Glossary of insurance terms

Please note that the value of the investment can go down as well as up and you may not get back as much as you put in.

Here is a handy guide to help you understand some of the terms used in the pensions industry.

Defined benefits pension - (also known as a final salary scheme) This is an employer-sponsored scheme where the eventual retirement income is based on your earnings, length of employment and the scheme's rate of accrual. The circumstances under which you take your pension – at retirement, as an early leaver, or through ill health – could also affect the income you get.

Defined contribution pension - (or money purchase scheme). This is a pension plan where the eventual retirement income is based on the amount of money paid in and the amount by which that money grows. There are several different types including company, personal, stakeholder, self-invested and group personal pension plans. The resulting pot is usually used to buy an annuity – an insurance contract that pays out regular income.

Accrual rate - This is the rate at which you build up pension benefits while a member of a defined benefit scheme. The rate is multiplied by your earnings to calculate how much money you will eventually be entitled to. It is typically expressed as a fraction, and the bigger the fraction the more pension benefit you will get.

Annuity - This is an insurance contract that pays out a regular income, either for a set period of time or until you die. It is usually bought with the money from your pension fund. The income it will provide will depend on a number of factors including your age when you buy it, whether or not you're a smoker, and annuity rates at the time of purchase.

RPI - One of the consumer price indices used as the domestic measure of inflation in the UK (see also Consumer Prices Index (CPI - below)). The RPI is published by the Office for National Statistics. It measures the average change from month to month in the prices of goods and services purchased by most households in the UK. The government uses the RPI for the uprating of pensions, state benefits, tax allowances and index-linked gilts. It is commonly used in private contracts for uprating of maintenance payments and housing rents. It is also used for wage bargaining.

CPI - The CPI is published by the Office for National Statistics. It measures the average change from month to month in the prices of goods and services purchased by most households in the UK. The government uses the CPI as the basis for its inflation target.

The CPI uses the same basic price data as the RPI, but there are some differences. For example, the CPI:
  • Does not include many housing costs nor savings and investments and charges for credit.
  • Covers a broader population than the RPI.
  • Adopts different mathematical formulae to calculate price changes.
  • Has different classifications for goods and services.

Annuity rate - The rate of return you get when buying a pension income with the money you have saved in your defined contribution pension scheme.

Final salary scheme - This is the type of pension scheme the government wants to move public sector workers away from. The pension paid to members is based on their salary at the point of retirement, the number of years they have belonged to the scheme and the accrual rate. It particularly benefits employees whose salaries rise steeply towards the end of their careers.

Career average scheme - A notional percentage of the employee's salary is put aside each year – the calculation is based on multiplying the employee's earnings during that year by the accrual rate. At retirement, the cash value of all these notional amounts is added up to produce the annual pension the employee is due. The averaging effect means this type of scheme generally produces smaller pension incomes, particularly for those who get big salary increases towards the end of their career.

Group personal pension - A collection of personal pension plans provided by an employer for its employees. Contributions are deducted through payroll, the employer may make contributions on behalf of the employee, and the scheme charges may be lower than those of an equivalent straightforward personal pension because the company providing the scheme is able to offer a reduction for bulk business.

Stakeholder pension - A pension scheme designed to incorporate a set of minimum standards set out by the government. Charges must be capped at 1.5% a year for the first ten years and 1 per cent thereafter; there can be no penalties for altering or stopping contributions or transferring the benefits to another scheme; and investors can contribute a minimum of £20 a month. Stakeholder pensions are available on a group or individual basis.