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Pensiones 1

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Department of Actuarial Mathematics and

Statistics

School of Mathematical and Computer

Sciences

Heriot-Watt University

Term III, 2006/07

the time he/she ceases full time employment

for the rest of his/her life. The pension can

be paid by an insurance company, the worker's

employer and the government. In this chapter,

I will provide an introduction to the concept

of pension funds and the mathematics of pension funds. You will learn the basic underlying

mechanisms of various pension funds and how

to perform simple calculations involving pension benets. More advanced topics and practical details about pension funds will be covered in the fourth year pensions module and

professional examinations. The outline of this

chapter is listed as follows:

Outline of Chapter 1

and their variants

Section 1.2: Valuation of the liabilities

Section 1.3: Valuation by commutation functions

Reference: Part III Pension Funds by M. R

Hardy and M Willder

pension funds and their variants

A Pension is an income paid to someone

from the time he/she ceases full time employment for the rest of his/her life

Question: Why are pensions important?

About 40% actuaries work in pensions

Pension funds account for signicant per-

Insurance company: Premiums (e.g. Per-

sonal pensions)

OPS

Pension (BSP))

Both the employer and the employee

Deferred pay

people receive?

Same as salary?

Half of salary?

A xed amount to employee per annum,

Higher wages can aord higher contri-

retirement

wages

Explanations:

Living costs are lower in retirement (e.g.

o)

years of service (N). How?

The longer an employee's years of ser-

retirement

NS

= 60

at

targets on two-third of salary

N = 40

years

tirement

40 S = 2 S

= 60

3

at re-

an OPS?

Age Retirement => Immediate Pension

+

Lump Sum

+

Spouse's Pension

=>

Lump Sum

Deferred

Pension or Return of Contributions

=>

Remarks:

Pensions are not only paid on age re-

tirement

DBS is an OPS where the benets are

num

N Average Salary

Example 2: Pension = 80

Current Salary

= 4

but we know how to evaluate it from a

formula

based on salary at retirement

Varying benets depending on the value

Another name: Money Purchase

Pensionable Salary

Salary used to calculate the contributions and benets

Example: Pension salary = Basic salary

salary received in the three years prior

to retirement

liabilities

Objectives:

Calculate the amount of money we need

(i.e. reserve)

promise on the benets (i.e. premiums

or contributions)

Active (a)

Active (a)

Active (a)

Dealth (d)

Active (a)

Withdrawal (w)

Service Table

A multiple decrement table with the decre-

and

wx, where l is the radix of the table

associated with the entry age

rx, ix, dx

Notation:

Dier from standard multiple decrement

notation

x

x+t

aa

aa

tpx = lx = tpx

| In service at age

r

x+tx+t+1

ar

x) = tpaa

x 1 px+t

= x+t

lx

x + t x + t + 1 | In

ix+t

ai

= tpaa

p

=

1 x+t

x

lx

service at age x)

ad = dx+t

service at age x) = tpaa

p

1 x+t

x

lx

| In service at age x) =

wx+t

lx

aa

aw

tpx 1 px+t

Tables (Page 90)

Remarks:

Lecture notes and tutorials: Yellow Tables

Past examination papers: Green Tables

Examination: Yellow Tables

In real situations, every scheme is dif-

Green Tables, Page 90): Qualitative Analysis

Withdrawal: Probability is initially high,

Age retirement

Normal retirement age (NRA) = 65

Everyone must retire

Normally retire by age 65

Early retirement: Allowed from 60 to 65

Salary Scale

OPS benets are related to salary

Salaries increase over time due to

1. Ination

2. Promotion

3. Merit

4. Experience

A promotional salary scale,

sx

is set up

sx+t

sx

Salary Earned x + t x + t + 1

Salary Earned x x + 1

provided that the employee is in service

in the entire period

= E

salary scale in the Yellow Tables, calculate the expected salary earned between

1. 19 and 20

2. 40 and 41

Solution:

s18 =

s19 =

s40 =

20 =

2. The expected salary between 40 and

41 =

rate

Salary Earned: The amount paid over a

time interval

payment

and x + t

Z t

0

(Salary

x+1

x and

x + 1/2

age 30 is 20,000 and salary rate increases by 4,000 at age 30.75. Calculate the salary earned between ages 30

and 31.

Solution:

=

The scheme rules will specify the pen-

or past salaries

sx2 + sx1)

y = Age

at retirement

x = Current

n=3

x1x

age

Then,

=

Expected FPS

!

sy1

sy2

sy3

1

SAL

+ SAL

+ SAL

SAL

sx1

zy

sx1

sx1

sx1

commutation functions

Invented in the 18th century

Simplify the calculation of numerical val-

a deterministic model

insurance models based on probability

theory

Life annuities

Dx = v xlx

survivors

= Discounted number of

Nx = Dx + Dx+1 + Dx+2 . . .

Sx = Dx + 2Dx+1 + 3Dx+2 = Nx +

Nx+1 + Nt+2 + . . .

Life insurance

Cx = v x+1dx

deaths

= Discounted number of

Mx = Cx + Cx+1 + Cx+2 + . . .

Rx = Cx +2Cx+1 +3Cx+2 + = Mx +

Mx+1 + Mx+2 + . . .

x

Recall that Ax = M

Dx and that (IA)x =

Rx

Dx

Accruals basis: Account for the benets

paid

2. Future service accrual

Example: An OPS provides a pension of

FPS for each year of service. Suppose a member joined this scheme aged

x and he is now aged y . Assume the

NRA is 65. What is the member's

1. past service pension ?

1

60

Solution:

Past Service = y x

The member has already earned a pension of yx

60 FPS, which is payable

from age 65

Suppose the future service is F

Then, the member will earn a pension

F FPS, where y + F is the age

of 60

when the member leaves the service

or scheme

Note that F

[0, 65 y]

FPS is the average salary earned in the

Accrual = 60

60

is earned each year for each year of ser-

vice)

Member

x =

n =

SAL

NRA

Current age

Past service

Salary earned

= 65

General rule:

past service benets paid in year t t+

1 (t < 65 x)

Discount

= Amount Probability

the year

n SAL zx+t+0.5

Past service pension = 60

sx1

Probability

= x+t

lx

Discount factor

x+t+0.5

= v t+0.5 = v v x

Therefore,

!

EP V

zx+t+0.5

n

SAL

=

60

sx1

!

r

arx+t+0.5 x+t

lx

!

v x+t+0.5

vx

z C ra !

n

x+t

=

SAL

,

60

sx1Dx

and Dx = vxlx by the convention of

commutation functions

paid on retirement at age x + t

When

x + t < 65,

!

EP V

When

z

n

SAL x+t+0.5

60

sx1

!

rx+t

r

ax+t+0.5

lx

!

x+t+0.5

v

vx

z C ra !

n

x+t

=

SAL

60

sx1Dx

x + t = 65,

!

n

z65

EP V = =

SAL

ar65

60

sx1

!

!

65

r

v

65

lx

vx

!

z

ra

C65

n

=

SAL

,

60

sx1Dx

ra = z

where z C65

ar65 r65 v 65

65

Remarks:

Retirement at age 65 is at the exact age

Retirement before age 65 occurs at age

x + t + 0.5

Equal to past service liability

P

65x z ra !

Cx+t

t=0

n

SAL

60

sx1Dx

!

z

ra

Mx

n

=

SAL

,

60

sx1Dx

t=0

x+t

vention of commutation functions

the formula for the past service liability?

Solution:

=

Future service

Retirement can occur at any age y, where

x < y 65

1,

x+ 2

year's benet

1

2

one

Then,

=

!

z

64

1

X

y+ 2

1

ar 1

SAL

y+

60

y=x

y+ 1 !

sx1

!

z

1

1 x+

ry

v 2

r

2

a

1

x+ 2

lx

vx

2 sx1

!

!

!

1

z65

rx

r65

r

2

v +

a65

lx

sx1

lx

#

v 65x

=

SAL

where

P64 z ra

1 z C ra + z C ra !

C

y=x

y

x

65

2

60

s

Dx

!

! x1

!

1

1

z Mxra z Cxra

60

sx1Dx

2

z M ra = P65 z C ra

x

y=x

y

SAL

Write

zM

xra = z Mxra 1 z Cxra

2

Then,

=

! accrual

1

SAL

ra

zM

60

sx1Dx

Hence,

FSL

64x

X

SAL

1

zM

ra

x+t

=

60

sx1Dx

t=0

!

1

SAL z Rra ,

=

x

60

sx1Dx

zM

ra

where z Rxra = P64x

t=0

x+t

the nal year of accrual is the year from

age 64 to 65

Rx

n = 10. Calculate the past service liability

(PSL) and the future service liability (FSL)

for age retirement using the Yellow Tables

with 4% rate of interest

Solution:

PSL =

FSL =

Ill-health retirement

The EPV of past service benets paid

in year t t + 1

!

z

n

SAL x+t+0.5

aix+t+0.5

60

sx1

!

ix+t

v t+0.5

lx

!

z C ia !

n

x+t

=

SAL

60

sx1Dx

1 per annum from age y

Then,

!

P64x z ia !

Cx+t

t=0

n

SAL

60

sx1Dx

!

!

z

ia

n

Mx

=

SAL

,

60

sx1Dx

where i65 = 0

P SL =

Also,

F SL

z M ia 1 z C ia !

64x

X

1

x+t

x+t

2

SAL

=

60

sx1Dx

t=0

P64x z ia !

M

t=0

x+t

1

=

SAL

60

sx1Dx

!

z

ia

x

R

1

SAL

=

60

sx1Dx

Pension of P per year of service per

annum

tt+1

ix+t

i

= nP

ax+t+0.5

lx

ia !

Cx+t

= nP

Dx

v t+0.5

P SL = n P

= nP

ia !

64x

X Cx+t

t=0 Dx

!

ia

Mx

Dx

F SL = P

= P

ia 1 C ia

Mx+t

2 x+t

64x

X

t=0

!

ia

x

R

Dx

Dx

Cyi = iy v y+0.5

Mxi

P SL = n L ( Dx )

xi

R

F SL = L ( Dx )

(Why?)

(Why?)

Age retirement

If

y < 65 Cyra = v y+ 2 ry

ar 1

y+ 2

If

ra = v 65 r

y = 65, C65

ar65

65

P SL = n

= n

65x

X

ra + LC r

P Cx+t

x+t

Dx

t=0

!

ra

r

P Mx + LMx

Dx

F SL =

=

64x

X

ra + LM

r

PM

x+t

x+t

Dx

t=0

xra + LR

xr

PR

Dx

1

=

Total Salaries in Service

60

1

=

Career Average Salary Service

60

x0 =

P SAL =

P SL =

60

Future Service:

Ill-health

Age retirement

Dx

Ill-health

EPV of future service benets accrued

in ANY future year

X SAL

1 64x

=

sx + sx+1 + +

60 t=0 sx1

!

ix+t

1

i

ax+t+0.5

sx+t1 + sx+t

2

lx

v t+0.5

=

SAL

64x

X

60sx1Dx t=0

ia

Cx+t

sx + sx+1 +

1

+ sx+t1 + sx+t

2

Summation

!

1 ia

ia + + C ia

= sx Cx + Cx+1

64

2

!

1 ia

ia + + C ia

+ Cx+2

+ sx+1 Cx+1

64

2

!

1 ia

+ + s64 C64

2

=

=

64x

X

t=0

64x

X

ia

x+t

sx+tM

sM

ia = s R

x+t

xia

t=0

Hence,

SAL

F SL =

60

sR

xia

sx1Dx

Age retirement:

SAL

F SL =

60

sR

xra

sx1Dx

Contributions:

The employer (and often the employee)

the pension fund

Salary-Related Contributions:

k = Contribution

as a percentage of salary

64x

X

sx+t

k

SAL

100

t=0 sx1

!

!

x+t+0.5

lx+t+0.5

v

lx

vx

!

k

SAL

100

!

=

=

P64x

t=0 sx+tDx+t+0.5

sx1Dx

P64x

x+t

sx+tD

t=0

sx1Dx

P64x s

x+t

D

t=0

sx1Dx

sN

x

k

SAL

100

!

k

SAL

100

!

k

SAL

100

sx1Dx

Fixed Contributions

F = Contribution payable continuously (

per annum)

= F

64x

X

t=0 !

lx+t+0.5

lx

v x+t+0.5

vx

x

N

= F

Dx

143

x

N

Return of Contributions

On death or withdrawal, a return of employee contributions accumulated with

P SL =

k

ASAL

100

j M w +j M d

x

x

(1 + j)xDx

F SL =

k

SAL

100

sj R

xw + sj R

xd

(1 + j)xDx

Check Yellow Tables, Pages 148 149, Page 148 for death and Page

149 for withdrawal, accumulated in-

interest rate i = 4% p.a.

i = 4%

p.a.

x is the current age; PSAL is the salary

earned from x0 to x; RATE is the salary

rate at x. Derive suitable commutation

functions to value an ill-health pension of

1 average salary over member's career,

60

per year of service

Hints:

Construct a service table

Dene a promotional salary scale

Evaluate the EPV of past service bene-

End of Chapter 1

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