The actuarial valuation is the primary service that state and local government pension plans engage actuaries to provide, determining the contributions estimated to be necessary for funding the plans benefits and providing information about the plans current funded status.1 The actuarial valuation is also the foundation for calculating the accounting information presented in the plans annual financial report (although calculations for funding purposes and calculations for accounting and financial reporting purposes differ).
Because actuarial information directly affects the funded level and sustainability of pension plans, the GFOA urges pension plan fiduciaries to take the following steps to obtain additional information that will enhance the reliability of their actuarial valuations:
1. Ensure that all of the information the pension fund provides to the actuary is both accurate and up to date. Include the following information:
- Census data. This is information such as birth dates, hire dates, gender, pay, member contributions, and other data related to active and retired members and used in the valuation.
- Changes to plan provisions and plan administrative procedures. This is information such as changes to the plans benefit provisions, actuarial factors, special benefit calculations,2 investment policy, capital market expectations, or related risks.
2. Engage the actuary to perform additional services, to validate the actuarial assumptions used for the valuation or to help the plan with risk management strategies and future trends forecasting. Such services include:
- Actuarial Gain/Loss Analysis. An actuarial gain/loss analysis which determines the gain or loss arising from the difference between estimates and actual experience can help plan administrators better understand the differences between the plans assumptions and its actual experience with pay increases, investment returns, incidence of retirement, withdrawal from employment, and other assumptions. An actuarial gain/loss analysis is typically done over a single year and may be included in the actuarial valuation.
- Actuarial Experience Study. While an actuarial gain/loss analysis helps provide a better understanding of a plans assumed and actual experience during the year, this timeframe is not long enough to identify trends. An actuarial experience study reviews the differences between a plans assumed and actual experience over multiple years (typically 3 to 5), with the goal of examining the trends related to actual experience and recommending changes to assumptions, if needed.3
- Actuarial Projections. Public pension plans face a variety of risks, including investment losses, mortality improvements, and contributions that are lower than what is required to fund benefits. Projections can be used to examine these (and other) risks by building mathematical models of the plan and projecting the plans funded status, investment returns, or contributions under different scenarios. This helps decision makers understand the plans dynamics, the likelihood of adverse outcomes, and the effectiveness of proposed changes.
- Asset/Liability Study. Like an actuarial projection, an asset/liability study models and projects the plans future assets and liabilities under various scenarios. However, asset/liability studies differ from projections in that they focus more on the risks associated with the plans asset allocation and investment performance. Asset/liability studies are often used for examining changes to asset allocations or testing potential approaches to managing investment risks.
- Sensitivity Analysis. This is a type of actuarial projection that measures the effect of a change in actuarial assumptions on the plans funded status or required contributions.
- Analysis of Proposed Benefit Changes. In considering benefit changes, decision makers need to understand the potential cost implications of the changes before they are enacted. Consequently, an actuarial analysis of proposed benefit changes is strongly recommended before changes are approved. In addition to estimating the changes in costs, the analysis can also provide insight into potential related changes in participant behavior (i.e., retirement rates).
1 For additional information on the actuarial report, see the GFOA best practice, The Role of the Actuarial Valuation Report in Plan Funding (2013)
2 Special benefit calculations would include optional forms of payment (e.g., joint and survivor annuities, period certain annuities,), early retirement benefits, partial lump sum distributions, divorce orders, IRC 415 limits, and service purchase calculations.
3 The GFOA recommends that an actuarial experience study be performed at least every five years. (See The Role of the Actuarial Valuation Report in Plan Funding).