Hi! Pensions are normally defined by law, especially concerning social security, retirement benefits, and other mandatory contributions imposed on employees by governments. It is different from a separation or retirement fund, which is computed 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 it in installments rather than as a lump sum amount.
In the absence of laws that provide guidelines on the matter, a pension can be designed using 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 an adequate pension when the previous employment income is continuously 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 number 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 targeted. 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 terms 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.
Best wishes.
Ed Llarena, Jr.
Managing Partner
Emilla Consulting
*helps improve corporate governance in Asia and the Pacific Region*