Pensions are normally defined by law, esp. with respect to social security and retirement benefits and other mandatory contributions imposed on employees by governments.
It is different from a separation or retirement fund whose computation is based on the number of years of service of the employee.
Of course. an employee's separation benefit can be received like a pension, when the employee opts to receive them in installment, rather than as a lumpsum amount.
In the absence of laws that provide guidelines on the matter, a pension can be designed using the life insurance models.
Under the life insurance model, a pension is seen as a replacement income when the person has retired. As such, one can be said to have adequate pension when the previous employment income is continously received by a retired employee after retirement until death.
The critical question is: how do you calculate the aggregate amount needed and its cost?
The aggregate amount can be computed as follows:
LAST MONTHLY Salary X 12 months X expected no. of years to live after retirement
(Example: US $ 2,000 X 12 X 10 years = US $ 240,000.00)
The US $ 240,000.00 is the aggregate amount that will be targetted. In insurance language, this becomes the FACE VALUE of the employee's insurance that will have to mature when the employee retires. With this amount, even without considering its annual interest earned, the employee will be guaranteed a monthly income of US $ 2,000.00 every month for TEN years. With interest considered, this fund can even extend the life of the pension to another year or two.
Now, what is the cost?
The cost of this pension fund (US $ 240,000.00) in insurance lingo is equivalent to the monthly INSURANCE PREMIUM that the insurance company will ask you to pay.
If the PENSION PLAN or program is "NOT insurance-based", then this amount will have to be saved (with interests factored) by the employee and/ or the company under a "trust fund". This may be "contributory or non-contributory" in nature, depending on the company's policy.
When a company does not have money, the insurance based model is best. The problem is whether the company is willing to buy a life insurance benefit of such a huge face value for its employees? The normal corporate insurance plans for employees are "group term life", whose premium cost is less than half of full life plans.
The problem with term insurance is: it has no CASH VALUE that can mature when the employee retires.
Ed Llarena, Jr.
*helps improve corporate governance in Asia and the Pacific Reegion)
10th August 2004 From Philippines, Parañaque