Unfunded And Funded Pension Schemes Accounting Essay

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Under the current economic situation, with growing unemployment and increasing cost, employees might seek to scale back their expenditure and save in a pension. According to the report from NAPF, the statistics shows around 37% of employees believed pension is the best ways to save for retirement (figure 9).Pension fund have risen significantly over the last decade around the world. Under this financial instrument , people are expected to received some payment for their retirement Moreover, there are two type of pension schemes, the first scheme is called Unfunded pension schemes (pay as you go), where payments to pensioners are financed from those in work, also, the current level of contribution is depending on the current number and level of payment . Therefore, no pool of investible funds is created under this scheme.

The second type of pension scheme is funded pension scheme which involve the accumulation of fund of asset. And this scheme is mostly used in private sector. Under funded schemes, there are two different types , the first type is The Pension Protection Fund PPF, which is a guarantee fund for defined benefit occupational pension schemes, it was established in 2005 as a consequence of the previous crisis, where it specify the outset of pensioner expected to received and the required level of contribution. The second funded scheme is called Defined Contribution Scheme, where the contributions go together and invested into a pool of assets at market, and the pensioner will received a lump sum on the share of fund when retired.

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At the end of 2006, some research has revealed that UK is suffering from saving problem. A survey also shows about 25% of people in UK only knew little or nothing about pension funds, although the rest of the people are acknowledged the important of saving for future, but a third of them have never pay into a private pension. In 2007, the UK government has announced a new pension scheme to encourage greater people start saving for their retirement. Under the Pension Act 2008 published in 2007, the employers will automatically enrol eligible workers. However, the workers can decide not to be in the scheme if they think the scheme is not suitable for their personal situation. The new pension package will operate as an occupational pension scheme and it has been welcome by employees around UK, because the minimum contribution require for employers at the first time is only 3% on their earning with around 1% of normal tax relief. Consequence, over 140000 workers have joined the new pension scheme and around £2.9 billion of pension fund has been put together, According to the office of national statics in UK, the occupational pension schemes cover about 50% of the employees with 7.9 million active members and two third of this members are from public sector, it shows that automatic enrolment is one of the most effective ways to encourage workers to start saving for retirement. However, in the private sector, most of the defined benefit schemes have been closed consequence of the increasing cost of operating DB. Most employees from private sector have shifted their funding of pension schemes from defined benefit to defined contributions schemes , the reason of this is because more employers who are under defined benefit scheme find it difficulties to meet the contribution requirements.

According to the occupational pension schemes survey in 2008, the chat above shows in 2007, open a defined contribution schemes were only contributing 9% of salary, which is much lower compared with 20.5% for open a defined benefit schemes. As a result, the scope of defined contribution scheme has increased significantly in 2007 because less contribution is required and it does not fix the pension payment in the future since the amount of pension is only depending on the investment returns. However, the defined contribution scheme places the risk largely upon the pensioners.

In 2008, the news about the deficit of the pension funds has risen dramatically due to the worldwide credit crunch. According to the research from Pension Protection Fund, the number of pension fund in deficit has increased significantly between 2008.

Regarded to the chat above, In March, the number of pension fund in deficit were 4500, however, at the end of 2008, the number of pension fund that were underfund have reached around 6,300, which is the highest figure in past five years. Due to the crisis of deficit has increased further; a report revealed that the defined contribution pension sector has suffered a loss of £140 billion. There is no question that the financial crisis is a serious challenge to the pension funds. The UK's 200 largest private pension plans have a large shortfall, since investments such as stocks perform poorly, so, companies are struggling to meet the pension requirement. For instance, at 2008, BT is valued around £8.5 billion but with pension fund obligations of over £34 billion.

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The deficit of pension funds reflected a negative effect to the people's expectation in pension. The NAPF research has shown that from September to December in 2008, the confidentialness in pension has declined surprisingly, the employee's confidence in pension has dropped from 22% to 1% and the confidence of pension member has also decreased by 19%. .

Consequence, some employees would decide to make a change to their pension, researches indicated that some employees would actually cut back on their pension saving during the financial crisis.

According to the NAPF report 2008, it shows 82% of pension scheme members will remain unchanged as a result of the financial crisis, however, 11% of pension members will cut back on their pension saving by reduced on their contribution to pension or taking a pension holiday. .

As a result, the average contribution paid into the private pension scheme in 2008 has almost halved compare to the last two years, according to the Prudential 2008 retirement saving report; the average contribution to private pension scheme has reduced from £277.38 per month in year 2006 to £144.57 per month in 2008. It is because reduction of pension contribution may seem to be a reasonable short term option for employees during the financial crisis. However, reduction of funding level can lead to a change in pension fund investment strategies, such as cuts in pension promises, which include stop indexation of benefit payment. Another possible strategy for pension companies is to requests for additional contributions from members, although this option could help to maintain funding level, but it is unlikely to obtain finance during a recession.

Under the defined contribution system, the trustees will invests in a diversified portfolio, such as equity funds, bonds funds, and the values of assets is depending on the proportion of each investment .The protection of DC schemes can improved by a careful design of default investments and payout options." The delegation of investment authority in certain securities may be accompanied by explicit restrictions on the types of securities in which the funds may be invested, as well as risk limit."(2004, Alberto R p 21). For instance, during the financial crisis, the values of equities have fallen substantially; therefore, pension fund managers should reduce investments in equities to minimize the risk of further declined Also, mangers should increased international diversification of equity portfolios or use of derivatives to reduce both asset and liability risks.

On the other hand, UK government have made substantial changes to pension regulations. Government have added a new regulations and rules with regards to the final salary pension scheme. According to the exiting legislation, managers are required by law to reach the minimum funding level (105%) within three years. Nevertheless, government decided to give an additional two years for pension funds to reach the required funding in 2008. The reason of this was to avoid cutting retirement benefits by reduced the pressure on balance sheet.

Consequence, during the first quarter of 2009, the situation of funds has slightly improved compared to the previous year. According to Table 6, it indicates that the liability deficit in UK has dropped from £194.5bn to £179.3bn, and the number of funds in deficit has decreased from 6,914 to 6,383, therefore, pension funds have regained a fraction of the investment losses made in 2008.

The initial months of 2009 has indicated that investment returns have started increasing. However, it could be argued that it is difficult to ensure those assets growth steady over the recovery period.

To conclude, the financial crisis have damaged on pension schemes all over the world. And the degree of effects is depending on the structure of the pension scheme. The financial crisis had the major effects on countries that with a high proportion of funded scheme such as Ireland and Hong Kong .Moreover, some of the defined benefit occupational pensions schemes have been closed since the companies' managers find it difficult fulfil the funding requirements. As a result, the crisis had led to a change in the investment strategy and government's pension regulations.