Your questions answered

A deferred member is a person who has benefits in a pension scheme as a result of a previous employment.

A pension scheme in which the primary pension benefit payable to a member is based on a defined formula, frequently linked to salary. The sponsor bears the risk that the value of the investments held under the scheme fall short of the amount needed to meet the benefits. Contrast with defined contribution (DC).

A DB pension scheme surplus occurs when the scheme's assets exceed its liabilities—that is, the total value of promised pension benefits to members. This surplus indicates that the scheme is more than adequately funded, providing a buffer that can potentially be utilised for other purposes. (PLSA) 

A pension scheme in which the sponsor stipulates how much it will contribute to the arrangement for each individual member, which sometimes will depend upon the level of contributions the member is prepared to make. The resultant accumulated fund (or “pot”) of money for each member is a function of the investment returns achieved (net of expenses) on the contributions and how long the money is invested. DC members typically use their accumulated pot for one of three purposes – annuity purchase, cash or drawdown. In contrast to a defined benefit (DB) scheme, the individual member bears the risk that the investments held are insufficient to meet the desired level of benefit. The vast majority of newly established UK pension schemes are defined contribution.

In a defined contribution (DC) arrangement, a form of lifestyle in which, in the run up to the point at which a member starts to take their benefits, assets are gradually switched into an appropriate mix of investments from which the member can source (or “drawdown”) an income while leaving the balance of their pension pot invested to provide future growth and income. In practice, it is common as part of the switching process for up to 25% of the member’s pension pot to be moved into cash which the member can take as a tax-free cash lump sum when they first start to take their benefits, with the remainder being allocated to drawdown.

The value of assets divided by the value of the liabilities as defined by the funding target for a defined benefit (DB) pension scheme at the calculation date.

The value of the assets that is calculated (on a given set of assumptions determined by the trustees) as being required at the calculation date in order for a pension scheme to meet its liabilities.

A Group Personal Pension (sometimes called a 'GPP') is a type of defined contribution (DC) pension arrangement. It is normally established by a company with a pension provider – typically an insurance company – on behalf of a group of employees. This grouping allows the company to negotiate better terms – eg lower investment management charges – than individuals would receive from the provider directly. However, while termed a group arrangement, it is important to note that in practice, each employee has their own individual contract with the pension provider. A GPP is sometimes referred to as a form of contract-based DC scheme so as to distinguish it from a trust based DC scheme.

An obligation to make a payment in future. An example of a liability is the pension benefit “promise” made to a defined benefit (DB) pension scheme member, such as the series of cash payments made to the member in retirement. The more distant the liability payment, the more difficult it often is to predict what it will actually be and hence what assets need to be held to meet it.

An investment approach which focuses more (than has traditionally been the case) on matching the sensitivities of a pension scheme’s assets to those of its underlying liabilities; this may be in response to changes in certain factors, most notably interest rates and inflation expectations.

A life fund is a type of pooled investment vehicle offered as an investment option under a life insurance policy. Access to this type of arrangement is restricted typically to certain types of investors, for example pension scheme trustees.

A longevity swap is an agreement between two parties (typically a pension scheme and either an investment bank or insurance company) to exchange streams of payments; one of which is “fixed”, based on a pre-agreed set of demographic and other assumptions and the other of which is variable, or “floating”. Typically, the pension scheme will receive the floating stream of payments (which corresponds to the pension payments it is obliged
to pay based on its actual experience) and the bank/insurer receives the fixed stream. The floating stream of payments will continue until pension payments cease, regardless of how long the members covered by the swap actually live. As a result, the longevity swap eliminates the risk to the pension scheme that members covered by the payments live longer than expected. Of course the pension scheme will be worse off (compared to not entering the swap) if scheme members do not live as long as predicted under the longevity swap.