The Choice Of Actuarial Funding Methods For Funded Defined Benefit Pension Schemes

Abstract

Defined benefit pension schemes are pension schemes in which pension benefits payable at retirement are determined using a pre-defined formula contained in the schemes’ trust deed and rules. The pension benefit formula is usually a multiple of a pension accrual factor, years of service and final salary as defined by the scheme rules. The responsibility of the liability of these schemes solely lies with the sponsor who is required to set aside funds usually by way of regular contributions into a designated fund to meet the anticipated future benefit payments. It is therefore critical that the sponsor adopts an appropriate actuarial funding method that will result to the remittance of sufficient contributions in a manner not detrimental to normal business operations. Four main actuarial methods of funding pension schemes have been developed to calculate an appropriate pattern of contributions to meet the expected future benefit payments. These methods are: 1. The Attained Age Method (AAM) 2. The Entry Age Method (EAM) 3. The Projected Unit Method (PUM) 4. The Current Unit Method (CUM) The only difference in these funding methods is the timing of contributions but the overall long term cost of the scheme is the same. The choice of any of the methods to form basis of funding a scheme takes into account the following major factors: stability, security, flexibility and realism. This project examines and analyses the four funding methods, applies them to a model pension scheme and evaluates the results thus obtained to the extent to which they satisfy the factors of stability, security, flexibility and realism.