A new actuarial standard in the US took effect November 1 that requires pension plan actuaries to factor in potential risks that “may be reasonably anticipated to significantly affect the plan’s future financial condition.”
For many plan sponsors and actuaries who have already been performing this due diligence, it will be business as usual; however, for others, it may require a lot of extra work, but should provide a more thorough risk analysis of a pension plan.
Actuarial Standards of Practice (ASOP) 51, as defined by the American Academy of Actuaries’ Actuarial Standards Board (ASB), provides guidance to actuaries when measuring obligations under a defined benefit pension plan, and when calculating contributions. The new rule requires the assessment and disclosure of the risk that actual future measurements may differ significantly from expected future measurements.
“Any good actuary does this already,” Bob McBride, vice president of work space solutions at Transamerica, and a certified actuary, told CIO. “The standard is just making it a formal item that we’re obligated to incorporate in our practice. We [Transamerica] already provide that information, but this will memorialize it in case anyone questions if we were meeting the standard.”
Examples of the risks that must be considered include the possibility that investment returns will be different than expected, or that changes in asset values might not be matched by changes in liability values, as well as the potential that interest rates will be different than expected. Other examples include longevity and other demographic risks, and contribution risk.
“The big benefit of the ASOP is it’s putting more formally in place the types of risk measures that plan sponsors’ CIOs should be seeing from their advisors,” said Michael Carse, defined benefit product manager at financial technology company RiskFirst. “I think it will encourage a broader adoption of these metrics being discussed, and that will help the plan sponsors and asset owners in their role of managing the risk of these plans.”
Carse said that many of the items in ASOP 51 have been incorporated into RiskFirst’s PFaroe platform, which was launched in 2009 to manage risk for defined benefit pension plans.
“Different methods of risk assessment are something we have built into the product over time,” said Carse. “You’re able to run scenarios live with a client, and you can see what would happen if the credit crunch were to happen again. Looking at that type of analysis will resonate with people.”
According to the ASB, methods for assessing these risks can include scenario tests, sensitivity tests, stochastic modeling, stress tests, and a comparison of an actuarial present value using a discount rate derived from minimal-risk investments to a corresponding actuarial present value from the funding valuation or pricing valuation.
Section 3.4 of the ASOP says actuaries should take into account the degree to which the methods and models reflect the nature, scale, and complexity of the plan.
“In using professional judgment,” the ASOP says, “the actuary may take into account practical considerations such as usefulness, reliability, timeliness, and cost efficiency.”
The new guidelines also state that assumptions used for assessing risk may be based on economic and demographic data and analyses, which is available from various sources, such as representatives of the plan sponsor and administrator, investment advisors, demographers, and economists.
“Views of experts or principals may be considered,” section 3.5 of the rule states, “but the selection of assumptions for the assessment of risk should reflect the actuary’s professional judgment.”
Carse says that until now, the actuaries in charge of a pension’s funding valuations haven’t had to know too much about the assets for the work they do, and typically have been focused details, such as performing calculations to establish a value of the liabilities. Similarly on the investment side, he says an investment consultant is typically looking at what the strategy should be in terms of the asset portfolio, and how that should be invested, such as the split between bonds and equities, etc.
“Having this ASOP put in place is encouraging more collaboration between those two parties,” said Carse. “Advisors for plan sponsors need more joined-up thinking, and that can only be beneficial from the CIO perspective.”