Setting Expectations

The pensions provided by companies to their employees come in many forms, but fundamentally these fall into two distinct classes.

1. Defined contribution schemes Also known as money purchase schemes these are attractive to companies as they are easy to record, and more significantly it is the employees who bear the risk of poor performance by the pension fund established.

   The company's exposure is limited to their contractual commitment to pay an amount equal to a percentage of employee salary into the scheme. If the pension assets purchased with these funds perform poorly and result in a smaller pension, it is the former employee who suffers.

2. Defined benefit schemes Also known as final salary schemes these are becoming increasingly unattractive to employers as it is the company that now bears the risk of poor fund performance. In effect such schemes guarantee employees a percentage of their final salary as a pension the exact percentage being linked to the number of years service they have provided to the employer.

   These schemes need regular actuarial review (usually every 3 years) when the professionals involved perform complex modelling to evaluate a range of future events and their impact on the funds required by the pension scheme to meet its obligations. The projections of the future that an actuary will need to be made include:

   • Inflation

   • Interest rates

   • Numbers of people joining or leaving the scheme

   • The average service life of employees

   • Performance of capital markets.

Clearly this is not...