Edge Sample Exam #8

[Brak99]

Suppose the employee works full time until age 60 and part time from age 60 to age 65. He then might have two form of payment options:

A: The "phased retirement option": Partial commencement of benefits at age 60 to supplement his income from part-time employment; full commencement of benefits at age 65.

B: No benefits paid until age 65.

Options A and B would have the same present value at age 65. I think this is what the author means by "cost neutral".

[Kenny]

The goal was to make it cost neutral based on the age 65 benefit, not phased retirment and full early retirement. That is why the cost neutral calculation takes the PV of the age 65 benefit and reduces it by the accumulated value of previously paid benefits.

To be cost neutral the PV of total benefits paid would be equal at any point in time. In the original example this would require the benefit paid at age 65 and later to be reduced. It cannot be reduced only because legislation prevents us from doing it.

Notice that

Originally Posted by Kenny

PV at age 60 = 19,518 * N(65)/D(60) + 8,753 * [(N(60) - N(65)) / D(60)] = 141,003

is the same as
26,520 * N(65)/D(60) = 140,870 (okay, that didn't work out quite as expected )

I think the key is the plan's goal is to be cost neutral based on the ultimate full retirement benefit, not cost neutral between early full retirement and phased retirement. It can't be because the full early retirement benefit would have to account for future service and salary increases and obviously it can't do that.

[Sifto]

Originally Posted by Brak99

Suppose the employee works full time until age 60 and part time from age 60 to age 65. He then might have two form of payment options:

A: The "phased retirement option": Partial commencement of benefits at age 60 to supplement his income from part-time employment; full commencement of benefits at age 65.

B: No benefits paid until age 65.

Options A and B would have the same present value at age 65. I think this is what the author means by "cost neutral".

I'm not too sure these are equal. (A) is greater than (B) at 65 due to the increase in svc and FAS.

[Brak99]

OK, good luck.

[Sifto]

i also got this:

Originally Posted by Kenny

Notice that is the same as
26,520 * N(65)/D(60) = 140,870

but since it doesnt equate phased versus fully retired, i thought it was wrong.

Originally Posted by Kenny

I think the key is the plan's goal is to be cost neutral based on the ultimate full retirement benefit, not cost neutral between early full retirement and phased retirement.

Perhaps I can modify it to:
"The plan's goal is to be cost neutral based on the ultimate full retirement benefit during phased retirement, not cost neutral between early full retirement and phased retirement".

See, I always thought cost-neutral meant being equal under phased and full retirement. I may have missed it in the study notes, but in this question they clearly assumed that the student would take cost-neutral to be as quoted above.

So is it fair to say that the value under phased is larger than under full retirement using actuarial reduction?

[Kenny]

Originally Posted by Brak99

Suppose the employee works full time until age 60 and part time from age 60 to age 65. He then might have two form of payment options:

A: The "phased retirement option": Partial commencement of benefits at age 60 to supplement his income from part-time employment; full commencement of benefits at age 65.

B: No benefits paid until age 65.

Options A and B would have the same present value at age 65. I think this is what the author means by "cost neutral".

Originally Posted by Sifto

I'm not too sure these are equal. (A) is greater than (B) at 65 due to the increase in svc and FAS.

Brak is correct. If you want to be cost neutral, future payments are reduced by the actuarial value of prior payments to ensure that the PV of total payments equals the PV of the benefit at full retirement. In the original example a truly cost neutral plan would have reduced payments after age 65 to account for the pre-65 payments. It is only a legislative construct, not an actuarial one, that allows A to be greater than B.

[Sifto]

i meant with respect to this particular problem, and taking cost-neutrality to be with regards to eary ret and phased ret, the two are not equal.

yes, with regards to payments during phased retirement, the two are equal (as shown in the cost-neutral formula of the solution).