The following GFOA best practice is the first in a series related to actuarial topics.
The fundamental financial objective of public employee defined benefit and hybrid plans is to fund the long-term cost of benefits in a fiscally sustainable manner.1 To help reach this objective, public plans hire actuaries to determine the funded status of a plan and the necessary contributions which, when combined with investment earnings, will pay the promised benefits when they are due. Actuaries also act as technical advisors to a plans trustees regarding plan design, actuarial assumptions, and methods. High-quality actuarial work can help insure the long-term soundness of a pension plan, whereas low-quality work can undermine that security. Consequently, the process for procuring actuarial services should include steps to ensure due diligence in finding a qualified actuary.
GFOA recommends that state and local governments take the following steps to obtain high-quality actuarial services for their public retirement plans: 1) identify the actuarial services required; 2) establish selection criteria; 3) develop a clear and concise request for proposals (RFP); 4) determine, to the degree possible, the level of independence and objectivity of the actuary; 5) establish procedures for working with the actuary; and 6) periodically review and rebid actuarial contracts.
1) Identify the Actuarial Services Required. The actuarial valuation calculates a plans liabilities, the value of plan assets, and a plans funded status at a point in time. It combines demographic and economic information about plan participants with benefit provisions and actuarial assumptions to calculate the amount of money that needs to be contributed to a plan to fund it over a reasonable period. Actuarial valuations also typically provide the information required for accounting and financial reporting purposes by the Governmental Accounting Standards Board (GASB). However, actuaries perform other services that may be useful for a plan or the employer that sponsors a plan. These include:
- Providing asset/liability studies, asset allocation modeling, and cash-flow projections to measure the risks a plan is taking on and its likely long-term fiscal sustainability.
- Calculating the effect of benefit changes on cost.2
- Studying the differences between assumed experience and actual experience. The GFOA recommends that an experience study for a plan be conducted no less than once every five years.3
- Providing the information needed for public employers to comply with GASB financial reporting requirements.
- Providing other functions and specialized calculations needed to administer a plan (e.g., calculations related to benefit limits under Internal Revenue Code 415(b), benefit conversion calculations)
- Providing plan design modeling and requirements for the comprehensive annual financial report.
Decision makers should consider whether these additional services might be of use to the plan before developing the RFP.
2) Establish Selection Criteria. The actuarial firm and supervising actuary should have the following actuarial credentials and experience:
- Credentials. The supervising actuary must meet the American Academy of Actuaries Qualification Standards4 and be a Fellow of the Society of Actuaries (FSA) or an Associate of the Society of Actuaries (ASA), or an equivalent credential from an organization such as the Conference of Consulting Actuaries. Work by an enrolled actuary (EA) is also appropriate, provided the EA has substantial public-sector experience.5
- Experience. The supervising actuary should also have significant experience with public-sector retirement systems. Actuaries who will be required to testify before legislative and administrative bodies should also have experience providing such testimony.
- Clarity. The supervising actuary should be able to discuss actuarial theory, the basis for assumptions, and all other actuarial matters in language that is easily understood.
3) Develop a Clear and Concise RFP. An RFP should clearly explain the scope of work required, the timeline over which the work must be done, and the criteria by which responses to the RFP will be judged. The following items should be included in an RFP. (See the actuarial procurement RFP checklist for a more detailed list of items to include in an RFP.)
- Plan Description. Actuaries need a clear sense of the benefit plan so they can bid properly. An RFP should therefore include plan members demographic and economic characteristics as well as plan provisions and benefits to be valued.
- Scope of Services. An RFP should specify the services to be provided, desired completion dates, and whether the actuary will be required to make formal presentations to the governing body, along with which services are required under the contract and which are optional.
- Information about the Firm. An RFP should request detailed information about the firms background, the services it provides, its ownership structure, and the supervising actuary and other personnel who will assist in providing the services.
- Information about the Work Process. An RFP should ask for a detailed description of the firms overall approach to the work and a timeline of major tasks and due dates.
- Costs and Terms of Agreement. This section should request details related to the cost proposal and any required terms and conditions that must be met in the work. Be aware of limitations on liability and make sure the terms are fair and balanced on both sides.6 While low cost is important, an inordinately low-cost offering may not be compatible with providing the services that the plan actually needs.
- Transition Plan. An RFP should also ask the actuary to discuss the process for making the transition to another actuary if the contract is not renewed.
4) Promote Independence and Objectivity. Actuaries are bound by the Code of Professional Conduct to adhere to high standards of conduct and practice.7 Governments that are soliciting actuarial services should be aware of this code and discuss its implications with prospective actuaries during the bid process. Key provisions of the code require the actuary to:
- Act honestly, with integrity and competence.
- Perform actuarial services only when qualified to do so, based on education and experience.
- Satisfy the applicable standards of practice and keep current with those standards.
- Take steps to keep the services from being used to mislead other parties.
- Not perform services involving an actual or potential conflict of interest, unless the conflict is fully disclosed to the affected principals and they have expressly agreed to the performance of the services.
5) Establish Working Procedures. Actuarial valuations typically involve: obtaining demographic and financial data about plan participants; reviewing the data for general reasonableness; calculating the actuarial values; preparing the valuation report; and presenting the report to plan officials. Establishing effective working procedures can help to control costs and help the work get completed in a timely manner. Generally, the most labor intensive (and therefore most expensive) part of the process is reviewing the data and making necessary corrections. Governments can make actuarial valuations more timely and less expensive by working with their actuaries to keep the data records well maintained from year to year.
6) Periodically Review and Rebid Actuarial Contracts. Most state pension systems have established contract renewal periods of approximately five years, often with two- to three-year extensions.8 And although there are requirements for rebidding the work, in many cases there is no requirement to change the actuary after the contract period expires. While reviewing actuarial contracts is an important part of due process, frequently rebidding or changing actuaries can be time-consuming and expensive. It can also lead to the plan being serviced by individuals who are not familiar with its more complicated provisions. The GFOA therefore recommends that contracts for actuarial valuations be for multiyear periods of at least five years.
In this context, actuarial audits can help make sure the plan continues to receive high-quality actuarial work. In an actuarial audit, one actuarys work is reviewed by another actuary to see that the valuations are done correctly and the methods and assumptions are reasonable. Actuarial audits help plan trustees perform their due diligence and help assure that the information provided by the retained actuary is reasonable and accurate. The GFOA recommends that actuarial audits be done at least every five years, unless there is a change in the actuary.
Addendum: Additional Items Related to Procuring Actuarial Services for OPEB
The above discussion of procuring actuarial services for pension benefits also applies to other postemployment benefits (OPEB). However, because most OPEB plans provide retiree health care, the procurement process must also ensure that the actuarial team has the appropriate qualifications and experience with regard to health care benefits. The team should also have experience and expertise with regard to:
- Retiree health-care plan design.
- OPEB accounting and reporting information requirements under GASB Statement Nos. 43 and Statement No. 45, including implicit rate subsidies.
- Governmental funding arrangements for retiree health care, including 401(h) accounts, voluntary employee beneficiary associations (VEBAs), and Section 115 governmental trusts.
1 GFOA Best Practice, Sustainable Funding Practices of Defined Benefit Pension Plans.
2 See the GFOA Best Practice, "Sustainable Pension Benefit Tiers," for additional information.
3 See the GFOA Best Practice, "Sustainable Funding Practices of Defined Benefit Pension Plans," for additional information.
4 Only actuaries that meet the American Academy of Actuaries Qualification Standards are allowed to sign actuarial valuations and other actuarial documents. The American Academy of Actuaries Qualification Standards are available at http://www.actuary.org/qualstandards/qual.pdf.
5 The credentials of practicing actuaries can be found online by searching the Actuarial Directory at https://www.actuarialdirectory.org/SearchDirectory/tabid/242/Default.aspx.
6 For additional information, see the National Association of State Retirement Administrators 2003 paper, Limitation on Liabilities for Actuarial Services, at http://www.nasra.org/resources/limitationsonliabilities.doc.
7 Additional information about the Code of Professional Conduct is available at http://www.actuary.org/code.asp.
8 According to retirement system information posted on the National Association of State Retirement Administrators website.