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PENSION FUNDS

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Marijana Ćurak - University of Split, Faculty of Economics

Academic year 2014/2015

10/23/2014

International Week – New Frontiers in Finance and Accounting 2014

University of Economics in Katowice

Course: Financial Institutions

These lecture slides are based on the
book:

Mishkin F. S., Eakins, S. G. (2012), Financial
Markets + Institutions, Addison Wesley

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Marijana Ćurak - University of Split, Faculty of Economics

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AGENDA

Introduction

Defined-benefit and defined-contribution
pension plans

Private and public pension plans

Review points

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INTRODUCTION (1)

A pension fund is a financial institution that
accumulates contributions over an individual’s
working years and pays out pensions during the
retirement years

Institutional investors

Pension plans are rapidly growing

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INTRODUCTION (2)

Population ageing has been one of the main
driving forces behind pension policies and
reforms in the past two decades

The degree of ageing is measured with the

Dependency ratio: the number of people of pension
age (age 65+) relative to the number of people of
age 15-64
Support ratio: the number of people of working age
relative to the number of pension age

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INTRODUCTION (2)

Ageing is the result of two demographic
changes:

Decline in the number of births
Increasing life expectancy

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INTRODUCTION (3)

Fertility rates averaged 1.74 across OECD
countries in the period 2010-15, well below the
level that ensures population replacement (the
number of children needed to keep the total
population constant)

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INTRODUCTION (3)

Additional life expectancy at age 65 for
the period 2060-2065:

Women: 25.8 years
Men: 21.9 years

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DEMOGRAPHIC DEPENDENCY RATIO
(AGE 65 + RELATIVE TO AGE 15-64)

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Source: Wöss (2011)

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OLD-AGE SUPPORT RATIO (1)

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Source: OECD

OLD-AGE SUPPORT RATIO (2)

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Source: OECD

OLD-AGE SUPPORT RATIO (3)

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Source: OECD

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TYPES OF PENSIONS

Defined-benefit

plans

Defined-

contribution plans

Private pension

plans

Public pension

plans

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DEFINED-BENEFIT PLANS (1)

Under a defined-benefit plan, the plan
sponsor promises the employees a specific
benefit when they retire

The payout is usually determined with a
formula that uses the number of years
worked and the employee's salary

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EXAMPLE – FORMULA (1)

Annual payment = 2% x average of final 3
years’ income x years of service

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EXAMPLE – FORMULA (2)

If a worker had been employed for 35 years and
the average wages during the last three years
were $50,000, the annual pension benefit would
be

0.02 x 50.000 x 35 = 35,000 per year

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DEFINED-BENEFIT PLANS (2)

The plan puts the burden on the employer to
provide adequate funds to ensure that the
agreed payments can be made

Fully funded – if sufficient funds are set aside by
the firm for this purpose

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DEFINED-BENEFIT PLANS (3)

Overfunded – if more than enough funds
are available

Underfunded – if insufficient funds are
available

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DEFINED-CONTRIBUTION PLANS (1)

Instead of defining what the pension plan will pay,
defined-contribution plans specify only what be
contributed to the fund

The retirement benefits are entirely dependent on the
earning of the fund

They are becoming popular – the burden is put on the
employee rather than the employer to look out for the
pension plan’s performance (this reduces the liability of
the employer)

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PRIVATE PENSION PLANS

They are sponsored by employers, groups, and
individuals

They are increasingly investing in the stock
market

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ASSET STRUCTURE

Stocks
Government securities
Corporate bonds
Foreign bonds
Money market instruments
Deposits

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PUBLIC PENSION PLAN

The plan that is sponsored by a
governmental body

“Pay-as-you-go” system

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REVIEW POINTS

Pension plans are rapidly growing as a
result of population ageing

There are two primary types of pension
plans: defined-benefit and defined-
contribution

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REFERENCES

Mishkin F. S., Eakins, S. G. (2012): Financial Markets +
Institutions, Addison Wesley

OECD (2013): Pension at a glance – OECD and G20
indicators, OECD

Wöss, J. (2011): The impact of labour markets on
economic dependency ratio – Presentation of
Dependency ratio calculator, http://www.oegj.at/servlet/
(Accessed: October 18, 2014)

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