Summary

In this chapter we introduce some of the notation and concepts of pension plan valuation and funding. We discuss the difference between defined benefit (DB) and defined contribution (DC) pension plans. We introduce the salary scale function, and show how to calculate an appropriate contribution rate in a DC plan to meet a target level of pension income.

We then define the service table, which is a summary of the multiple state model appropriate for a pension plan. Using the service table and the salary scale, we can value the benefits and contributions of a pension plan, using the same principles as we have used for valuing benefits under an insurance policy.

Introduction

The pension plans we discuss in this chapter are typically employer sponsored plans, designed to provide employees with retirement income. Employers sponsor plans for a number of reasons, including

• competition for new employees;

• to facilitate turnover of older employees by ensuring that they can afford to retire;

• to provide incentive for employees to stay with the employer;

• pressure from trade unions;

• to provide a tax efficient method of remunerating employees;

• responsibility to employees who have contributed to the success of the company.

The plan design will depend on which of these motivations is most important to the sponsor. If competition for new employees is the most important factor, for example, then the employer's plan will closely resemble other employer sponsored plans within the same industry.