The UK Pension Scheme
Background
It is a form of contract that is awarded to
former workers which entitled them to a stream of income and other forms of
subsidy when they retire from the labor force. The party who is obligated to
provide such scheme can be the employer, an insurance firm or the government.
The amount of pension to be awarded during retirement years varies depending on
the type of the scheme. Generally, the contribution of the worker will be
applied with a fixed formula that depends on the amount of the contribution and
the number of employment years. There is also a type of a scheme wherein the
amount to be received by the worker depends on the investment performance of his
contribution during retirement.
In the UK, there are major pension schemes
available. These include basic state pension, second state pension,
occupational pensions, individual pensions, group pensions and stakeholder
pensions. In state pensions, the role of the government is explicit and
automatic to avoid old aged people from being poor. To be entitled with this,
the workers must have an age of at least 65. Because of its nature, pensions
that are awarded by the state are commonly of utmost importance. There are
three categories of state pension. The first is the basic state pension which
is a function of the amount the worker has contributed to National Insurance.
The second type is called the
additional pension. The requirement is that the workers must have contribution
in the National Insurance and run much like the basic pension. Their difference
is that there are additional perks and membership is not mandatory. For
example, there are Graduated Retirement Benefits, State Earnings-Related Pension
Scheme and the State Second Pension. The third type is referred as pension
credit. This is the latest category of the state pension scheme in the UK
primarily responsible to reduce the quantity of the old-aged population that is
in poverty. There is several advantages pension credit such that taps tax,
savings and other investment vehicle of the claimants.
Pricing of Pension Schemes
Being financial instruments, options provide the
right without obligation to parties that enter contracts for a specified
security. There are two general kinds of options; namely, call option and put
option. The former gives the right a party to purchase a security at a
specified price, also called strike price, prior to expiration date. Reversely,
the latter gives the right the selling of security at a specified price prior to
expiration date. Traditionally, participants in an option primarily aim to
hedge their risks but option trading is also a source of speculative
investment. For example, the holder of a call option may exercise his or her
right if the strike price at expiration is greater than the strike price at the
date of purchase. The holder would gain the positive difference between the
acquisition and exercise dates. On the other hand, the party who has the
obligation to facilitate the option of the holder can gain if the reverse about
the strike price happens.
Different types of options are
traded in the financial market such as exchange-traded, over-the-counter,
real-estate, prepayment and employee stock options. Further, there are also
specific categories on how to exercise option like European, American, Bermudan
and Barrier options. They are classified based on limitations of having certain
options under them. For example, there is an option who can only be exercised
at expiration date (European option), any trading day on or before expiration,
(American), specific day on or before expiration (Bermudan) a kind of option
that demands a particular strike price before the transaction can occur
(Barrier). Due to the enormous role of options, various techniques are
developed to measure the risks associated with its trading, and consequently, to
price them.
Developed in the late 1970s by Cox and others,
this model uses iterative process that enables the classification of valuation
analysis during the valuation date up to expiration. The first characteristic
of binomial option pricing is that it can reduce price volatility of the
underlying asset which theoretically reduces its risk. Secondly, this model
minimizes speculative behavior through reduction of arbitrage opportunities.
Third, there is simplicity in analysis that coincides on how developed trading
locations operate which assumes an efficient market. Lastly, the model
condenses the maturity of the option.
Developed in the early 1070s by
Scholes and others, black-scholes model price options over a specified period of
time. It also assumes that the price of options is similar to Brownian schedule
that has continuous drift and volatility. In pricing stocks, it analyzes the
behavior of the stocks for continuous price changes, the concept of time value
of money, the strike price of the option and the extirpation date of the
option. The differences of the two approaches option pricing have their
advantages and disadvantages but binomial option pricing model can have more
comparative implications. Discussed below are four characteristics of option
pricing model which can provide implications on the advantages and disadvantages
of black-scholes model.
The Global Financial Market
Due to mobility of foreign exchanges as well as
technological advancement, globalization of financial markets was made
possible. Diversification of investment such as buying of foreign securities
suited to the taste of investors who developed progressive strategies of
investing. As a result, the role of foreign investors is dramatic in benefiting
the increased trade and higher liquidity of domestic financial markets.
Globalization served as an opportunity for host economies (e.g. usually the
developing countries) to absorb the excessive funds from home economies (e.g.
usually the developed countries). This phenomenon is evidenced way back through
the gold standard system from 1870 to 1914 when many nations expanded their
economic well-being due to financing provided by the savings and surplus of
other countries.
It is not only the story of
developing nation benefiting from developed nation. The reverse is also true in
the case of US when its equities market experienced increased rate of return
from 12% to almost 14% and reduction of volatility of that return from 18.3% to
17.5% when it started to buy foreign shares. Another important outcome of
globalization of financial markets has minimal relation to finances. The
spill-over effect includes the best practices on corporate governance honed in
developed processes and business environment which is largely lacking in
developing countries. Legal framework and principles of conduct in host
countries are significant elements of the investing propensity of foreign
investors. These comprise of disclosure requirements, taxation, ownership
barriers and protection of the right of minority shareholders.
These initial aspects give rise to
several other criteria which investors are looking to their next funds
destination within the developing world which include access of information to
domestic issuers and application of international accounting/ auditing/
financial reporting. In the end, corporate governance of host economies is
being molded if not pressured by international investors for the sake of the
latter investments. Indirectly, domestic institutions undergo gradual change to
provide the investing and business environment that foreign investors demand.
After this response, only then will globalization can impact increased
efficiency and economic growth of local economies. To note, there is a
stimulus-and-response phenomenon between foreign investors and domestic
economy.
In the case of Poland, flow of
foreign investments did not necessarily result to increase in stock market
liquidity because most of these funds are supplied to big companies (e.g. blue
chip firms). This priority disabled the large volume of funds to positively
impact the whole market and would had been distribute in sub-optimal manner.
The rational behavior of investors for liquid shares enables them to sell these
securities without restriction and fear of loss. There were two elements that
the stock market of Poland required to be able to progress on its privatization
efforts; namely, increase of issuance by large domestic companies and listing of
foreign investors in domestic exchange.
Banks participated not only because
of globalization but also for the fact that competition from the corporate bond
market predated their clients. As a result, banks joined foreign exchange
trading and its hedging as well as inclusion to the derivative market. In
London, large banks provide high liquidity to shoulder the risk involved in one
example of derivative market which is the interest rate swaps market. This is
an illustration that domestic banks can enter derivatives market as long as the
global finance industry is helping on increasing the liquidity and volume of
transactions.
Among other financial sectors,
pension funds are clear manifestation of how globalization changed the way
financial entities deal with one another. It also plays a key role in improving
liquidity of the global market. It is natural for pension funds to materialize
in transactions between different markets with different liquidities because of
the significant arbitrage opportunities involved. If a market is not liquid,
there is no potential for short-run transaction without confronting excessive
risks in the process. On the contrary, pension funds in more developed and
efficient market such as US would operate in less liquid markets to look for the
above average return. In effect, price anomalies are more substantial in less
liquid markets than more liquid ones wherein the use of information competence
towards the former can exploit an arbitrage opportunity (e.g. search for Alpha)
in favor of the latter. Generally, less liquid markets not only tend to incur
spot price abnormality but also behave for greater price volatility.
Speculation of pension funds gives financial
markets additional liquidity and expanded number of financial instruments
available. This in turn can be used by banks, companies and other institutions
for their financing, hedging and investing needs. However, the growth of
pension funds is negatively related with the improvement of the market’s
informational efficiency because price anomalies are decreased. As long as
there are emerging markets in the global arena, pension funds will continually
used the inefficiencies of how domestic financial markets are regulated,
operated and played by participants. Pension funds are attracted to
inefficiencies and are willing to pour-in funds to local economy for the sake of
speculating on price changes and winning the quest for Alpha.
UK Chartered Accountants
The Labor Force
A newspaper reported that accountants in the
United Kingdom earns 55% more than French, however, offset by working longer
hours than any other country in Europe (Ledger 2001). This statement can
bring about many questions such as UK labor force response to family-work
conflict and demand on luxury items. The country is industrialized and belongs
to upper bracket of world economies with United States and Japan. Also, it is
recently reported that it slowly getting back in its economy. So why then there
is a need for its accountants to work for extending hours whereas public
utilities are priced minimal, mostly, free? Or it is the very high compensation
due to supply shortage or demand surplus that shakes the preference of the
population and institutions to place greater significance to the industry?
Georgopoulos indicated that if an individual is
aware of the potential benefits and costs of doing the job, he can adjust his
effort (productivity) accordingly. In addition, the decision criteria of
choosing between high or low performance are embedded on ability of that
particular job to contribute to his personal goals (cited in Miner 2002 p.
191). However, in the real world, incomplete information is tantamount to
ignorance to potentialities and therefore being subject to external stimulus.
This study is simply a generalization of such circumstance with the goal of
configuring the importance of basing recruitment and selection practices (RSPs)
to the characteristics of the job seeker. Alternatively, this can serve as a
guide for employment seeking individuals whether to use certain signals in
determining the best employer that can maximize their individual needs.
To evaluate the performance of the labor market,
efficiency of the pricing and equity of the market system should be considered (Briggs
Jr. & Marshall 1989). This is useful to be able to appreciate the quantity
and quality of the labor being supplied or demanded in a certain industry
including the determination how equitably the supply of labor is spread in the
economy. This is important especially for the developed economies wherein
population rates are decreasing. Pricing of labor can be based according to the
long-run trend, cyclical movement and cross-sectional data. As the third refers
to the present and more dynamic situation in the economy, the first two refers
to more predictable movement of the labor market.
Further, traditional conceptual
framework used to determine the price of labor is attributed to supply and
demand analysis (Briggs Jr. & Marshall 1989). Supply of labor is
affected by variables such as wage rate, household incomes, size of the
households, and age structure of the population. On the other hand, the demand
side includes the wage rate, industrial pattern of demand for goods and
services, the capital stock of the economy, and the general level of prices.
However, these variables are acknowledged to be insufficient for analyzing the
labor market of an economy.
For our purposes, in explaining the
wages differential, these variables and our own theories including the
characteristics of the perfect labor market will aid us in explaining a certain
phenomenon. The ideal labor market includes characteristics such as workers and
employers have full information of the market, they wanted to maximize their
welfare and profits, workers are mobile, employers are not in deciding
collusively, and labor is organized while each have their own decision (Briggs
Jr. & Marshall 1989). These features fit perfectly to push the wage towards
equilibrium whenever there is a short-term demand and supply
fluctuations.
Principles of Worker Compensation
Since no organization is alike, same is the
situation in human resources management landscape. Even there were written,
proven and based-from-experience theories and beliefs on how to handle employees
for the benefit of the company, each are under varying conditions and corporate
values. Because of this, human resources personnel tend to have general
approach to these available strategies while final decisions are subjective and
contingent. Also, the emergence of sudden organizational change, internal
problems and other external junctures that caught an organization unprepared
result to puzzled human resources decisions. This includes wage increase behind
annual net loss, employee benefits under inefficiency brought by machine
breakdown or expansion in face of corporate tax increase. Such incidents leave
the HR personnel torn between corporate constraints and employee welfare.
HR role in compensation schemes and career
development are crucial factors in employee motivation for optimum performance
because these affect their present and future status and undertakings. An
employee who feels that the company is providing just wages or issue appropriate
performance-based benefits will manifest work satisfaction. On the other hand,
when he is not afraid to loose job and a persistent hard-worker because of ample
knowledge gained from relevant trainings and provision of clear career paths, he
will exemplify work excellence.
Every organization wants to have a pool of human
resources that can create sustainable competitive advantage. According to
Barney (1991), an organization aiming to achieve this
should have a certain resource, in this case human capital, which can
create value for the firm. It must also be rare, inimitable and
non-substitutable (cited in Wright 2001). Since human resources are not only
proven to be the most important company resource but also the most complex in
terms of making it act for the achievement of corporate objectives, HRM is
responsible to keep motivation among employees within the context of corporate
culture, employee characteristics and other outside factors
Conclusion and Recommendation
Privatization provides the future retirees to
shoulder investment risks and channel their contributions based on their return
expectation. They are benefited because customized needs will be addressed and
retiree satisfaction is optimized. In macroeconomic terms, it can trigger
increase in wealth of retirees that can trickle down to rise in consumer
spending which can lead to economic expansion. In contrary to the current
Pension Scheme, however, privatization houses moral hazards because excessive
risks that will be confronted by individuals can proceed to investment crash.
The current system is characterized by lower risks and management costs compared
to the possibility of zero returns and reduction of principal in privatization.
As the current system is bound for bankruptcy, it is aggravated by high payroll
taxes, poor return and discrimination against women, low-waged and minority
workers. However, it minimizes the issues of insolvency that privatization
failed to resolve.
Along with the current system, there are three
non-privatization alternatives with regards to Pension Scheme; namely, tax
increases, reduction of benefits and obtainment of greater return by real
capital asset investing. Increasing tax rates is supported by the research that
UK citizens are willing to pay indefinite amount of tax as long as it targets
appropriate programs in which apparently Social Security is inclusive. Further,
it is projected that in the near future gross domestic product or GDP will
outgrow Social Security taxes by at least 10% caused by pressures of aging
population. To save the solvency of Pension Scheme from 2016 forecasted
deficit, tax rise should meet 3 per worker and by 2030 such increase is
required to hit ,543 per worker. In this course, adverse effects of tax
increase option will result such as reduction in jobs as well as slower economic
growth. There will be also less incentive for workers to work because their
Social Security contributions are viewed as pure tax rather as investment that
they will receive when they retire.
The second option is benefit cut. One advantage
of this is that retirees would be able to receive greater face value even after
the reduction of benefits because the payment is done periodically. The
privatization alternative also offers benefit cuts but on extreme terms such as
ad adjustment of benefit indexing formula with inclusion of adjusted wage
productivity and setting a non-greater-than inflation rate ceiling for rising
benefits. The benefit cut option will most likely follow the economic growth to
prevent adverse economic impacts. Specifically, the current Pension Scheme plan
of increasing the benefits should be lowered to 3%. Considering excessive
benefit cuts of privatization approach, some analysts believed that reduction or
even eradicating spouse benefits can be employed. This strategy is said to
solve the issue of small-wage earners.
The third alternative is government-led
investing by which the state will have the discretion of putting the money from
the Pension Scheme to private assets. Privatization also allows this feature
with the difference of decision-maker who will make the call which is the
workers themselves through creation of private accounts. Government-led
investing reduces the probability of individual workers to manager their
finances on sub-optimal and risky manner. It addresses the lacking of the
current system for higher returns with limitation of risks from private
accounts. Potential retirees can enjoy greater returns on one hand and minimal
risks on the other. However, there is bottleneck on this approach. One of the
major hurdles is that the substantial finance eminent in Pension Scheme can buy
a major stake on UK companies. In effect, the negative image of Government
agencies and even politicians can mix in corporate world.
Bibliography
Internet
AC Nielsen Website 2006, viewed April 14, 2008,
<www.acnielsen.com>
Euro Monitor 2003, viewed on April
14, 2008, <www.euromonitor.com>
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World Bank, viewed April 14, 2008, <www.worldbank.org>
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Brubeck, M (ed), Theune, C (ed), Wessels, W &
Zapf 1980, Minimum Wages, Fringe Benefits and Working Conditions,
American Enterprise, Washington, DC.
Condrey, Stephen E. Handbook of
Human Resource Management in Government. San
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Europe’, The Evening Standard. 14 August.
‘Shortage Ups Accountants’ Pay Sharply’ 2005,
Manila Bulletin, 20 July.
Wagar, T 1998, ‘Determinants of Human Resource
Management Practices in Small Firms: Some Evidence from Atlantic Canada’,
Journal of Small Business Management, vol. 36, no. 2.
Schipper, K & Vincent, L 2003, “Earnings
Quality”, Accounting Horizons, vol.17, pp. 97+.
Williamson, O 1985, The Economic Institutions
of Capitalism, New York: Free Press.
Credit:ivythesis.typepad.com
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