Money-Purchase Pension -
It is like a savings account attached to the share and property markets. All
interest, dividends and capital growth on property and shares is added to a
member's account holdings. Premiums for Ill-Health and Death Benefits are
paid out of this account. On retirement, the member is handed the full value
in the fund. After tax, the member can use the money to buy a pension or
invest the money.
Defined Benefit -
The Pension Benefit on Retirement is defined
by the rules of the Fund.
In most Defined Benefit
Pension Funds, the rules are along the following lines:
On date of retirement,
the member will become entitled to a pension based on number of years
service with the fund.
A formula to calculate
the pension could be as follows:
final salary for each year of service
Example 2% per
year of service for 25 years of service would give the pensioner a
pension equal to 50% of his/her final salary.
Whilst the employee is still working, the
actuary calculates how much money must be set aside to fund the employee's
pension based on the employee's current age, salary and length of membership in the Fund,
As the Pension Fund will owe the member this pension, the value calculated
by the actuary is called an "Actuarial Liability".
Assets - Money invested on behalf
of a member is invested in a "spread" investment portfolio to fund the "Liability" - i.e cash, stocks, property, bonds, etc. Regulation 15 spells out how the
actuary must report on how the money is invested. The actuary must place a
realistic value on the stock market and property shares, as these fluctuate
- Note: If all the money was
held in cash in a fixed deposit, the "assumed growth" would be lower
than a spread investment portfolio. Therefore, more cash would be required to be
set aside to fund the pension on retirement. So, the Actuarial Liability
of a Cash-only investment would be higher than an Actuarial Liability
for a Spread-investment portfolio.
So, in the case of the Assets to fund the
Liability, the Assets will be described in two ways:
- "Actuarial Value of Assets"
which is a theatrical value. This value must equal the "Liability".
- "Fair Value" or "Market
Value of Assets" - This is the value of the portfolio at market
rates. When share prices are higher than what the actuary considers
realistic, the overall Market value of the Assets will be higher
than the Actuarial value of Assets. When the stock market is in a
slump, the market value of the portfolio could be lower than the
The actuary uses a number of assumptions
to calculate both the Liability and the supporting Assets of the pension.
- The actuary has to assume how long a
member will live after retiring. The country's average "lifespan" for
males and females is normally used for this assumption.
- The actuary must also assume how much
the investments will grow over-and-above inflation - this in normally
- The actuary uses this percentage
to "discount" the value needed to be set aside. If R100 000 is
needed in five years time to fund the pension, only around R82 000
will need to be set aside now as it will be expected to grow at 4%
faster than inflation.
Below is a chart that sets out the
calculation process. The calculation for an entire pension fund is reported
in one collective figure, but it is made up of individual calculations based
on each member's age, salary and years of service.