme?
And how will the equivalence test work for a member joining the targeted
DC scheme with both defined benefit and cash balance service?
Who chooses investments
Moral hazard members choose high risk, employer low risk, due to floor
How investment return is applied
(ii)
If the member intends to stay until retirement age, they should consider the
benefits that each arrangement is projected to provide at retirement
Which should be close to the equivalent defined benefit for the targeted
DC scheme
But there is nothing in the question to suggest the target benefit under the
cash balance scheme
As well as the projected benefit, the member should seek to gain some
understanding about the level of risk to that benefit
In terms of investment risk in the accumulation phase
And any risk that the rebalancing mechanism under the targeted DC
scheme will fail to function satisfactorily
For example, if the employer reserves the right to vary the arrangements
or there are upper limits to the contributions payable
In practice, it will be hard for the member to gain a full appreciation of
these risks
Other considerations will include the minimum rate of member
contribution payable under each arrangement
Or higher contributions
And the ancillary benefits provided under each arrangement
Such as benefits on death in service and withdrawal
Note that if the member expects to leave service prior to retirement, they
would want to compare the projected benefits at different withdrawal ages
The member should consider their attitude to risk when making investment
choices
And review the different investment options available
In terms of the choice of different types of asset strategies
And any default option
Page 11
And the fund manager that will be managing the assets

Noting that the cash balance scheme arrangement offers some form of
investment guarantee
And that the employer is underwriting (to some extent at least) investment
risk under the targeted DC scheme by offering increased contributions
should the fund fall below the target level
And compare the different lifestyling options available close to retirement
to assess the extent to which they offer protection to the retirement pension
and lump sum
If the member can switch between the schemes, they should consider
whether there is an optimal switching date which would maximise the
projected benefits at retirement
The member should consider the governance of each scheme
And the protection against employer insolvency (which might be relevant
if the employer is underwriting the investment guarantees in the cash
balance scheme)
Finally, the member might be interested in the quality of the support
services available
Such as access to online platforms offering asset switching facilities etc.
Possible volatility of contribution rates
Expected rate of member/employer contributions
Likelihood of 0% floor i.e. perceived value of guarantee
Understanding of either scheme
Availability of advice
Generally quite well answered again successful candidates demonstrated more depth and
breadth to answers with no repetition.
7 (i) Scheme Experience

During the intervaluation period, and in the absence of a financial
management plan, the actuary is unlikely to fundamentally change the
valuation assumptions
And so the reported position will relate to actual experience over the
intervaluation period compared to the assumptions made by the actuary
And the assumptions are likely to be reassessed at the date of the next
valuation
In terms of experience items, a failure to achieve the investment returns
underlying the basis is a potential risk
And probably the most significant in terms of likely impact
Particularly noting the relatively high level of growth asset exposure
And the fact that the scheme is likely to be disinvesting
Although changes in the market yields underlying the discount rate
assumption may also be significant
Other experience items will either be financial in nature
- And will either relate to a change of market view (e.g. a change in the
rate of long term price inflation)
Page 12
- Or in terms of actual experience being worse than assumed (e.g.

salary increases awarded being significantly above the assumed rate
or expenses being higher than expected)
Noting that whilst the scheme is closed to accrual, it is possible that the
accrued benefits still enjoy a final salary link
Or they will be demographic in nature
For example, an early retirement exercise on terms above those in the past
service reserve for the affected members could have a significant impact
on the funding position of the scheme
Or the scheme might experience very low rates of mortality (particularly
relating to pensions in payment)
Although limited impact over 3 year period
Or the scheme might experience very high rates of mortality (which might
have an impact if generous spouses pension and life assurance benefits are
offered by the scheme to in service members)
Without a financial management plan, any adverse experience will emerge
as deficit at the time of the next valuation
Since the employer is only meeting the running costs of the scheme
And not making any payment to help the trustee reduce the dependency of
the scheme on the covenant
For example, by starting to build up a reserve which would allow the
trustees to secure the benefits in the insurance market.
Employer Covenant
The scheme will also face risks in relation to the strength of the employer
covenant
Although without the financial management plan the impact is unlikely to
be assessed until the time of the next actuarial valuation when the trustee
next reviews the position
The trustees are concerned about the level of debt
And there is a risk that profits will fall
Due to adverse market conditions
Or management failures
To such an extent that interest payments on the debt will not be met
So that the debt will be called in by the debtholders and replaced on worse
terms or not replaced at all
In which case, scheme benefits would need to be reduced
Because the scheme is only 67% funded on a solvency basis
The trustees should be particularly alert to risks that negatively impact
both the pension scheme and the employer covenant
Other Issues
Other risks that might impact the financial position of the scheme relate to
retrospective legislation
Or any legal claims that members might have for higher benefits
Or the emergence of data errors leading to materially higher benefits
Page 13
Or the receipt of additional members (e.g. through a bulk transfer) where

the transfer value is insufficient to cover the value of the benefits being
transferred)
(ii)
The trustee requires information about the status of each key risk listed
above
For each risk, the trustee must define a measure (or measures) intended to
give information on the status of the related risk indicator
And obtain information relating to that measure on a timely basis
The measures can be at the aggregate scheme/employer level or can be at
an individual risk level
For example, the most appropriate measure at the aggregate scheme level
would be the ongoing funding level
Updated to take account of experience and changes in market conditions
since the valuation date
Possibly made available on a daily basis
And in relation to the employer covenant, the trustees might choose to
consider just a single measure such as an average of credit rating agency
scores
However, more information can be obtained by considering measures
related to the individual risks themselves
If it is possible to obtain such information e.g. it may not be possible to
obtain up to date market value information for a direct property investment
At the scheme level, the trustee should expect a breakdown of the reasons
for a change in the funding position
Which attributes the change against each risk indicator ie an analysis of
surplus
Covering actual investment performance
Changes in market conditions affecting future investment
performance/discount rate
Changes in inflation impacting salary (if accrued benefits retain salary
link) and pension increases
Together with an assessment of any non-market information that might
impact the next valuation of the scheme e.g. the anticipated introduction of
mortality tables reflecting higher life expectancy
At the employer level, there is no generally accepted measure of employer
covenant strength
And there are a variety of different information sources including
- sponsors published accounts
- published credit ratings
- information from retained covenant adviser
- information provided by the company to the trustees
Which could be used to detect
- further indebtedness
- changes in NOI
- changes in free cash flow
Page 14
- and changes in market capitalisation

A poor covenant may trigger an update of the solvency position
(iii)
If the funding level falls below a specified level
Or if the chosen measure of employer covenant strength gives a trigger
reading
The financial management plan is likely to give the trustees a number of
different powers
Such as demanding the introduction of employer contributions (in excess
of expenses)
Noting that it is difficult to specify in advance the size of such payments
So that it is more likely that the power would relate to the ability to call an
early valuation
Giving both parties the opportunity to consider the issues within the
standard timelines of such a valuation
The trustees will be keen to ensure that any free cash in the business is
used for the benefit of the business or ideally paid in to the scheme
So the plan might state that the company will not make any dividend
payments to shareholders whilst the valuation is being undertaken
Including making capital payments to the parent company
Or give effect to any share buybacks
Or that the company will not increase its level of debt without the consent
of the trustees
Or that a temporary charge over assets is put in place
The plan might also cover circumstances where changes to the investment
strategy would be undertaken to reduce the risk of the strategy
Noting that it is likely that moving a portion of growth assets to matching
assets will reduce the expected return from the asset portfolio
So increasing expected long term costs
And potentially making it even more likely that contributions will need to
be introduced in the short term (particularly if an early valuation has also
been triggered)
So placing even more dependence on the employer covenant
At the extreme, the trustees might want to consider what protections could
be available to protect the scheme in the event of an employer default
And insurance or other financial instruments where a payment is triggered
by such a default could be considered
Although this will be very expensive and therefore unlikely to be a
practical option.
(iv)
Failure to achieve investment returns assumed by the actuary
- Insurance contracts generally offer only a very low guaranteed rate of
return
- And are unlikely to be helpful in mitigating this risk
Reductions in market yields leading to lower growth returns being
assumed by the actuary when setting the discount rate
Page 15
- If it is possible to transfer some of the accrued benefits to an insurance

company on terms that are similar to the actuarial reserve
- Such as those relating to pensions in payment
- Which are already matched by government debt
- Then the insurance contract will protect the scheme from adverse
changes to market yields having a negative funding impact for this
tranche of liabilities
Changes to the rate of price inflation
- An index linked annuity will be effective in protecting the scheme
from inflation in relation to pension liabilities that increase in line with
price inflation
- Again assuming such annuities are available at a price that is similar to
the reserve being held in the scheme relating to these liabilities
Changes to salary inflation
- Insurance is not effective to mitigate salary inflation risks
- Since these are in the control of the sponsoring employer
High incidence of early retirement on preferable terms or low level of
withdrawals or receipt of underfunded bulk transfer
- Again insurance is not effective to mitigate these risks since they are
largely in the control of the sponsoring employer
Low rates of mortality
- The scheme could transact a longevity swap to protect against this risk
- If the assumption made by the actuary is very strong and it is possible
to trade it in the open market at a lower rate
High level of death in service claims
- Insurance is effective at mitigating this risk
- Since insurers hold a lot of information on mortality rates which make
them relatively predictable on an aggregate basis
Impact of retrospective legislation, data risks or risk of legal claims
- Specialist insurers might offer protection against these risks
- Although the underwriting process is uncertain
- And the costs can be prohibitive
Deterioration of the employer covenant
- Insurance contracts are not generally available to protect against this
risk
- Although some protection can be achieved through investment markets
by trading in credit default swaps in the sponsoring employer
This question was less well answered. Answers were often incomplete. For example, in (ii)
some candidates focused only on monitoring the covenant and did not discuss monitoring the
scheme experience. In part (iv) quite a few candidates only considered the appropriateness
of buying out the benefits entirely - they overlooked other possible insurances, for example,
death in service, longevity swaps etc.
END OF EXAMINERS REPORT
Page 16
1
2 INSTITUTE AND FACULTY OF ACTUARIES
3
4
5
6
7 EXAMINATION
8
9
8 October 2015 (am)
10

11
12
13
14
15 Time allowed: Three hours
16 INSTRUCTIONS TO THE CANDIDATE

17 1. Enter all the candidate and examination details as requested on the front of your answer
18 booklet.
19 2. You have 15 minutes before the start of the examination in which to read the
questions. You are strongly encouraged to use this time for reading only, but notes
20
may be made. You then have three hours to complete the paper.
21
3. You must not start writing your answers in the booklet until instructed to do so by the
22 supervisor.
23
4. Mark allocations are shown in brackets.
24
5. Attempt all six questions, beginning your answer to each question on a new page.
25
26 6. Candidates should show calculations where this is appropriate.
27
AT THE END OF THE EXAMINATION
28
29 Hand in BOTH your answer booklet, with any additional sheets firmly attached, and this
question paper.
30
31 In addition to this paper you should have available the 2002 edition of the Formulae
and Tables and your own electronic calculator from the approved list.
32
33
34
ST4 S2015 Institute and Faculty of Actuaries
35
1 (i) Define the term Net Replacement Ratio. [1]
In a developed country, no income tax is levied on the first $15,000 per annum of an
individuals income, which includes income from pensions. A 30% rate of income
tax is levied on income in excess of $15,000 per annum. There is no income tax relief
given for pension contributions or repayments on house loans.
Adam is currently working and earns a pre-tax income of $60,000 per annum. He
pays pension contributions of 10% of pre-tax earnings and repayments on house loans
of $1,000 per month, both of which will cease on retirement.
(ii) Calculate the Net Replacement Ratio if Adams pre-tax pension in retirement
is $30,000 per annum. [2]
Adam has been targeting a Net Replacement Ratio of 1.
(iii) (a) Explain why this may be an inappropriate target in order to sustain his
living standards after retirement.
(b) Propose, with reasons, a more appropriate Net Replacement Ratio for
Adam. [6]
[Total 9]
2 Company A is a large national business. It provides its employees with a death in

service benefit equal to four times salary. You may assume the employees have the
same salary and probability of death, and the lives are independent.
In your answers to parts (i) (iii) below, define all symbols used and state any key
assumptions.
(i) Write down a formula for the expected cost over the next year of the benefit
expressed as a proportion of total salary. [1]
(ii) Derive a formula for the standard deviation of the cost over the next year of
the benefit expressed as a proportion of total salary. [3]
(iii) Write down a formula for the probability that there is at least one death in a
given year. [1]
Company B is a family business employing 50 employees, with an average age 45, in

one factory. It provides the same death in service benefit as Company A. The
business is managed by a husband and wife, who are also employees each aged 63
with a salary that is 10 times greater than the average of the rest of the employees.
(iv) Discuss whether it will be preferable for Company B to insure the benefit
rather than meeting the cost of claims out of business cashflow.
Your answer should make reference to, but is not restricted to, your answers to
parts (i) (iii) above. [6]
[Total 11]
ST4 S20152
3 The HR Director at a large employer is considering establishing an arrangement to
meet in full all post-retirement medical fees and healthcare costs of its employees.
(i) List the assumptions that would need to be made in order to estimate the cost
of the arrangement. [5]
(ii) Discuss three approaches the employer could take to financing the
arrangement. [10]
The Managing Director is concerned by the affordability of such an arrangement. He

takes advice from an actuary on ways to control the cost, whilst still offering a benefit
that is attractive to current and prospective staff.
(iii) Discuss four key aspects of benefits design that could be adjusted to achieve
the employers objective. [12]
[Total 27]
4 An employer in a developed country operates a revalued average earnings pension

scheme. Pensions are revalued in line with price inflation before and after retirement.
The majority of the schemes assets are invested in domestic investment grade
corporate bonds.
(i) List the main investment characteristics of corporate bonds. [3]
The managers of the pension scheme are concerned about the risks of domestic
inflation and are proposing switching their fixed interest corporate bond holdings into
domestic inflation-linked government bonds.
(ii) Outline the advantages and disadvantages of this proposal. [4]
(iii) Suggest, with reasons, other asset classes that the pension schemes managers
could adopt in order to reduce the risk to the scheme of domestic inflation. [6]
[Total 13]
5 An employer currently sponsors a defined benefit pension scheme which is fully

funded on an ongoing basis. It wishes to discontinue the scheme and has approached
the schemes managers to consider this.
(i) List six ways that the managers of the scheme could achieve this. [3]
The managers of the scheme wish to continue running the scheme, funding it on a
self-sufficiency basis, without the further accrual of benefits.
(ii) Discuss the factors that the managers should consider in their approach to the
following aspects:
funding;
investment strategy; and
provision of discretionary benefits. [7]
[Total 10]
ST4 S20153 PLEASE TURN OVER

6 A triennial actuarial valuation of a final salary pension scheme is due. The scheme
provides the following benefits:
Accrual Rate: 1/60th of basic salary for each year of

pensionable service
Normal retirement age: 65
Leaving service benefit: Deferred pension based on basic salary at
leaving and pensionable service completed
Pension increases in deferment: Price inflation
Pension increases in payment: Price inflation
Death before normal retirement age: Lump sum equal to 5 times the members
contributions to the scheme
Death after retirement age: Spouses pension equal to 50% of the members
pension at the date of death
Member contributions: 5% of basic salary
(i) List the items of membership data the actuary will require to complete the
actuarial valuation. [7]
(ii) Describe the data checks that the actuary should carry out on the membership
data. [10]
An early retirement option is to be introduced. The sponsoring employer has asked

for the terms to be set so that the actuarial value of the early retirement pension is
equivalent to the actuarial value of the deferred members pension. Active members
are assumed to have left the at the point of early retirement.
(iii) Set out a formula for the early retirement pension, defining any terms you use.
[4]
The sponsor does not wish the early retirement option to introduce significant
additional risk into the scheme.
(iv) Describe the risks introduced by the early retirement option. [4]
(v) Discuss ways these risks can be managed. [5]

[Total 30]
END OF PAPER
ST4 S20154
EXAMINERS REPORT
September 2015

Introduction
The Examiners Report is written by the Principal Examiner with the aim of helping candidates, both
those who are sitting the examination for the first time and using past papers as a revision aid and
also those who have previously failed the subject.
The Examiners are charged by Council with examining the published syllabus. The Examiners have
access to the Core Reading, which is designed to interpret the syllabus, and will generally base
questions around it but are not required to examine the content of Core Reading specifically or
exclusively.
For numerical questions the Examiners preferred approach to the solution is reproduced in this
report; other valid approaches are given appropriate credit. For essay-style questions, particularly the
open-ended questions in the later subjects, the report may contain more points than the Examiners
will expect from a solution that scores full marks.
The report is written based on the legislative and regulatory context pertaining to the date that the
examination was set. Candidates should take into account the possibility that circumstances may
have changed if using these reports for revision.
F Layton
Chairman of the Board of Examiners
December 2015
Institute and Faculty of Actuaries

Subject ST4 (Pensions and other Benefits Specialist Technical) September 2015 Examiners Report
A. General comments on the aims of this subject and how it is marked
1. The aim of the Pensions and Other Benefits Specialist Technical subject is to instil in
successful candidates the ability to apply, in simple situations, the mathematical and
economic techniques and the principles of actuarial planning and control needed for the
operation on sound financial lines of providers of pensions or other employee benefits.
2. This subject examines the ability of candidates to apply core actuarial techniques and
concepts, together with specific knowledge of pensions and other benefit arrangements
to simple, but practical situations.
3. The examiners therefore look for candidates to apply their knowledge of the core reading
to the specific situation that the examiners asked, having read the question carefully.
Too many candidates write around the subject matter of the question in more general
fashion, or focus on one aspect of the issue at great length, in either case gaining few of
the marks available.
4. Good candidates demonstrate that they have used the planning time well - an attempt to
get a logical flow is a big advantage in making points clearly and without repetition. This
also enables candidates to use the latter parts of questions to generate ideas for answers
to the early parts (or use their solutions to earlier parts of questions to create a structure
for latter parts). Time management is important so that candidates give answers to all
questions that are roughly proportionate to the number of marks available.
B. General comments on student performance in this diet of the

examination
1. The overall standard of scripts was broadly as expected, with a pass rate slightly higher
than in the previous sitting. There was a wide spread of marks and the paper enabled
the better candidates to demonstrate their knowledge and understanding of the syllabus.
2. It is very important that candidates consider all aspects of the question, and read the
preamble fully. Candidates should consider the specific scenario given in the question
and tailor their answers to the relevant points rather than listing all they know about a
topic. There is never superfluous information in the question, and by using all of the
information available, candidates can ensure they give a full answer. Giving just a little
more to clearly show depth can turn a close fail into a pass.
3. The questions are set so that it should take approximately twice as long to answer a
10 mark question as a 5 mark one. Answers should therefore be similarly proportionate,
as mentioned in the general comments above.
4. 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. The list of published command verbs should help students to
understand the form of answers that the examiners expect.
Page 2
5. More detailed feedback is provided on each question below.
C. Comparative pass rates for the past 3 years for this diet of examination
Year %
September 2015 43
April 2015 39
September 2014 43
April 2014 40
September 2013 41
April 2013 41
Reasons for any significant change in pass rates in current diet to those in the
past:
The pass rate for this examination diet is broadly in line with previous diets. Some variation
in the pass rate between sessions is expected as different cohorts of students sit the
examination.
Solutions
After-tax income in the year after retirement

Q1 (i) Net Replacement Ratio =
After-tax income in the year before retirement
(ii) After-tax income before retirement = 1 * $15,000 + 0.7 * $45,000

= $46,500
After-tax income after retirement = 1 * $15,000 + 0.7 *$15,000

= $25,500
Net Replacement Ratio = $25,500 / $46,500 = 55%
(iii) (a)
Pension contributions cease on retirement

Mortgage repayments cease on retirement
There are other reasons why a lower replacement ratio may be sufficient:
Lower travel-related costs (e.g. travel to work)

Other work-related costs no longer apply (e.g. clothing/uniform)
Children are grown up and no longer require financial support
Other, non-pension, saving may have taken place whilst working and these
savings no longer need to be built up
Page 3
There may be savings that can be spent in retirement to support retirement

income
Discounts on products and services may be available to retired people
Income in final year of work may not be representative of career e.g. if
bonus received
There are some reasons why a higher replacement ratio may be needed:
More money may be required for leisure activities after retirement

Healthcare costs may be higher after retirement
(b)
The income he has available to spend, after pension contributions and

mortgage payments, before retirement is therefore:
$46,500 less ($12,000 + $6,000) = $28,500
Because he does not incur these costs in retirement, a net replacement ratio
of $28,500 / $46,500 = 61% would be sufficient to give him the same
amount of income to spend.
Other well argued, sensible approaches were credited even if they resulted
in a different figure to 61%.
Generally candidates did well although some candidates incorrectly included

pension contributions and/or mortgage repayments in the calculation of Net
Replacement Ratio.
Q2 (i) n = number of employees

S = Salary of each employee
q = probability of death of each employee
Expected cost of benefit = n * 4S * q

Total payroll = n * S
Expected cost of benefit as proportion of payroll = n * 4S * q / (n * S) = 4q
(ii)
For one employee, the probability distribution of the cost is:
4S with probability q
0 with probability (1 q)
Therefore the expected cost = 4S * q + 0 * (1 q) = 4Sq.
Page 4
The variance of the cost is:
{(4S)2 * q + 02 * (1 q)} (4Sq)2 = 16S2 * (q q2).
For n independent random variables, the variance of the sum equals the
sum of the variances
Therefore, the variance of the cost for the n employees is 16nS2 * (q q2).
The standard deviation is the square root of this,
i.e. 4S * n1/2 * (q q2)1/2
Dividing by the total payroll (n * S) gives the result:
4 * (q q2)1/2 * n1/2.
(iii) Because the lives are independent, the probability of no deaths is (1 q)n
Therefore the probability of at least one death is 1 (1 q)n.
(iv)
The standard deviation is a measure of the risk of providing the benefit
The standard deviation of the cost of the benefit for n employees,
expressed as a proportion of payroll, is inversely proportional to the square
root of n
And therefore reduces as n gets larger
Hence, for a small firm of 50 employees the risk is fairly high
E.g. just one death of an employee on average salary will increase the
companys costs by a significant percentage of payroll in that year
Particularly if it is one of the managers
The resulting volatility of profits may be too great without insurance
And may cause liquidity problems for the employer
The risk is further increased by the fact that the lives are not
independent
but may be positively correlated
For example, because all employees work at one site
an accident at work could cause multiple deaths at the same time
The managers of the business have much higher wages than average
are older (higher probability of death)
and positively correlated (husband and wife)
and therefore represent a significant amount of mortality risk
By insuring the benefit the company would pay a known insurance
premium
rather than an unknown cost of claims each year
The insurance premium is likely to be higher than the expected cost of
claims
because of the insurance companys operating expenses
capital requirements
Page 5
and profit margins

The company will need to consider whether it is worth paying the
additional expected cost in order to remove the mortality risk
Medical underwriting, especially of the managers, may help reduce the
cost
Many candidates struggled with this question. Some appeared not to know
the formula to calculate variance, and others failed to simplify the answer
sufficiently. The answers for final part (iv) were stronger although few
candidates were able to demonstrate the link to the earlier part of the
question.
Q3 (i)
Pre retirement mortality
Leaving service / staff turnover rates
Expected retirement age
Ill-health early retirement rates
Post retirement mortality
including projections for future improvement
Expected number of medical claims per annum in retirement
broken down by age
and sex
Expected cost of medical claims
and recovery rates / duration of illness
Expected rate of medical expense inflation
and other inflation e.g. administrative expenses
Discount rate / investment return
(ii)
Pay as you go
Claims are paid as and when they are made by beneficiaries when they
arise
No monies are put aside to fund for the claims
although the company may wish to establish a book reserve
This method has minimal cash outflow initially
The cashflow will increase greatly later on when eligible employees have
retired
It is possible that the company may not have the resources to meet the
cashflow at this time
There is little security of the benefit for the member
Security could be improved by combining with Just-in-Time funding
triggered by certain events such as takeover of the sponsoring employer
The cashflow is likely to be volatile
a smoothed PAYG approach could be adopted to reduce the volatility
No opportunity cost
Page 6
Terminal Funding
A fund is established at the retirement of a member
by means of a capital payment at that time
The fund would be calculated to be sufficient to meet the cost of claims
during the period after retirement
This method has minimal cash outflow initially
The cashflow will increase greatly later on when eligible employees reach
the point of retirement
The presence of a fund provides an element of security to retired members
during the course of the scheme the adequacy of the fund will need to be
monitored
and adjustments made either by means of further payments or offsetting
against future retirement payments (if there is a surplus)
Opportunity cost if funds could be more profitably deployed elsewhere
Funded in advance
E.g. Lump Sum in Advance or Regular Contributions
A fund is established by making contributions over the working lifetime of
each member
which are calculated to be sufficient to meet subsequent costs after
retirement
This method places an immediate cashflow requirement on the employer
But cashflow should be more stable than the other two methods as there
should not be significant increases at or during retirement
The cost is paid during the time that each employee is providing services
to the company
and there should be no need to provide additional contributions in
respect of an employee after he has left service of the company
The fund will need to be monitored for its adequacy on a regular basis
and adjustments made to the contribution rate on account of surplus or
deficit
This method provides greater benefit security for members
Insurance
The sponsoring employer pays premiums to an insurance company
The insurance company will then be responsible for funding the medical
benefits
Premiums could be paid annually during the retirement of each member
(variant of PAYG)
Lump sum premiums could be paid at the point of retirement of each
member (variant of Terminal Funding)
Regular premiums could be paid during the working lifetime of employees
(variant of Funded in Advance)
The risk / variability of costs will be reduced by taking out insurance
But the sponsoring employer remains exposed to the risk that the insurance
rates vary over time
Would be expected to be more expensive than meeting costs directly
Page 7
Because of contribution towards insurers profits, capital requirements etc.

Regular rebroking in a competitive insurance market will help to control
costs
(iii)
Introduce benefit accrual
The scheme currently covers medical costs in full whether an employee
works for one day or all the way up to retirement
The cost would be significantly reduced if members accrued the benefit
over their working lifetime up to retirement
or at a fixed rate per annum (e.g. 2.5% per year up to 40 years)
This might help to attract / retain staff
as it will reward long-serving employees
Require member contributions from employees towards the expected cost

of the benefits
This will directly reduce the cost to the employer
The increased cost might be unpopular with existing employees
Although employees might appreciate the value of a benefit that they
previously overlooked
Require contributions from pensioners to pay a proportion of medical fees
when they arise
either a fixed excess
or a fixed proportion of the claim
Would reduce both the size of the cost of individual claims
and the likelihood of claims
because members would be discouraged from making small or
unnecessary claims
The employer could restrict the scope of the benefit

By introducing eligibility criteria
for example a waiting period
or restricting to certain classes of employee
Or by introducing restrictions on the treatment covered
for example by only covering certain medical conditions
or exclusions for pre-existing conditions
or excluding treatments that are provided for free by the State
Introduce a medical check-up on entry and refuse entry if failed
This would make the benefit less attractive to employees if the restrictions
are too great
Place a cap on the total amount of benefit

either during each year of retirement
or in total
Still attractive to members if cap is set high enough
As the benefit would not be available to those members who need it most
Page 8
So the employer should consider what medical benefits are provided by

the State to cover the shortfall
Encourages members to look after their own health
This question was answered well, and most candidates were able to obtain
points in relation to three funding methods, and changing the benefit design of
the scheme (although few suggested that the benefit could accrue with
service and missed some marks as a result).
Q4 (i)
They provide a fixed rate of interest (coupon)
And fixed redemption proceeds at a given point in time
Often a higher running yield than equities
They are normally tradable at any point up to the redemption date
Liquidity will vary greatly between different bonds
Depending on things such as the issue size
Security of return depends on the creditworthiness of the issuer
The yield is typically higher than equivalent government bonds
Accounting for higher credit risk
And lower liquidity
Higher yielding (junk) and lower yielding (investment grade) varieties
reflect the creditworthiness of the issuer
Available in a number of different currencies
A small amount of inflation-linked corporate bonds are available
(ii) Advantages
Inflation-linked government bonds more closely match the inflation-linked

nature of the scheme liabilities
Hence funding level will be more stable
Default risk is lower compared with corporate bonds
Better marketability of portfolio
Longer dated inflation-linked government bonds may be available, making
it easier to match longer dated scheme liabilities
Disadvantages
There will be transaction charges associated with the switch

Inflation-linked government bonds are lower yielding than corporate bonds
Hence a lower discount rate may be needed to value the schemes
liabilities
Resulting in higher liabilities
And higher employer contribution rate
The availability of bonds of suitable duration might be limited
Difficult to time the switch optimally markets could move against the
scheme
Page 9
(iii)
Equities
Volatile investment returns
Therefore not a close match for inflation in the short-term
But over the long-term company profits may be correlated with inflation
Property
As rents may be correlated with inflation over the medium term
Or have specific inflation-linked increased built into the rental agreement
Not a good short-term inflation match
Overseas assets
As high domestic inflation should cause a depreciation of the domestic
currency over time
Leading to overseas assets rising in value when measured in the domestic
currency
The inflation protection is only approximate
And this introduces currency risk
Invest in globally traded commodities

Such as oil, precious and industrial metals, gold
As high domestic inflation should lead to an appreciation of the price when
measured in domestic currency
The inflation protection is only approximate
Purchase inflation-linked annuities

Very good match for liabilities
But might be expensive due to insurance company loadings
Use inflation swaps or other derivatives

Good match for inflation
Introduces counterparty risk
Introduces complexity
A relatively straightforward question that was answered well. For part (iii), in
some cases, candidates lost marks for not making sufficient points regarding
how the alternative asset class would reduce domestic inflation risk.
Q5 (i)
gradual removal of liabilities by the continuation of the scheme without
any further accrual of benefits
transfer of the liabilities to another pension scheme with the same sponsor
transfer of the funds to the beneficiary to extinguish the liability
either as cash or transfers to individual DC pension schemes
transfer of the funds to an insurance company to invest and provide a
benefit
Page 10
transfer of the liabilities to an insurance company to guarantee the benefits

transfer of the liabilities to a central discontinuance fund, operated on a
national or perhaps industry wide basis
(ii)
The funding target scheme should ensure that the Scheme has a very good
chance of meeting its liabilities without further help from the employer.
Prudent assumptions should be used for funding
Together with a prudent funding/valuation method
These may be similar to the assumptions used for a buyout valuation
Including future expenses
Without the margins for insurance company profit
Scheme will be moving from fully funded to a deficit position
Consideration needs to be given to the amount and timing of contributions
to eliminate the deficit
A more cautious investment strategy should be followed

With the liabilities closely matched
Typically government and corporate bonds will be used
And longevity swaps/bonds and annuities may be used
Consideration needs to be given to the timing of the transition in
investment strategy
Market or funding level triggers may be used
The amount of risk taken will depend on whether the Scheme sponsor is
willing and able to make up any shortfall
The managers should consider the past practice of awarding discretionary

benefits
member expectations
And the extent to which they are provided for in the funding target
Are there any restrictions in the scheme rules or legislation?
Fairness between different generations of member
And different categories of member will be difficult
If generous discretionary benefits are provided early on then there may not
be sufficient funds to provide discretionary benefits later on
if mortality or investment experience is adverse
Whereas if the managers adopt a more cautious approach to discretionary
benefits, then only members still alive when the discretionary benefits are
granted will benefit
Page 11
Overall, discretionary benefits may be less likely if the Scheme is moving

to a deficit position on the new funding basis
Some candidates answered this question well, but others missed obvious
points (e.g. that the change to a self-sufficiency basis would likely put the
scheme in to deficit). A number of candidates struggled with the implications
for discretionary benefits, in some cases making the assumption that the
provision of such benefits was being considered for the first time.
Q6 (i) Membership data
Name or unique identifier

Category of member (staff/works)
Status (active, deferred, pensioner, dependant pensioner)
Sex
Date of birth
Date joined scheme
Contributions paid to Scheme
For actives current basic salary
For actives part time working details / periods of absence
For deferreds Date of leaving pensionable service
For deferreds Basic salary at date of leaving
For deferreds Deferred pension at date of leaving
For Pensioners Date of leaving
For pensioners Date of commencement of pension
For pensioners Current pension in payment
Anything indicating non-standard benefits
E.g. transfer-in, augmentation
Marital status
Date of birth of spouse
Typically an assumption will be made rather than data collected for the last
two items
(ii)
Reconciliation of membership in each category compared with the data
used for the last valuation
and the pension scheme accounts
taking account of new entrants, leavers, retirements and deaths
and checking date of leaving/retirement within last 3 years where there
is a status change
Check than new entrants have not been omitted
Checks on individual data investigate outliers

Age of active and deferred members between 20 and 65 (say)
Age at date of joining 20 or greater
Age of pensioners 65 or over for normal retirements
Page 12
Age of dependant pensioners 50 or over

Active salaries within a particular range
Deferred pensions within a particular range
Pensions in payment within a particular range
Increase in basic salary since last valuation within a particular range
Increase in pension in payment since last valuation consistent with price
inflation
Member contributions consistent with length of service and salary
Date of leaving service after date of joining
Deferred pension consistent with salary and length of service
Check for missing data
Global checks compare with last time

Compare total
and average
Pension, deferred pension, accrued pension
Compare average age in each category
Investigate any unusual results
Check contributions paid

And pensions and lump sum benefits paid
Against figures in pension scheme accounts
Spot checks for random members against administration data

And last times data
Checking all groups with different benefits are covered
Similar spot checks for high value members
(iii)
x is the members age
AP is the members accrued pension
EP is the members early retirement pension
r is the assumed rate of price inflation (and revaluation in deferment)
i is the discount rate
l65 and lx are from the mortality table used in the valuation
a65 and ax are annuity rates at a net interest rate of i pension increase rate
C is the members contributions to the Scheme
The simplifying assumption has been made that death in deferment would
occur half way to retirement age
The equation of value is then:
EP * ax = AP * a65 * (l65 / lx) * ((1 + r) / (1 + i))65x

+ 5C * (1 l65 / lx) * (1 / (1 + i))(65x)/2
Page 13
(iv)
Liquidity risk pensions will be brought into payment sooner and the
Scheme my not have sufficient assets to pay the benefits
There may be a surge of early retirements in the first year
Mortality risk if pensioners and spouses live for a shorter period than
expected then they will normally receive a more valuable benefit under the
early retirement option
Although early retirees with no spouse who die very quickly may receive
less pension than the death in deferment return of contributions lump sum
Investment risk duration of liabilities will change and existing liability
matching may be inappropriate
and matching will be less precise as duration will be harder to calculate
when members have the option
Selection risk members in poor health may be more inclined to take early
retirement than members in good health
so that the mortality assumptions in the equation of value are not
appropriate and the option is more expensive than expected
Changing market conditions
may mean that the discount rate is not appropriate and paying the
pension at age 65 would be less expensive
Administrative expenses of implementing the option are greater than
expected
Operational risk calculation errors
Reputational risk if conversion terms turn out to be poor value for
members
(v)
Give the employer the power to set the terms of the option
Make it a requirement for members to obtain the consent of the employer
before early retirement is permitted
Both of these will give the employer greater control
For example allowing it to suspend early retirements if liquidity is an issue
for the Scheme
Mortality and selection risk will be difficult to mitigate
Because individual underwriting is unlikely to be practical
An approximate solution might be to make the option less generous
By assuming slightly heavier mortality in the equation of value
Restrictions on the availability of the option could be introduced
For example relating to health status or minimum retirement age
The early retirement factors could be dependent on market interest rates
To account for changing market conditions
Although this will make the administration more complicated and
expensive
Compared with fixed factors
Review investment strategy to ensure correct duration of assets
and sufficient liquidity
Page 14
Reduce reputation risk by careful member communication or provision of

independent financial advice
Most candidates provided good answers to the first three parts of this
question, but struggled with the final two parts often as a result of failing to
consider a sufficiently wide range of risk types. In particular, in part (iv) most
candidates focused on the risks of defined benefit pension schemes in
general rather than on the introduction of the option.
END OF EXAMINERS REPORT
Page 15

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INSTITUTE AND FACULTY OF ACTUARIES

28 April 2015 (am)

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

ST4 A2015 Institute and Faculty of Actuaries

The Company is considering establishing a reserve at the beginning of each financial

2 The accounting standards board (ASB) of a particular country is considering the

A group representing investors is intending to make representations to the ASB. They

4 A developing country has introduced disclosure of information legislation in relation

The membership consists entirely of low paid manual employees. We

ST4 A20153 PLEASE TURN OVER

The minimum member contribution rate to such schemes is to be 5% p.a. of basic

(a) The potential short term financial implications for employees.

(b) The potential short term financial implications for employers.

(c) The potential longer term financial implications for employees.

(d) The potential longer term financial implications for employers.

6 A company currently sponsors a final salary pension scheme (the Scheme). It is

Option 1 is a shared cost targeted defined contribution scheme. Under this

Option 2 is a cash balance scheme which provides a guaranteed minimum deferred

Subject ST4 Pensions and other Benefits

Institute and Faculty of Actuaries

General comments on Subject ST4

Comments on the April 2015 paper

More detailed feedback is provided on each question below.

1 Advantages of the proposed approach

Liquidity (with any valid reason why this is important)

Disadvantages of the proposed approach

On one or more prescribed bases

3 (i) The introduction of the following options could be considered:

(ii) The member should consider the following initial points:

How the benefits will be taxed

Other miscellaneous points that the member should consider are:

5 (a) Potential short term financial impacts on employees

(b) Potential short term financial impacts on employers

No contributions will need to be paid in respect of those members opting

(c) Potential longer term financial impacts on employees

(d) Potential longer term financial impacts on employers

6 (i) Design points relating to the targeted DC arrangement

Design points relating to the cash balance scheme

Some general points:

And the fund manager that will be managing the assets

7 (i) Scheme Experience

- Or in terms of actual experience being worse than assumed (e.g.

Or the receipt of additional members (e.g. through a bulk transfer) where

- and changes in market capitalisation

- If it is possible to transfer some of the accrued benefits to an insurance

END OF EXAMINERS REPORT

Subject ST4 Pensions and other Benefits

16 INSTRUCTIONS TO THE CANDIDATE

Adam has been targeting a Net Replacement Ratio of 1.

2 Company A is a large national business. It provides its employees with a death in

Company B is a family business employing 50 employees, with an average age 45, in

The Managing Director is concerned by the affordability of such an arrangement. He

4 An employer in a developed country operates a revalued average earnings pension

(i) List the main investment characteristics of corporate bonds. [3]

(ii) Outline the advantages and disadvantages of this proposal. [4]

5 An employer currently sponsors a defined benefit pension scheme which is fully

ST4 S20153 PLEASE TURN OVER

Accrual Rate: 1/60th of basic salary for each year of