The Role of the Actuarial Valuation Report in Plan Funding

The actuarial valuation report has always played an important role as the basic source document for information regarding actuarially determined contributions and the funded status of pension and other post-employment benefit (OPEB) plans.[1] The actuarial valuation report, prepared in accordance with Actuarial Standards of Practice (ASOP), will soon come to play an even more critical role in the wake of the implementation of GASB Statement No. 68, Accounting and Financial Reporting for Pensions, because funding information for pensions will no longer automatically be provided in financial reports. That is, the actuarial valuation report will soon be the sole source of information for many financial decision makers desiring to make informed decisions about the funding of pension benefits.

Reviewing and Understanding the Valuation Report

The purpose of an actuarial valuation is 1) to determine the amount of actuarially determined contributions (i.e., an amount that, if contributed consistently and combined with investment earnings, would be sufficient to pay promised benefits in full over the long-term) and 2) to measure the plan’s funding progress. Key items to consider in reviewing the valuation report include:

In both cases, the number of periods for which data are presented should be sufficient to allow for the meaningful analysis of trends (e.g., 6 to 10 years and longer if available).

• Actuarial Comments. Actuarial Standards of Practice (ASOPs) require actuaries to make certain disclosures in their reports. These disclosures are commonly presented as comments intended to help users understand the report and include: 1) the report’s intended purpose; 2) cautions regarding risk and uncertainty; and 3) constraints regarding the use of the report for other than its intended purpose. In addition, if a prescribed assumption or method is used that the actuary believes is unreasonable or conflicts with the ASOPs, the actuary has a duty to disclose that fact in the report.[3]
• Information Needed to Prepare Financial Reports. The actuarial report may also provide all of the information needed to prepare the government’s financial reports in conformity with generally accepted accounting principles (GAAP) or legal or contractual requirements.  This information may be provided as part of the valuation report or through a separate actuarial report.
• Other information. An actuarial valuation report also may include: 1) projections of future contributions and funded status; 2) an analysis of the impact of potential changes in actuarial assumptions; and 3) the impact of economic volatility on the plan’s contributions and funded ratio.[4]

Recommendation: 

Using the Actuarial Report to Make Appropriate Decisions

The information contained in an actuarial report is complex and can be difficult to understand for those who are not accustomed to working with this kind of information. For this reason, simply providing a copy of the actuarial report to decision makers does not ensure that everyone has a full understanding of its short-term and long-term implications. In most governments, the finance officer is in the best position to communicate the contents of the actuarial report, as the finance officer is familiar with the nuances of the actuarial report and is also intimately familiar with the organization’s financial situation. Accordingly, the first step toward using an actuarial report to make appropriate decisions is for the finance officer to communicate the information the report contains to decision makers and the general public in a clear and understandable manner. Effective communication is especially important when changes to benefits are being considered.

To draw full benefit from the information contained in an actuarial report, the review of the information it contains must be followed by appropriate action steps:

• Making Required Contributions. The key purpose of an actuarial valuation is to inform plan sponsors of the amount that needs to be contributed each year to adequately fund benefits. Consequently, the first action step is to take appropriate steps to ensure that actuarially determined contributions are faithfully paid to the plan each year.  If those contributions are not made, follow-up action should be taken to understand the underlying cause of the underfunding and to resolve it.
• Assessing Funding Progress. Historical information should be used to assess funding progress (e.g., Is the plan’s funded ratio improving over time? Is the rate of improvement consistent with the employee’s funding policy?).
• Mitigating Risks. Information from the actuarial valuation can help to uncover risk exposure related to the funding of benefits.  Decision makers should identify those risks and take appropriate and timely action to mitigate them.  For example, if the valuation shows a high degree of asset volatility, it may be prudent to lower that volatility through adjustments to asset allocations or by other means, such as examining the methodology used to determine the actuarial value of assets.  
• Ensuring Reliable Data. For an actuarial valuation to be reliable, the underlying data must be reliable as well, including the demographic information related to plan members, the economic information related to investment returns and payroll growth, and the detailed descriptions of current benefits.  Employers should work closely with the actuary to ensure that reliable information is provided in a timely manner.
• Validating Methods and Assumptions through Experience Studies. The reliability of an actuarial valuation also depends on the use of reasonable methods and assumptions.  Experience studies, performed no less frequently than every five years, can help to ensure the assumptions are in line with the plan’s demographic and economic experience, or can be used as a guide to make necessary changes. Likewise, a comprehensive audit of the plan’s actuarial valuations performed by an independent actuary at least once every five to eight years can be used to evaluate the appropriateness of the actuarial methods, assumptions, and their application.