Enlightenment on the Actuarial Valuation Process
As the years pass and plan documents change, there is one constant in your defined benefit plan; complex actuarial reports received annually. It is important to understand the report(s) your plan receives and the significant factors that go into the actuarial analysis.
Actuarial reports come in different shapes and sizes. Defined benefit plans primarily receive FASB ASC 715 and FASB ASC 960 reports. The reports provide users with detailed information regarding plan obligations, as well as funding requirements related to Employee Retirement Income Security Act (ERISA) and IRS filings.
ASC 715 Reports:
- Establish pension obligations and expenses for use in plan sponsor financial statements
- Provide beginning of year projected benefit obligations
- Provides the plan benefit obligations and detailed financial statement disclosure information at year-end
ASC 960 Reports:
- Establish pension obligations and expenses for use in plan financial statements
- Provides the present value of accumulated plan benefits calculation and a year-to-year reconciliation for use in plan financial statement disclosures
It is pertinent that plan sponsors recognize their responsibility for understanding key assumptions used in ascertaining these actuarial valuations. The assumptions are based on plan provisions provided to the actuaries. The goal is to use the most appropriate data available in order to provide the best estimates of benefits owed by the plan given details in the plan document and details about the participant population. The assumptions must be plan specific and based on reputable industry data applicable to the plan.
The Actuarial Standards of Practice provide guidance on which approach should be used in setting assumptions under various valuation circumstances. The actuary’s report summarizes the process used to set assumptions, with detail available upon request. Assumptions are based on the best estimate of the plan sponsor for ASC 715 reports and of the plan administrator for ASC 960 reports.
There is a litany of actuarial assumptions used in the valuation process, many of which change between ASC 715 and ASC 960 reports; however, the most common assumptions include:
Interest (Discount) Rate:
- Required by regulators
- Used to bring the future projected benefit payment to present value as of the date of measurement
- Is normally the rate of return expected on current plan assets or a rate that reflects the settlement of future benefit payments at the current date
- Required by regulators
- New mortality tables were released in October 2014, which reflect longer life spans and in turn, lead to higher plan obligations and expenses.
Rate of Return on Plan Assets
- Not required by regulators
- Frequently used as it projects assets available to pay future plan obligations
- Uses forecasts provided by economists and applies these forecasts as applicable to current portfolio holdings
Plan sponsors must understand the actuary’s reports and the assumptions used to determine the valuations within. Having a basic understanding of the reports and assumptions will provide plan sponsors the knowledge necessary to lead their plan into the future.