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Introduction and Key Findings

Our
actuarial consulting firm has been hired by The Chocolate Factory to assist
them in determining whether the company should establish a pension plan for its
employees. The
Chocolate Factory was incorporated in year 1985 located in Cascadia that a
country has adopted an interesting blend of the social insurance and tax
structures of Canada and the U.S. Due to the lack of tax-assisted pension plan,
some workers decided to leave. To encourage employees to contribute longer
period to company, The Chocolate Factory has established a budget of 15% of
aggregate employee earnings each year, beginning in 2006, to provide pensions
for its employees.

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Below
are several questions that The Chocolate Factory is interested:

·        
What
is your recommended defined contribution formula for The Chocolate Factory
Pension Plan?

·        
How
do the expected defined contribution pension amounts using your recommended
contribution formula compare to the target pensions for career employees under
the proposed final earnings defined benefit plan?

·        
Do
you recommend a change to the basic formula for any of The Chocolate Factory
employees?

·        
What
is the expected pension (as a percentage of earnings at retirement) for a
typical career employee, given your recommended formula? How does this compare
to the goals?

·        
What
are the expected pensions for the actual Chocolate Factory employees, given
your recommended formula?

·        
How
do the expected defined contribution pensions vary with a change in fund rate
or a change in inflation rate?

·        
What
amount of defined contribution pension (as a percentage of earnings at
retirement) should a career employee expect to receive with a 95 probability?
How does this vary for the oldest and youngest Chocolate Factory employee?

·        
Does
the recommended contribution formula meet The Chocolate Factor’s budget goals?

·        
What
are the risks that should be monitored if this defined contribution pension
plan is adopted?

·        
Will
your defined contribution pension plan provide appropriate pensions for all of
the Chocolate Factory employees? Do you recommend a different approach for some
of the employees?

·        
Has
the problem been defined completely and the appropriate risks considered for
the Chocolate Factory and its employees?

Below
are the key findings and results for above issues:

·        
After
analysis between defined benefit pension and defined contribution pension, I recommend
the Chocolate Factory adopting 15% defined contribution formula on all pensionable
earnings. This is the maximum contribution level under a Cascadian private
pension plan (CPP).

·        
By applying 15% defined
contribution formula, I propose a 15% reduction in the base defined
contribution formula to 12.75% for all employees who join the pension plan between
age 30 and age 34. Besides that, I also recommend a 25% reduction in the base
defined contribution formula to 11.25% for all employees who join the pension plan
before age 30.

·        
After applying the
recommended formula and adjustments on base defined contribution formula, the
expected defined contribution pensions for a male employee of age 30 are
approximately close to target established by the Chocolate Factory’s management
(70%). The expected defined contribution pensions for female employees of age
30 are slightly lower than target. The results are summarised in Appendix I.

·        
The recommended
contribution formula is not able to fully serve of all the Chocolate Factory’s
existing employees. The expected defined contribution pension for those
employees who joined the plan after 40 years old are significantly less than
target (70%). The results are summarised in Appendix II.

·        
For impact of future
fund return and inflation to expected defined contribution pension, future fund
return is highly related to the pensions under the defined contribution plan. 2% increase in fund rate will
lead to an increase in the private pension by about 69% for male employees and
68% for female employees. In the other hand, 2% decrease in fund rate will
cause a decrease in the private pension by about 65% for male employees and 64%
for female employees. Similarly, inflation has also high
influence on the pensions as well. 1%
increase in inflation will cause a drop in private pension by about 21% for
male employees and 23% for female employees while 1% decrease in inflation will
lead to a rise in private pension by about 22% for male employees and 21% for
female employees. Risk of huge fluctuation in fund
return and inflation rates should be mitigated in the future. The results are
summarised in Appendix III.

·        
Almost half of
employees will achieve less than 70% of defined contribution pension with 95%
probability. Most of them join the pension at age 40 and above. Only those
employees who join the defined contribution pension plan before age 40 can expect
to receive the target pension with 95% probability. In the other word, the
recommended defined contribution pension plan will not reasonably provide the
targeted pensions with a 95% probability. The results are summarised in
Appendix IV.

·        
The result of aggregate
annual contribution rate of total earnings would be 10.98% by using my
recommended contribution formula. This is within the 15% budget that The
Chocolate Factory has established.

·        
There are three
potential risks which are future fund returns, future inflation rates and
changes to annuity purchase rates that the Chocolate Factory should monitor in
the future.

·        
The
recommended defined contribution pension plan does not provide appropriate
pensions for all of the Chocolate Factory employees, especially for long
service employees. The recommended contribution
pension for the Chocolate Factory is only appropriate pensions for new hire employees
or employees who newly join the plan

·        
Since its more senior
existing employees will not be well served under this plan, communication to
the members is essential. Besides that, I recommend that a combination between
recommended defined contribution plan and defined benefit plan for short and
long service duration employees might be more appropriated. However, further
investigation is required.

·        
The Chocolate Factory’s
problem may not have been defined completely at this stage. Recommended defined
contribution pension plan would be inadequate for long service term employees
but suitable for short service term and new hire employees. I recommend that
the Chocolate Factory management must take into account for above issue before
implementing the pension plan. 

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