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Retirement Plan Design, Pricing and Managment

Why Are Retirement Plans Important?

A retirement plan is a type of savings plan that helps to ensure that participants will have sufficient resources put away for their use during their retirement years, or in the eventuality that they are unable to work as a result of a long term injury or illness. This helps to avoid potential significant declines in the standard of living of the retired individual. It also helps to avoid pressure on governmental authorities to step in with measures to provide emergency retirement income to their elderly citizens in order to avoid exceptional suffering due to inadequate retirement savings.

Retirement systems may be either private or public in nature. In many countries, government policy is designed to actively encourage the formation of both public and private retirement plans. In the US, for example, employee retirement plans are governed by the provisions of the Employee Retirement Income Security Act (ERISA). The US Department of Labor is responsible for the regulation of employee retirement plans and enforcing the provisions of the ERISA.

Public Sector Retirement Plans

Public sector plans are sponsored by national, local or state governments. These plans may be for all the citizens of the country, whether employed in the private or public sectors. Alternatively, public sector plans may be exclusively for the participation of the employees of a particular governmental entity (including nationally owned corporations).

The importance of these plans is often great enough that governments will usually offer tax benefits to workers who participate in public retirement plans, even if this participation is voluntary. The tax benefit usually takes the form of allowing plan contributions to be made from pre-tax dollars. This effectively means that governments are helping to subsidize the cost of these plans to their citizens.

Private Sector Retirement Plans

In contrast to public sector plans, employer based retirement plans have private sector entities as the plan sponsor. Private sector employers will often benefit from offering retirement plans to their employees, even when there is already a substantial public retirement plan available.

As with public plans, many private plans are tax subsidized by governments. This means that the provision of an employer based retirement plan is a tax efficient form of employee compensation.

Designing, Pricing & Managing Retirement Plans

It is evident that a properly designed retirement plan should satisfy certain criteria in order to fulfill its intended purposes:

  • Retirement plans may be either defined benefit or defined contribution in terms of their design. A defined benefit plan guarantees the benefits that the participants will receive at the time of retirement. Many state and local government plans across the world still use this design. On the other hand, a defined contribution plan defines the contribution level required of participants with the retirement benefits being governed by the resources that are available in the participant’s retirement account at retirement date. The 401 k plans available in the US are one prominent example of a defined contribution plan. The choice between these design options is one of the most important considerations in retirement plan design.
  • A high priority in benefit design is the anticipation of situations that may cause financial distress to employees and the incorporation of benefits that will meet these needs in a cost effective manner. Circumstances such as an injury that may force early retirement or the death of a spouse after retirement (with the possible loss of that spouse’s retirement benefits) need to be anticipated and built into the plan’s benefit structure if it is to adequately meet the needs of citizens or employees.
  • Another important concern (especially in the present environment) is inflation. Employees will spend decades contributing to the plan before starting to draw on its benefits. When they do, the benefits that are available must be commensurate with the cost of living at that time, instead of during the employee or citizen’s working years.
  • Just as with insurance plan pricing, adequate retirement plan pricing is of critical importance. Since these plans are long term in nature, the contribution level needs to be set at a level that will not fluctuate unduly or result in the need to increase sharply, especially as the employee nears retirement. The cost of the benefits depends on both financial and demographic factors. As a result, actuarial expertise in estimating long term rates of investment return, inflation, mortality, morbidity and other factors is an essential input to the process.
  • The investment policy is also a critical plan administration factor in helping to ensure its long term success. It is critical that the policy should result in an investment portfolio that reacts to financial events in a way that helps to offset the corresponding changes in benefit costs due to the same events. Hence, expertise in the assessment, measurement and management of asset-liability risk is very important.
  • Credit risk is another important consideration as any significant counterparty default could result in investment losses that may threaten the financial security of the plan (and thus of its beneficiaries).

How Actuarial Services Can Help

The services we can offer related to retirement plan formation and administration include the following:

  • Suggesting a structure of benefits that will help to meet the critical needs of retirees as and when these needs arise;
  • Determination of contribution levels that will not fluctuate unduly during employees’ working years.
  • Helping to develop an investment policy that minimizes asset liability risks and thus helps to reduce potential fluctuations in contribution rate levels due to unexpected financial events such as reductions in interest rates or share price declines;
  • Working with plan administrators to develop documentation that will explain the functioning of the plan to current and prospective employees. This is important to ensure employee buy-in and full participation, especially if there is a voluntary element of plan contributions;
  • Periodically reviewing the financial position of the plan and recommending timely changes to investment policy or contribution levels;
  • Helping to ensure that the plan complies with any government legislation relating to matters such as maximum contribution levels or minimum benefits. In many countries, both national and local governments impose limits on contribution levels to tax subsidized retirement plans. This is done to avoid potential abuse of these plans for tax avoidance purposes.
  • Setting up procedures for monitoring mortality, morbidity and other demographic events in order to ensure that assumptions can be adjusted as necessary in a timely manner.
  • Advising on the reinsurance, hedging and other risk management strategies that may be needed to manage the financial and operational risks borne by the plan. An important aspect that is often neglected is the development of internal administrative procedures to monitor and manage operational risks.
  • Last but by no means least, Actuarial Services can advise governments that would like to introduce or update a framework for the regulation of retirement savings plans. This would include both publicly and privately sponsored plans. The proper regulation of these plans will help to ensure that they will have the effect intended by government policy on the retirement security of employees and citizens.