International Conference on Statistics and Analytics 2019

Entry Age Normal Method for Defined Benefit Pension Funding

I G A K Shanti1*, M Novita2, S Devila3

1,2,3
Department of Mathematics, Universitas Indonesia, Kampus Baru UI, Depok, 16424, Indonesia.

*)
Corresponding author: kartikashanti@sci.ui.ac.id

Abstract

The employees will reach their normal retirement age, so they will no longer be able to work and

get paid. To make sure they can still fulfill their needs, they can join pension fund and get benefit

when they are retired. There are two kind of benefit they will get, normal benefit and ancillary

benefit. The amount of benefit they will earn can be count with actuarial cost method for defined

benefit pension funding. In this paper, the concern is about one of projected benefit cost method

which is entry age normal method. First, the benefit and the present value of those benefits will be

count. Next, normal cost and the actuarial liability will be count. The data for this paper is using

salaries of civil servant in Indonesia.

Keywords: actuarial liability, ancillary benefit, defined benefit pension fund, entry age normal

method, normal benefit, premium or normal cost

Introduction

People have to work so they will get paid to fulfill their needs. When they are getting older,

their productivity will decrease. Because of that, every company has their own normal retirement
 International Conference on Statistics and Analytics 2019

age. When the employees reach their normal retirement age, they will no longer able to work and

do not have any income to fulfill their needs.

To prevent those things, employees can join insurance program especially pension funding.

Benefit they will get if they join this program are monthly benefit when they reach their normal

retirement age or conditional benefit. Benefit from pension funding divided into four (Aitken,

1996), which are: normal benefit, death benefit, withdrawal benefit, and disability benefit. We call

death benefit, withdrawal benefit and disability benefit as ancillary benefit.

First, we introduce notation that is used in this paper. Normal retirement age denoted with 𝑟.

The entry age of the employees denoted with 𝑒. The amount of benefit employees will get when

they are retiring defined as 𝐵𝑟 . 𝐵𝑟 count by using final average formula. From that benefit, we will

find present value of future benefit depends on what kind of benefit employees will get. There is

a difference between counting 𝑃𝑉𝐹𝐵 for normal benefit and ancillary benefit. The difference is

probability that will be used to count them.

Materials

Pure Endowment

Pure endowment is a life insurance contract which if the policyholders still alive from the

contract is made until certain period of time, then the policyholders will get some sum

insured. Pure endowment denotes as 𝑛𝐸𝑥 , which can be count with:

𝑙𝑥+𝑛
𝑛𝐸𝑥 = 𝑣 𝑛 𝑛𝑝𝑥 = 𝑣 𝑛
𝑙𝑥

Where 𝑣 𝑛 is discount factor, 𝑛𝑝𝑥 is probability that the policyholders will survive from age

𝑥 to 𝑥 + 𝑛, 𝑙𝑥+𝑛 is the amount of people who still survive until age 𝑥 + 𝑛 , and 𝑙𝑥 is the

amount of individual who still survive until age 𝑥.

 International Conference on Statistics and Analytics 2019

To simplify the calculation for the other life annuities, we can write sum notation as:

𝐷𝑥 = 𝑣 𝑥 𝑙𝑥 dan 𝑁𝑥 = ∑𝑤−𝑥−1
𝑡=0 𝐷𝑥+𝑡
𝐷𝑥+𝑛
So, 𝑛𝐸𝑥 can be written as 𝑛𝐸𝑥 = .
𝐷𝑥

Life Annuity

Several life annuities that will be used according to Futami (1963) in this paper are:

1. Whole Life Annuity-due

The life annuity with payments in advance is known as whole life annuity-due. Defined as

follows:
𝑁𝑥
𝑎̈ 𝑥 = 𝐷𝑥

Where 𝑎̈ 𝑥 means payment of 1 at the beginning of the year is carried out as long as the

policyholders is still alive.

2. Term Annuity

Term annuity is payable annually to a life now aged 𝑥 for a maximum of 𝑛 years. Defined

as follows:

𝑁𝑥 − 𝑁𝑥+𝑛
𝑎̈ 𝑥:𝑛|
̅̅̅ =
𝐷𝑥

Where 𝑎̈ 𝑥:𝑛|
̅̅̅ means payment of 1 at the beginning of the year as long as the policyholders

is still alive after 𝑥 + 𝑛 years.

Actuarial Assumptions

In general, according to Standar Praktik Aktuaria Dana Pensiun (SPA DP) Persatuan

Aktuaris Indonesia, actuarial assumptions divided into:

 International Conference on Statistics and Analytics 2019

1. Decrement assumptions, which are assumptions regarding the decrement in pension fund

participants. The assumptions used in this paper are based on the GAM table 1971, where in

the table there are 3 types of decrement correlated on each other, and will be converted to

decrement which are independent (associated single decrement) using the following formula:

(1) ′(1) 𝑞𝑥′(2) + 𝑞𝑥′(3) 2 𝑞𝑥′(2) 𝑞𝑥′(3) 3

𝑠𝑞𝑥 = 𝑞𝑥 (𝑠 − 𝑠 + 𝑠 )
2 3

′(1) ′(3) ′(1) ′(3)

(2) ′(2) 𝑞𝑥 + 𝑞𝑥 𝑞𝑥 𝑞𝑥
𝑠𝑞𝑥 = 𝑞𝑥 (𝑠 − 𝑠2 + 𝑠3)
2 3

(3) ′(3) 𝑞𝑥′(1) + 𝑞𝑥′(2) 2 𝑞𝑥′(1) 𝑞𝑥′(2) 3

𝑠𝑞𝑥 = 𝑞𝑥 (𝑠 − 𝑠 + 𝑠 )
2 3

(1) (2) (3)

Where 𝑞𝑥 , 𝑞𝑥 , 𝑞𝑥 is the amount of individual who is dead because of cause 1, 2, 3 from

′(1) ′(2) ′(3)

age 𝑥 to 𝑥 + 1, and 𝑞𝑥 , 𝑞𝑥 , 𝑞𝑥 is the amount of individual who is dead because of cause

1, 2, 3 from age 𝑥 to 𝑥 + 1, which each other cause are correlated.

2. Salary assumptions, which are the assumption of income for participants in the pension fund

insurance program in the future. However, because the data used in this thesis are civil

servant salary, the amount of salary is known so that it does not require a salary assumption.

In practice, this method is often used when employees work for private companies.

3. Interest assumptions, namely assumptions about the value of money associated with time,

where inflation is one of the causes of the rise and fall of interest rates so that currency values

can change. The interest rate assumption in this paper is assumed to be flat to make

calculations easier.

Fundamental Function of Pension Fund

Benefit function is used to form retirement benefits based on income from pension fund

participants. There are several formulas for calculating benefit functions according to
 International Conference on Statistics and Analytics 2019

Winklevoss (1993): flat benefits, career average benefits and final average benefits. In this

paper, the benefit function used is the final average benefit which is defined as:

1
𝐵𝑟 = 𝑘(𝑟 − 𝑒) (𝑆𝑟 − 𝑆𝑟−1 )
𝑛

Where 𝐵𝑟 is the amount of benefit that the policyholders get when they are retiring (age 𝑟),

𝑘 is salary proportion, 𝑛 is the amount of year, 𝑆𝑟 is the amount of salary in the last year, and

𝑆𝑟−1 is the amount of salary the year before.

Entry Age Normal Method

The steps to get the result:

1. Convert the group annuity mortality (GAM) 1971 into associated single decrement

model. Interest assumption in this paper is 7%.

2. Count the benefit of pension funding from A based on his final average. Assumed that A

join the pension fund at age 28 and will retire at age 58. The salaries will increase 2%

every two years. Proportion from the salaries that will be used to count the benefit is 4%.

3. Count the present value of future benefit (PVFB) based on the benefit, whole life annuity

in his retirement age, and the discount factor.

4. Count the normal cost for both normal and ancillary benefit using entry age normal

method. And then count the actuarial liabilities, valuated when A join the pension fund.

Entry age normal method formulas defined as:

(𝑃𝑉𝐹𝐵)𝑒 = (𝑃𝑉𝐹𝑁𝐶)𝑒

Results

Data Description

The salary data that will be used for the illustration in this chapter is the salary data of civil servants

in Indonesia. In practice, this method is commonly used by private companies, because the
 International Conference on Statistics and Analytics 2019

calculation of pension funds for private companies and government is different. However, due to

various obstacles in obtaining salary data for private company employees in Indonesia, salary data

will be used in this paper are based on Peraturan Pemerintah Republik Indonesia Nomor 15 Tahun

2019 about Civil Servant Salary.

Benefit

The amount of benefit A will get when he is retiring based on final average assumption is:

𝐵𝑟 = 𝑘(𝑟 − 𝑒)𝑆𝑟−1

= 4% (58 − 28)𝑅𝑝32.659.379,45

= 𝑅𝑝39.191.255,33

Present Value of Future Benefit

1. PVFB of Normal Benefit

Using the following equation, PVFB of normal benefit by using the TMI III Male table

with i = 7% is:

(𝑃𝑉𝐹𝐵)𝑒 = 𝐵𝑟 𝑟−𝑒𝑝𝑒(𝜏) 𝑣 𝑟−𝑒 𝑎̈ 𝑟

(𝜏)
= 𝐵58 30𝑝28 𝑣 30 𝑎58
̈

= 𝑅𝑝47.880.880,18

2. PVFB of Spouse Benefit

Using the following equation, PVFB of spouse benefit is:

𝑟−𝑒
𝑠 (𝑃𝑉𝐹𝐵) (𝑠) 𝑁𝑟 𝑘
𝑒 = ∑ 𝑘−1𝑞𝑒 𝐵𝑒+𝑘 𝑣
𝐷𝑒+𝑘
𝑘=1
 International Conference on Statistics and Analytics 2019

30
(𝑠) 𝑁58 𝑘
= ∑ 𝑘−1𝑞28 𝐵28+𝑘 𝑣
𝐷28+𝑘
𝑘=1

= 𝑅𝑝11.474.612,43

3. PVFB of Withdrawal Benefit

Using the following equation, PVFB of withdrawal benefit is:

𝑟−𝑒
𝑤 (𝑃𝑉𝐹𝐵) (𝑤) 𝑁𝑟 𝑘
𝑒 = ∑ 𝑘−1𝑞𝑒 𝐵𝑒+𝑘 𝑣
𝐷𝑒+𝑘
𝑘=1

30
(𝑤) 𝑁58 𝑘
= ∑ 𝑘−1𝑞28 𝐵28+𝑘 𝑣
𝐷28+𝑘
𝑘=1

= 𝑅𝑝106.920.600,55

4. PVFB of Disability Benefit

Using the following equation, PVFB of disability benefit is:

𝑟−𝑒
𝑑 (𝑃𝑉𝐹𝐵) (𝑑) 𝑁𝑟 𝑘
𝑒 = ∑ 𝑘−1𝑞𝑒 𝐵𝑒+𝑘 𝑣
𝐷𝑒+𝑘
𝑘=1

30
(𝑑) 𝑁58 𝑘
= ∑ 𝑘−1𝑞28 𝐵28+𝑘 𝑣
𝐷28+𝑘
𝑘=1

= 𝑅𝑝4.758.270,17

Term Annuity

The value of term annuity counted during A works for the company is:

𝑁𝑒 − 𝑁𝑟
𝑎̈ 𝑒:𝑟−𝑒|
̅̅̅̅̅̅̅ = ( )
𝐷𝑒

= 110, 8754691
 International Conference on Statistics and Analytics 2019

Normal Cost or Premium

Calculations for premium or normal cost will made by giving the following 4 payment

schemes. It has been stated before that participants in pension funds are required to take

insurance programs with normal benefits. As a rider or an addition to the mandatory

insurance program, participants in the pension fund are allowed to take one additional

benefit. From the following 4 premium payment schemes, it can be seen which are the most

beneficial for participants to follow.

1. Premium for Normal Benefit

Premium for normal benefit count using entry age normal method is:

(𝜏) 𝑁𝑒 − 𝑁𝑟
𝐵𝑟 𝑟−𝑒𝑝𝑒 𝑣 𝑟−𝑒 𝑎𝑟̈ = 𝑁𝐶 ( )
𝐷𝑒

(𝜏)
𝐵𝑟 𝑟−𝑒𝑝𝑒 𝑣 𝑟−𝑒 𝑎𝑟̈
𝑁𝐶 =
𝑁 −𝑁
( 𝑒 𝐷 𝑟)
𝑒

𝑁𝐶 = 𝑅𝑝431.843,77

2. Premium for Normal Benefit and Additional Spouse Benefit

Premium for normal benefit with additional spouse benefit count using entry age normal

method is:

𝑟−𝑒
(𝜏) (𝑠) 𝑁𝑟 𝑘 𝑁𝑒 − 𝑁𝑟
𝐵𝑟 𝑟−𝑒𝑝𝑒 𝑣 𝑟−𝑒 𝑎𝑟̈ + ∑ 𝑘−1𝑞𝑒 𝐵𝑒+𝑘 𝑣 = 𝑁𝐶 ( )
𝐷𝑒+𝑘 𝐷𝑒
𝑘=1
 International Conference on Statistics and Analytics 2019

(𝜏) (𝑠) 𝑁𝑟 𝑘
𝐵𝑟 𝑟−𝑒𝑝𝑒 𝑣 𝑟−𝑒 𝑎𝑟̈ + ∑𝑟−𝑒
𝑘=1 𝑘−1𝑞𝑒 𝐵𝑒+𝑘 𝐷 𝑣
𝑒+𝑘
𝑁𝐶 =
𝑁 −𝑁
( 𝑒 𝐷 𝑟)
𝑒

𝒔
(𝑁𝐶) = 𝑅𝑝535.334,76

3. Premium for Normal Benefit and Additional Withdrawal Benefit

Premium for normal benefit with additional withdrawal benefit count using entry age

normal method is:

𝑟−𝑒
(𝜏) (𝑤) 𝑁𝑟 𝑘 𝑁𝑒 − 𝑁𝑟
𝐵𝑟 𝑟−𝑒𝑝𝑒 𝑣 𝑟−𝑒 𝑎𝑟̈ + ∑ 𝑘−1𝑞𝑒 𝐵𝑒+𝑘 𝑣 = 𝑁𝐶 ( )
𝐷𝑒+𝑘 𝐷𝑒
𝑘=1

(𝜏) (𝑤) 𝑁𝑟 𝑘
𝐵𝑟 𝑟−𝑒𝑝𝑒 𝑣 𝑟−𝑒 𝑎𝑟̈ + ∑𝑟−𝑒
𝑘=1 𝑘−1𝑞𝑒 𝐵𝑒+𝑘 𝐷 𝑣
𝑒+𝑘
𝑁𝐶 =
𝑁 −𝑁
( 𝑒 𝐷 𝑟)
𝑒

𝒘 (𝑁𝐶)
= 1.396.174,30

4. Premium for Normal Benefit and Additional Disability Benefit

Premium for normal benefit with additional disability benefit count using entry age

normal method is:

𝑟−𝑒
(𝜏) (𝑑) 𝑁𝑟 𝑘 𝑁𝑒 − 𝑁𝑟
𝐵𝑟 𝑟−𝑒𝑝𝑒 𝑣 𝑟−𝑒 𝑎𝑟̈ + ∑ 𝑘−1𝑞𝑒 𝐵𝑒+𝑘 𝑣 = 𝑁𝐶 ( )
𝐷𝑒+𝑘 𝐷𝑒
𝑘=1

(𝜏) (𝑑) 𝑁𝑟 𝑘
𝐵𝑟 𝑟−𝑒𝑝𝑒 𝑣 𝑟−𝑒 𝑎𝑟̈ + ∑𝑟−𝑒
𝑘=1 𝑘−1𝑞𝑒 𝐵𝑒+𝑘 𝑣
𝐷𝑒+𝑘
𝑁𝐶 =
𝑁𝑒 − 𝑁𝑟
( 𝐷𝑒 )

𝒅 (𝑁𝐶)
= 474.759,21
 International Conference on Statistics and Analytics 2019

Actuarial Liability

In this simulation, a scheme will be given at a certain time to calculate whether the pension fund

can fulfill the benefit of pension fund insurance participants. Using the equation in chapter 3,

actuarial liabilities for A will be count during A’s year of service. The table above is the amount

of actuarial liabilities calculated when A join the pension fund.

Discussion

1. To count normal benefit using entry age normal method we should concerned on the amount

of salary, probability that the policyholders survive during their years of service, the entry

age and the retirement age. Meanwhile, to count normal benefit using entry age normal

method, we should concern on the amount of salary, age at time of event, and probability

that it will happen which can affect the amount of benefit, premium, and actuarial liability.
 International Conference on Statistics and Analytics 2019

2. The amount of benefit and premium for withdrawal benefit are greater than the other

benefit. It caused by probability that the employee resign from the company is greater than

probability that employee dead or disabled during their years of service based on GAM

table 1971. Actuarial liability increased each year because the employee’s salary and

probability that employees will dead, resign and disable also increase each year.

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