One assumes their pension is calculated carefully. But how can you be sure of this? At RiskCo, we developed the Administrative Periodic Inspection for pension funds, in order to verify regularly whether all calculations are correct. When a pension fund asks us to perform an administrative periodic inspection, we compare all entitlements of its members with the entitlements that we calculate ourselves. This way, the pension fund acquires an idea of his pension database quality. We get a copy of the pension database and the regulations and use these to calculate the entitlements of all members from scratch. Hence, we never use stored intermediate results in our calculations.
Executing this database verification is harder than it seems. That is why we usually start with a group of ‘plain’ members. When we find the exact same entitlements for these members as the pension fund did, we know we have a solid base to execute the rest of our administrative check. A plain member is someone who for instance:
- Has worked less than one year at one employer
- Has not been (partially) disabled
- Did not have any benefit transfers
We can calculate the pension for these members easily with the following formula:
Entitlement = (Salary-National Insurance Contributions) * accrual rate * Duration of Employment
The national insurance contributions and accrual rate are the same for every employee and are stated in the regulations of the pension fund. Salary and the duration of employment are taken from the pension database. A simple formula. Nevertheless, we usually already find points for improvement in this stage of the inspection. I will give three examples below.
The number of members in the pension fund database
Often, the number of members in the fund’s database is not equal to the member count of the pension fund. This may be due to deceased members still being counted or members the age of 18 being excluded from the count. Although these counts do not influence the entitlements, these details are usually an indicator of the carefulness taken in maintaining the administration.
Reproducibility of the financial report
The entitlements that we calculate are compared to the entitlements as calculated by the pension fund. We use official documentation to compare with, such as formal communication to the members or the financial report. However, this documentation is not always useful. Why is this? A pension administration is an organic thing. Modifications are added to the model constantly, sometimes even in retrospective. To calculate the same entitlements as the pension fund, it is hence important to know on which date the calculations were made and filter out all retroactive changes. In many cases, however, these dates are not known. This means that the financial report or letters are not reproducible, not by us, nor by the pension fund. This is in conflict with the regulations of most national regulators and will be documented by us as an issue.
In these cases the entitlements have to be calculated using another source, of which the date is known.
Duration of employment
If the plain members are not contracted for exactly one year, their entitlement is calculated proportionally. The entitlement for this is multiplied with the year fraction (called duration of employment in the formula above). But, how does one calculate such a year fraction, accounting for leap years and a variable month length? Until now, we have found 12 different ways to calculate this year fraction. A few examples:
- The number of calendar days from the start of the employment divided by 356. (or 365.25 or 360, or the number of days in that specific year)
- The number of working days from the start of the employment divided by the number of working days in that specific year
- ((number of full months of employment/12)+(number of worked days in the first month/number of days in the first month))/12
We also encountered administration systems in which the duration of employment is stored in a separate field in the database. This value did not match with the duration that we calculated according to the calendar. Differences reached up to 209 days, without any reasonable explanation for this. All methods result in a slightly different year fraction, leading to different entitlements. The method to calculate the year fraction as stated in the regulations (if there is such a statement at all) does usually not correspond to the method that is actually executed by the pension fund. This way, it is possible that we calculate a different entitlement than the pension fund, even for the plain members.
When the above issues are solved and the entitlements of the plain members are correct, we have established a good basis for the rest of the Administrative Periodic Inspection. Now we can start with the real work. But more about this in following posts.