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Pensions, DHW Eg. 10.4 : Why is mortality not relevant?

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asked Sep 21, 2018 in BUS 3024S - Contingencies by anonymous
In section 10.4 of the textbook, example 10.4 asks us to calculate the contribution rate. The question mentions that the proceeds of the invested contributions are paid to the employee or the employees survivors upon withdrawal. 
I don't fully understand why mortality is irrelevant in the event of the member's death. 

1 Answer

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answered Sep 22, 2018 by Njabulo.Dube (2,950 points)

To understand why mortality on contributions is irrelevant in this example you have to distinguish between a defined benefit (DB) and a defined contribution (DC) pension plan.

In a DB plan the rules of the pension fund define the benefits independently of the contributions payable, and the benefits are not directly related to the investments of the pension plan. Thus, the risks (mortality, investment, expense, etc) lie with the sponsor of the scheme.

In a DC plan (which this example refers to), the individual member's benefits depends on the contributions the member pays into the fund, taking into account investment returns and expenses. Thus the risks lie with the member. So essentially a DC fund operates similarly to a bank account.

Now, in a DC fund, if a member dies or withdraws prior to retirement the member or the beneficiaries of the fund will just receive the accumulated value of the fund at the date of death or date of withdrawal. Think of it as just returning the balance on a bank account when the member dies or the member just withdraws their balance when they leave the fund. Another way to reason as to why mortality is irrelevant in a DC fund is that the mortality risk lies solely with the member.