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					Faculty of Actuaries                        Institute of Actuaries




                        EXAMINATION

                           April 2006

       Subject SA4RSA     Pensions and other Benefits
                  Specialist Applications

                       MARKING SCHEDULE




                                              Faculty of Actuaries
JB 13.2.06                                   Institute of Actuaries
    Subject SA4RSA (Pensions and other Benefits Specialist Applications)   April 2006   Marking Schedule



1        (i)      Set out the issues normally considered when deciding on which of two funds
                  should be the recipient for the transfer of all assets and liabilities in a merger
                  exercise, and state with reasons which of Fund A or B above should be the
                  receiving fund in this instance.                                                 [5]

                  Which fund is larger.                                                                [½]
                  Less disruption if larger fund not moved, fewer members disgruntled
                  etc.                                                                                 [½]
                  Which fund is better funded.                                                         [½]
                  Next two points subject to surplus apportionment issues:                             [½]
                  (1) Easier to move members to the better funded fund, more
                        security for those being transferred.                                          [½]
                  (2) Existing members of better funded fund may have to accept
                        slight dilution of security.                                                   [½]
                  Which fund has better overall trustee/administration arrangements.                   [½]
                  There may be issues in rules       does one fund facilitate merger
                  better than other.                                                                   [½]
                  Consider any amendments that may be required.                                        [½]
                  Is one company more dominant than other            what are the
                  respective preferences of employers/trustees.                                        [½]
                  Communication aspects        but this will be required in both funds.                [½]
                  Does one group of members have more difficult issues in terms of
                  section 197 of Labour Relations Act?                                                 [½]

                  Decision as to which fund to use as receiving fund

                  Members past service rights must be protected whichever fund is
                  chosen.                                                                              [½]
                  Including any member share of surplus in B.                                          [½]
                  And any employer share of surplus in B can be used in whichever
                  fund is chosen.                                                                      [½]
                  No transfer can be concluded before surplus apportionment in B
                  concluded                                                                            [½]
                  Therefore, it comes down to size/funding/trustee &                                   [½]
                  administration/LRA section 197 issues     On basis of size/funding
                  possibly B will be more suitable vehicle.                                           [½]
                                                                                                 [Up to 5]

         (ii)     Discuss the factors each set of trustees should take into account in                 [8]
                  deciding whether to accept the parent company s proposals

                  Future Benefits

                  Who has power to change them in rules?                                               [½]

                      If employer, then trustees can only seek to influence the changes.               [½]
                      Might not be able prevent employer from changing future
                      service.                                                                         [½]
                      Should not be seen to endorse changes as members benefits
                      being worsened but need to proactively seek solutions.                           [1]


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Subject SA4RSA (Pensions and other Benefits Specialist Applications)   April 2006   Marking Schedule


              Consider implications in terms of LRA section 197                                    [½]
              Employment contracts                                                                 [½]
              Get legal advice                                                                     [½]
              Discuss with employers get understanding.                                            [½]
              Discuss or negotiate with members    get consent.                                    [½]

              What are the alternatives?                                                           [½]

                  Total closure, with DC only who has power to initiate this.                      [½]
                  Winding-up who has power to initiate this.                                       [½]
                  Would either measure be in the best interests of actives.                        [½]
                  Possibly very detrimental in case of Fund A members.                             [½]

              Past Benefits

              Is the security of members benefits improved by the merger.                          [½]
              A     Definitely but NRA to be 65 not 63 and also issue of member
              surplus account, B      Less clear cut because of R50m.                              [½]
              How has the R50m special contribution been arrived at?                               [½]
              What is the overall funding level of merged arrangement on a
              realistic basis.                                                                    [½]
              Effect of shortfall in A will be eliminated by R50m special
              contribution.                                                                       [½]
              Are past benefits to be maintained on full salary link basis
              company proposals suggest CPI revaluation for future.                               [½]
              Are past benefits to be restructured on a basis of equivalent value
              section 14 considerations      again plan looks to be CPI revaluation.              [½]

              Surplus apportionment issues

              What is status of member s surplus account in A        can it be
              withdrawn and set against shortfall.                                                [½]
              Was there an employer surplus account in A that has been used
              already in reduction of shortfall.                                                  [½]
              What is reason for delay of surplus apportionment exercise in B.                    [½]
              Have commitments to former members in B been fully determined.                      [½]
              And what is B s obligation in terms of surplus at last statutory
              valuation    is current surplus sufficient for those obligations.                   [½]
              What are surplus apportionment rules or decisions for future service
              in both A and B.                                                                    [½]

              Revaluation issues

                  How will revaluation proposal actually work?                                    [½]

              What are the company s (sponsoring employer to merged fund and
              ultimate parent) plans for future funding. Commitment, strength of
              covenant etc.                                                                       [½]




                                                                                               Page 3
  Subject SA4RSA (Pensions and other Benefits Specialist Applications)   April 2006   Marking Schedule


                 Overall

                 Take legal advice.                                                                 [½]
                 Take actuarial advice                                                              [½]
                                                                                               [Up to 8]

         (iii)   Outline the issues the actuaries must consider in fulfilling the
                 statutory requirements of transfer and any other factors they should                [4]
                 take into consideration.
                 Is merger proposal reasonable and equitable and will it accord full
                 recognition to:                                                                    [½]
                 (1) rights and reasonable benefit expectations of members in each
                        fund for past service pre and post merger                                   [½]
                 (2) any additional benefits (pension increases) payment of which is
                        established practice; and                                                   [½]
                 (3) payment of minimum benefits                                                    [½]
                 The merger is unlikely to render receiving fund financially unsound                [½]
                 or, if A, prevent it from attaining a financially sound condition
                 timeously.                                                                         [½]
                 because of the R50m proposed payment.                                              [½]
                 Actuary to ceding fund to also consider any other aspects of rules of              [½]
                 receiving fund that might be less advantageous in receiving fund.
                 Such as commutation or winding up provisions.                                      [½]
                 He could suggest the use of guarantees to be applied to transferees
                 only.                                                                              [½]
                 And the need for legal advice.                                                     [½]
                 Both actuaries might wish to consider the future funding
                 commitment from sponsor to merged plan.                                            [½]
                 Note: it is possible that surplus apportionment issues will be
                 mentioned in this sub-part too, but clearly marks can be awarded
                 only once for those points.
                                                                                               [Up to 4]

         (iv)    Discuss the impact of the proposed changes from the employed members
                 viewpoint and comment on which of the two benefit scales is likely to be the
                 more popular choice.                                                       [7]

                 Past service: accrued leaving service benefits unaffected.                         [½]
                 And minimum benefit technically unaffected                                         [½]
                 Assume death benefits unchanged.                                                   [½]

                 NRA: A impaired B same.                                                            [½]
                 Adjustment for two years late should be considered for A s existing
                 members     not required for future members.                                       [½]

                 Pensionable Salary:
                 B members lose the bonus element.                                                  [½]
                 Salary adjustments should be considered.                                           [½]
                 But need to harmonise salaries in any event.                                       [½]



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Subject SA4RSA (Pensions and other Benefits Specialist Applications)   April 2006   Marking Schedule


             And so possibly adjustment to B benefit for existing B members
             only.                                                                                [½]

             Contributions: But as lower Pensionable Salary also used for
             contributions, then mitigates above effect.                                          [½]

             A: 7% to 7.5% increase is small but maybe important in eyes of
             members.                                                                             [½]
             B: 6% to 7.5% is much larger increase and problematic.                               [½]
             Some adjustment should be considered for both A and B existing
             actives.                                                                             [½]

             Revalued Career Average

             Merit, productivity and promotional increases, and general salary                    [½]
             inflation that is not linked to CPI will be forfeited
             But those members whose earnings only increase at rate close to CPI,
             may feel little downside.                                                            [½]

             And in engineering sector perhaps majority of salaries broadly only
             inflation linked.                                                                    [½]

             However, executives / managers / specialised staff and any so-called
             high fliers most affected                                                            [½]
             For them there may need to be some adjustment to compensate.                         [½]


             Basic Salary on 1 April

             This could be disadvantageous to A and B                                             [½]
             Because increases in year ignored    hence ignored in revaluation                    [½]
             But also means contribution increases only once a year                               [½]
             A and B salary increase dates need to be harmonised.                                 [½]

             Option to choose 2% or 1.6% accrual

             Given above comments most A members would probably stay on 2%
             for a similar contribution amount.                                                   [½]
             If no compensating adjustment for existing B members, then more
             might opt for 1.6% rate to keep contribution amount similar.                         [½]
             However those who place a high value on defined benefits will opt to
             stay on 2%.                                                                          [½]
             It will be good governance to illustrate effect of changes.                          [½]
             This will highlight the problems with the proposals.                                 [½]

             General

             A actives employed as artisans may see the deal as acceptable.                       [½]
             Although there could be problem in regard to NRA 65.                                 [½]
             There is likely to be problems in regard to existing B actives.                      [½]


                                                                                               Page 5
  Subject SA4RSA (Pensions and other Benefits Specialist Applications)   April 2006   Marking Schedule


               Who give up more than A actives.                                                     [½]
               Difficult to justify given that Fund B is financially sound                          [½]
               And that there may be substantial surplus accounts.                                  [½]
               Also problems for all staff not in artisan category                                  [½]
               Thus it may not be possible to implement restructure without quid
               pro quo s .                                                                          [½]
                                                                                               [Up to 7]


         (v)   The chief financial officer (CFO) of the parent corporation currently
               acts as a trustee to both Funds A and B.
               (a)     Outline his general responsibilities and duties as a trustee.           [3]
               (b)     Comment on any areas of potential conflict of interest for the
                       CFO.                                                                    [3]
               (c)     Suggest ways in which any conflict could be minimised.                  [2]
                                                                                     [Sub-total 8]
               (a)
                            Administer fund within Rules.
                            Operate within Trust Law.
                            Operate within Legislation.
                            Act in the interests of the beneficiaries.
                            Act prudently / honestly / not for profit.
                            Seek specialist advice where appropriate.
                            Strike a fair balance between the interests of different
                            classes of beneficiary.
                            Invest the fund assets, safe custody.
                            Maintain confidentiality.
                            Exercise discretionary powers.
                            Meet regularly and maintain proper minutes.
                                                                                 [½ each, up to 3]

                (b)     Possible conflict between the 2 sets of trustees.                           [½]
                        If merger perceived as better for one fund than other.                      [½]
                        Difficult to act for both sets of members impartially.                      [½]
                        Conflict with CFO role.                                                     [½]
                        Where he will look to control costs.                                        [½]
                        So reduction of benefits is good in this respect.                           [½]
                        May wish to reduce the amount of the special contribution
                        (incentive for the trustees to agree to merger). Set special
                        contributions and future funding on a weaker basis, leading
                        to less member security.                                                     [1]
                                                                                               [Up to 3]

                (c)     Resign as a trustee to both funds.                                          [½]
                        Do not participate at trustee meetings for project duration.                [½]
                        Attend trustee meetings but do not vote on the merger
                        proposals or attempt to influence.                                          [½]
                        Confine input to trustees to information and employer
                        motivation for change.                                                      [½]



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Subject SA4RSA (Pensions and other Benefits Specialist Applications)   April 2006   Marking Schedule


                      Resign as CFO (unlikely).                                                   [½]
                      Appoint an independent trustee as a temporary replacement.                  [½]
                                                                                            [Up to 2]
                                                                                       [Total up to 8]

     (vi)    At the last valuation dates the asset allocation was:
             Fund A: 60% equities, 40% bonds;
             Fund B: 75% equities, 15% bonds, 10% cash.
             Outline key issues for strategy going forward.                                        [5]


             The active member liabilities were 23% of total for A and 24% of
             total for B.
             However, matching difficulties exist in SA.
             Small inflation-linked bond market & very low turnover.
             Not a good spread by duration of either long nominal RSA bonds or
             long inflation-linked RSA bonds.
             That said, the current strategy for B definitely appears to be
             overweight in equities.
             And possibly a little on high side for A.
             Bond exposure in B appears far too low.
             And B s cash holding is possibly moderately high.
             Although not greatly in excess of liability to former members.
                                                                            [½ each, up to 2]

             In considering strategy going forward, need to look at:
                 combined liability profile
                 statement of investment principles
                 cashflow requirements
                 high pensioner liability and low actives so may be net negative
                 cashflow
                 attitude to risk of both trustees and employers
                 use R50m contribution in rebalancing asset allocation
                 strength of covenant of sponsor
                 possibly more index-linked benefits going forward with revalued
                 career average
                 but existing salary related liabilities might also be mainly
                 inflation driven than merit etc. (given suspected artisan make-up)
                 consider manager review or review of mandates
                 is there need to hedge assets for former members or for
                 members surplus accounts?
                                                                                    [½ each, up to 3]
                                                                                           [Up to 5]
                                                                                     [Total up to 37]




                                                                                               Page 7
    Subject SA4RSA (Pensions and other Benefits Specialist Applications)   April 2006   Marking Schedule



2        [½ mark per bullet point except where stated]

         (i)      The HR director has asked you to comment on the proposed design. Set out
                  the points that you would make in your response, highlighting how well the
                  following design objectives will be met:                                 [11]

                  Improving recruitment and retention                                            [Up to 5]

                      Assuming no compensating cuts in remuneration package, pension fund
                      should make overall package more attractive.
                      But will workforce appreciate the value of a pension fund?
                      Or prefer extra direct remuneration, as option instead of fund?
                      Communication will be important to emphasise the value of the fund.
                      There is some flexibility in design    could be more.
                      It is simple to understand.
                      Although level of benefits will be modest.
                      Especially death in service (particulary if service not long).
                      Age related contribution scale may be regarded as unfair.
                      But proposed scale itself not adequate in dealing with problem of
                      increasing cost of benefits as age increases.
                      Is fund competitive for this sector?
                      Compulsory member contributions might be unattractive.

                  Meeting the budget set by the FD                                              [Up to 4]

                      Overall costs initially depend on take up by existing staff.
                      But, Income Tax Act requires compulsory membership for new
                      employees.
                      And so in a few years (depending on staff turnover) take up not an issue.
                      Compulsory member contribution might mean initial take up is less than
                      100%.
                      Depends on take up of over 45s compared to under 45s.
                      If age/salary profile is evenly spread then likely to be within budget.
                      Have initial and ongoing expenses been allowed for.
                      Cost issues related to longevity and investment guarantees implicit in
                      conversion rates set by Trustees could pose problems for budget in longer
                      term.
                      Because of minimum benefits in terms of Pension Funds Act there will be
                      no profits on withdrawal or death in service to help finance Fund.
                      And because of minimum pension increase provisions of Pension Funds
                      Act no profits could emerge here to help financing.
                      Can budget be afforded in future years? Would not be easy to reduce
                      contribution scales in future.

                  Managing risk for the Company                                                 [Up to 2]

                      DC places traditional DB risks before retirement onto members.
                      But risk of imbalance between members under & over 45.


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Subject SA4RSA (Pensions and other Benefits Specialist Applications)   April 2006   Marking Schedule


                  Longevity and investment risks post-retirement could cause a shortfall to
                  emerge in Fund      hence risk of additional employer funding required.
                  Hence need to ensure these risks are priced appropriately on ongoing basis.
                  Risk of cost increases for administration and actuarial and for fidelity &
                  professional indemnity insurance eliminated by gross employer rate of 6%.
                  Risk that members are disappointed with ultimate benefits achieved.
                                                                                           [11]

     (ii)     Suggest some modifications to, and other issues that should be considered in
              regard to, the design that would help to alleviate some of the difficulties that
              you have identified in each of the three areas in (i) above:                   [5]

                  Allow flexible retirement ages.
                  Avoid having compulsory member contributions            but that will mean
                  higher employer rate will be required for meaningful benefit.
                  Have a level contribution rate for all members if subsidisation is an
                  issue.
                  But this will not address aspect of increasing benefit costs with increasing
                  age, which requires contribution scale increasing with age.
                  Question implies that ongoing expenses will be deducted from members
                  funds.
                  Make annuities of choice with insurers at retirement in members names
                  obligatory.
                  But insurers have many margins        also possibility of commissions to
                  third parties   hence aggravates problem of inadequate level of benefits.

              Other points

                  Investigate employees preferences in regard to a pension or provident
                  fund and contribution rate and benefits including risk benefits.
                  Tax efficient to have member contributions up to 7.5% in a pension fund.
                  But tax advantageous before retirement to have all contributions paid by
                  employer if provident fund.
                  Risk benefit costs can be prohibitive, especially in AIDS affected
                  industries, leaving too little contribution for retirement saving.
                  Allow additional voluntary contributions.
                  Likely inadequate level of benefits can only be addressed by higher
                  contributions.
                  And part of risk of disappointment in ultimate benefits can possibly be
                  addressed by investment guarantees, but at expense of lower returns.
                  It is assumed defined benefits will not be considered by employer.
                                                                                     [Up to 5]

     (iii)    List the key requirements of the following Myners Principles:

              Effective decision making                                                            [3]

                  Trustees should have necessary skills individually and collectively.
                  Decisions should only be taken by people with necessary skills.


                                                                                               Page 9
  Subject SA4RSA (Pensions and other Benefits Specialist Applications)    April 2006   Marking Schedule


                    Trustees must have sufficient skills/training to evaluate any advice given.
                    Trustees need sufficient in-house support on investment matters.
                    Trustees should be paid.
                    An Investment sub-committee should be set up to provide focus.
                    Trustees should have a forward looking business plan.

                 Clear objectives                                                                     [1]

                    Trustees should consider & publish characteristics of each investment
                    option on offer.
                    Trustees should take members circumstances into account when choosing
                    range of funds to offer.
                    Trustees should offer a sufficiently wide range of investment options for
                    members to invest in to satisfy risk & return criteria of most members.

                 Performance measurement                                                              [1]

                    Trustees should set investment policy objectives and measure success
                    against those objectives.
                    In regard to the performance of each option.
                    Their own performance.
                    And performance of their advisers.
                                                                                                      [5]

          (iv)   Using only the information provided in this table calculate the described
                 disclosures for a benefit statement with an effective date at the Launch Date
                 for the following two members:

                    A member who joins the fund on the Launch Date (which is his 35th
                    birthday), whose basic pay is R150 000 p.a. and who chooses to invest his
                    DC fund 100% in equities.

                    A member who joins the fund on the Launch Date (which is his 50th
                    birthday), whose basic pay is R250 000 p.a. and who chooses to invest his
                    DC fund 100% in cash.                                                 [8]

                 For 35 year old joiner

                 Joint contributions in years 1 to 10 inclusive = 10% basic salary                   [½]
                 Joint contributions in years 11 to 30 inclusive = 12% basic salary                  [½]
                 Accumulate at (9% pa less 1% for expenses) = 8% p.a. to age 65                      [½]
                 a10 @ 8.0 / 7.0 = net 0.93458% discount rate = 9.549                                [½]
                 a20 @ 8.0 / 7.0 = net 0.93458% discount rate = 18.250                               [½]
                 10%   R150 000 9.549 1.0830                                                         [½]
                       + 12% R150 000 1.0710                18.250       1.0820                      [½]
                 = 1 441 325 + 3 011 953
                 = 4 453 278                                                                         [½]




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Subject SA4RSA (Pensions and other Benefits Specialist Applications)   April 2006   Marking Schedule


              Convert to pension (i.e. 17)                                                        [½]
              = R261 958 p.a.                                                                     [½]
              Salary at 65 = 150 000 1.0730 = R1 141 838 p.a.                                     [½]
              Replacement ratio = 261958/1141838 = 22.9%                                          [½]

              For 50 year old joiner

              Joint contributions in years 1 to 15 inclusive = 12% basic salary                   [½]
              Accumulate at (6% pa less 1% for expenses) 5% p.a. to age 65                        [½]
              a15 @ 5.0 / 7.0 = net negative 0.018692% discount rate = 17.338                     [½]
              12% R250 000 17.338 1.0515 = 1 081 334                                              [½]
              Convert to pension (i.e. 17)                                                        [½]
              = R63 608 p.a.                                                                      [½]
              Salary at 65 = 250 000 1.0715 = R689 758 p.a.                                       [½]
              Replacement ratio = 63608/689758 = 9.2%                                             [½]

     (v)      The HR Director is wondering whether to provide an enhanced annual benefit
              statement to include both of the described disclosures and some additional
              disclosures. He has asked for your advice.                                 [12]

              (a)     Set out the limitations of providing the described disclosures only.
                      But see comment regarding repeated points for caveats in (b) below.

                           Provides an illustration to assist members with financial planning
                           for retirement.
                           But a member may choose an annuity that is not in the prescribed
                           form (e.g. pension increases, spouse s benefits).
                           And cost of annuities is likely to be different in practice from those
                           in table.
                           Does not give a member any idea of the sensitivity of the
                           projection to the assumptions in that:
                           - Investments may not perform as expected in long term.
                           - Moreover, short term movement in equities can cause
                               substantial change in value.
                           - With potential for grave concern if close to retirement.
                           - Salary may not increase as assumed.
                           - Contributions may not be paid as expected.
                           Hence, statement gives member no concept of the risk he bears.
                           Differential assumptions for performance of different asset classes
                           are not provided.
                           They may influence members investment choices.
                           A member needs indication of the additional saving he requires in
                           his private arrangements.
                           A member needs to consider his needs for risk cover.
                           Statement needs to show current Fund value.
                           Statements will be out of date by the time members receive them.




                                                                                              Page 11
  Subject SA4RSA (Pensions and other Benefits Specialist Applications)   April 2006   Marking Schedule


                (b)     List the additional caveats that you would wish to include
                        alongside the described disclosures.

                        These immediate following 6 points in italics are already points above
                        and should not be allowed to score twice.
                           Valid only at effective date.
                           Provides a guide to benefits, not a quote/guarantee.
                           Investments will not necessarily perform in line with assumptions.
                           Salary growth will not necessarily be in line with assumptions.
                           Small changes in the assumptions adopted can lead to large
                           variation in the results.
                           Cost of annuities will depend on level of increases and spouse s
                           benefits chosen.

                             Expense allowance may need to change in the future.
                             Cost will also depend on nominal and real interest rates at time of
                             retirement and on mortality bases considered appropriate at that
                             time.
                             A member might need to consider what additional saving he will
                             need and he might need to seek independent advice.
                             State benefits are minimal, and focused on the indigent, in SA and
                             so you should not rely on any supplementation from this source.
                             Assumes nil AVCs and no changes in member and company
                             contributions.

                (c)     Make some suggestions for the additional disclosures that might be
                        appropriate on an enhanced benefit statement.

                        Some points here should not count if already scored above in (a) or
                        (b).

                             Illustrate different investment options, but with cautionary about
                             risk.
                             Possibly with brief explanation why different asset classes can be
                             expected to give different returns.
                             Give clear statement/indication of risks (investment returns,
                             inflation, mortality, expenses).
                             Important for members to understand that cash and bonds also have
                             risk.
                             Clear statement of all assumptions.
                             Provide figures on a range of investment assumptions (e.g. to show
                             the impact of +/ 1% change in these).
                             Provide figures on a range of salary growth assumptions.
                             Provide figures using a range of annuity options.
                             Provide figures at an early retirement date.
                             Current fund value relative to a needs based value where needs
                             defined in some practical way for risk cover.
                             Provide stochastic illustration of results (funnel of doubt).



Page 12
Subject SA4RSA (Pensions and other Benefits Specialist Applications)   April 2006   Marking Schedule


     (vi)     Repeat the calculations in (iv) twelve months after the Launch Date for the 35
              year old joiner, listing any additional assumptions that you need to make. [5]

              Additional assumptions needed:                                           [½ mark each]

                  Ignore dividend income on equities.
                  Investment managers (and therefore DC funds) have performed in line
                  with market.
                  Salary increases midway through year in line with assumptions.
                  Market value falls in equities occurred evenly through year.
                  Expense deduction was actually 1% of fund value per annum.
                  No change in investment strategy during the year.

              For 35 year old joiner

              Fund value at end of year 1
              = 10% 150 000 1.07½ 0.75½ 0.99 = 13 303                                             [½]
              Accumulate at (8% p.a. less 1% for expenses) 7% p.a. to age 65                      [½]
              a9 @ 7.0 / 7.0 = net 0% discount rate = 9.000
              a20 @ 7.0 / 7.0 = net 0% discount rate = 20.000
              13303   1.0729 + 10% 150 000 1.07 9.0 1.0729
                     + 12% 150 000 1.0710 20.000 1.0720                                           [½]
              = 94 641 + 1 027 654 + 2 740 412
              = 3 862 707                                                                         [½]
              Convert to pension (i.e. 19)                                                        [½]
              = R203 300 p.a.                                                                     [½]
              Replacement ratio = 203300/1141838 = 17.8%                                          [½]

     (vii)    Set out the points that you would include in a letter to the HR Director
              explaining the results of your benefit statement calculations and the
              implications for communicating with members twelve months after Launch
              Date.                                                                    [5]

                  Essential to include some explanatory literature with this year s statements
                  because projected pensions at NRA are lower than shown last year.
                  This is due to:
                  - Investments have not performed in line with assumptions.
                  - In particular 25% fall in equity market values over whole year.
                  - Which accounted for about 13% of overall lower results.
                  - And fall in expected future returns for both equities and cash
                  - Although fall in bond yields would have given good returns for
                     members with portfolios geared to bonds.
                  - Moreover, cost of annuities has increased by 10%.
                  - Reflecting a fall in future yields (assuming no mortality changes).
                  Impact is worst for those members furthest from NRA.
                  Impact is worst for those members invested in equities.
                  But members with long term horizons can possibly hope for a recovery in
                  equities.



                                                                                              Page 13
  Subject SA4RSA (Pensions and other Benefits Specialist Applications)   April 2006   Marking Schedule


                    Members could be assured that all contributions were paid and invested.
                    Might want to offer face to face communication/helpline for members who
                    are concerned.
                    Is investment performance down due to market performance or poor
                    manager performance?
                    Those invested in cash portfolios might want to consider switch of part of
                    programme into equities or bonds, because:
                    - Cash returns very low relative to inflation.
                    - And equity portfolios after 25% fall might now be offering better
                        relative value even on a risk adjusted basis  this view might need to
                        be tested.
                    - Bonds likely to be offering more than cash need to look at different
                        duration portfolios.

       (viii)   Outline the points that you would make in your response, concentrating on the
                following aspects:                                                       [12]

                Whether the introduction of these underpins is likely to improve or
                worsen the chance of the fund meeting the three design objectives set out
                in part (i) above.                                                      [6]

                    Option of underpins might make fund more attractive.
                    In that it would improve member security.
                    And help to lessen risk.
                    But members might see any additional contribution as a negative factor.
                    However, the defined benefit minimum has immediate apparent value for
                    both the 35 year old and the 50 year old member, seeing as it offers
                    minima of 30% and 15% replacement ratios, respectively.
                    Other employers unlikely to be offering anything similar      these types of
                    underpins are rare, especially investment guarantee.
                    Company will very likely incur extra cost unless excessively cautious
                    pricing of options.
                    Pricing will need to be reviewed on a regular basis.
                    And, in case of minimum 0% return in each year, reviewed at frequent
                    intervals depending on approach to pricing and willingness of employer to
                    participate in meeting costs.
                    Protects Company from risk of members becoming disgruntled about the
                    level of risk in DC funds.
                    But with downside of price for the options if Company s risk is to be zero.
                    Care needed re selection against fund     need to think carefully about
                    whether members should only have a one-off choice to select an underpin.
                    Guarantees of this nature not viable proposition if too few select them.
                    There will be minimum benefit implications and complications.
                    Costs of running fund likely to increase with increased complexity.
                    Risk that members will invest their funds more aggressively once they
                    have paid for the underpin.
                    Effect of underpins will need to be included on annual benefit statement.




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Subject SA4RSA (Pensions and other Benefits Specialist Applications)   April 2006   Marking Schedule


              How you would estimate the cost of each underpin                                     [4]

              Investment return min 0%

                  Examine statistical data on market returns in different sectors.
                  Stochastic modelling of assets to understand probability of negative
                  returns occurring in any particular year.
                  Impossible to calculate cost exactly.
                  Separate modelling needed for each asset class.
                  Look at costs of options on continuous, or rolling, basis    but very
                  expensive this way, and costs of options changes over time.
                  Look at costs of zero-cost collars on continuous, or rolling, basis.
                  And not possible to give firm commitment to members about option price
                     will vary as financial conditions vary.
                  Note the cost will be higher than the cost of a capital guarantee because
                  return is guaranteed at minimum zero in every year.

              DB underpin

                  Stochastic modelling needed to assess how likely underpin is to bite.
                  Deterministic modelling indicates that underpin is likely to bite for all
                  members.
                  Cost will vary by age of member.
                  Past service shortfalls could emerge periodically they will have to be
                  funded.
                  Surpluses may similarly emerge       need to consider how such will be
                  managed.
                  Impossible to calculate cost exactly.
                  Again possibility of using options and zero-cost collars to reduce
                  possibility of serious shortfalls  but again with associated cost issues.

              How you would structure the underpin charge to members                               [1]

              Investment return min 0%

                  Charges need to reflect investment choices made.
                  Charges need to err on cautious side to reduce Company exposure to risk.
                  Pass on additional running costs.

              DB underpin

                  Charges should be age-related (at least banded by age).
                  Charges need to err on cautious side to reduce Company exposure to risk.
                  Pass on additional running costs.




                                                                                              Page 15
  Subject SA4RSA (Pensions and other Benefits Specialist Applications)   April 2006   Marking Schedule


                How the funding and investment strategy of the fund might need to
                change as a result of introducing these underpins                                    [1]

                    Actuary will need to advise about reserves required to fund underpin.
                     Pay as you go basis would not be acceptable to Registrar.
                    Company will want some say in investment strategy relating to additional
                    reserves.
                    And possibly also in relation to basic liabilities.
                    Might wish to restrict range of fund choices offered to members (e.g.
                    remove very volatile asset classes).
                                                                                    [Total 63]


                          END OF MARKING SCHEDULE




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