Actuarial Valuation Basics
An actuarial analysis is an analysis typically performed by an actuary to determine the assets and liabilities in a pension plan. An actuarial valuation evaluates whether pension plans are sustainable or not. Many people use the actuarial calculation to make decisions on plan sponsors. A key feature of a defined benefit pension is a financial commitment that is typically fulfilled many years into the future. For instance, this year’s retirees are expected to collect their pensions for the next 30 years. Therefore, the sponsors of the pension plans need to ensure they have sufficient assets for payments that become due during the 30-year period.
Deficit and Surplus
The basic function of a pension appraisal is to determine the value of assets and liabilities over a specific period. The plan is considered a surplus if it’s funding ratio exceeds 100 percent. A surplus usually occurs when the value of assets in a pension plan exceeds the value of liabilities. On the other hand, the plan is considered a deficit if the funded ratio is less than 100 percent. A deficit occurs when the value of liabilities in a pension plan is higher than the value of assets.
Several assumptions or predictions are usually made when conducting an actuarial evaluation. Some of the assumptions or projections include:
How long members will live
How long members will work
When members will retire
Salary increases the members are likely to receive
Likely earnings from the pension plan
These assumptions or predictions are usually selected over a specific period. However, it is essential to understand that actual circumstances could deviate from the predictions. Some of the activities done during a pension appraisal are stress testing and sensitivity analysis to determine the possibility of crucial assumptions deviating from real experiences.
Various terms are used to describe some of the assumptions made during an actuarial evaluation. For instance, primary non-economic assumptions are related to retirement, job termination, and mortality. They include all factors that may cause members to withdraw their membership for any reason other than death and retirement.
The assumptions made during an actuarial evaluation are based on estimates developed through experience studies. However, some assumptions, such as demographic assumptions, are based on past experiences.
Pension appraisals have significance in both the public and private sectors. In 2016, pension appraisal determined that U.S. Steel had a funding ratio of 88 percent. This means the firm’s assets were not enough to meet its obligations that year.
Some U.S. states are facing financial constraints because of higher liabilities for workers’ pay. Reports indicate close to half the states in the U.S. had a funding ratio of 71 percent and less as of 2016. New Jersey’s ratio was the most unfavorable at 31 percent. Only two states, Washington D.C. and Wisconsin had a funding ratio of 100 percent in 2016.
Experts use actuarial assessment to value a pension plan. This type of valuation relies on assumptions or inference, demographic changes, interest rates, and inflation.
Schwartz & Madden is one of the leading pension appraisal firms in the U.S. Our clients rely on us to provide accurate estimates of their pension values. Contact Moon, Schwartz, & Madden at (925) 258-7100 for a free consultation.