Actuarial Liabilities FAQs Flashcards
- What is an actuarial valuation and why is it conducted?
An actuarial valuation is a comprehensive assessment of a pension scheme’s financial health. It
involves calculating the scheme’s liabilities (the present value of future benefit payments promised
to members) and comparing them to the scheme’s assets (the investments held to fund those
benefits).
Actuarial valuations are conducted for several reasons, including:
* Legal compliance: Legislation often mandates regular valuations.
* Funding assessment: To determine if the scheme has sufficient assets to meet its liabilities.
* Contribution guidance: To advise the sponsoring employer on the required contributions to
maintain or improve the funding level.
* Transparency: To provide trustees and members with insights into the scheme’s financial
position and future prospects
- What are the key assumptions involved in an actuarial valuation?
Actuarial valuations rely on various assumptions about future events that impact the scheme’s
liabilities and assets. These assumptions fall into two main categories:
* Financial assumptions:
o Discount rate (investment return): The rate used to discount future cash flows,
reflecting the expected long-term investment performance of the scheme’s assets.
o Salary growth: The assumed rate of future salary increases for active members,
impacting their final pensionable earnings.
o Inflation: The assumed rate of general price increases, affecting pension benefits and
expenses.
o Pension increases: The assumed rate of increases applied to pensions in payment
and deferred pensions.
o Expenses: The estimated costs associated with administering the scheme.
* Demographic assumptions:
o Mortality: The assumed rates of mortality for scheme members, influencing life
expectancy and the duration of pension payments.
o Early retirement: The proportion of members expected to retire before the normal
retirement age.
o Ill health retirement: The proportion of members expected to retire early due to ill
health.
o Withdrawals: The rates at which members are expected to leave the scheme before
retirement.
o Marital status: The proportion of members who are married, impacting potential
spousal benefits.
o Age difference between members and spouses: Relevant for calculating spousal
benefits.
o Child benefits: The proportion of members with children eligible for benefits
- How is the actuarial liability for different member types calculated?
The actuarial liability represents the present value of future benefits promised to each member. The
calculation differs depending on the member’s status:
* Pensioners: The liability is calculated by multiplying the current pension payment by an
annuity factor, which reflects the expected remaining lifespan of the pensioner.
* Deferred members: The liability considers the projected pension at their normal retirement
date, discounted back to the valuation date. Factors like future revaluation, inflation, and the
probability of survival until retirement are incorporated.
* Active members: The liability is based on their projected final pensionable earnings, accrued
service, and future service until retirement. Assumptions about salary growth, mortality, and
discount rates are also applied
- What factors can impact the funding position of a pension scheme?
Numerous factors can affect a scheme’s funding position, including:
* Investment performance: Positive investment returns increase assets, while negative returns
can lead to a deficit.
* Changes in assumptions: Adjustments to key assumptions, such as discount rates or
mortality rates, can significantly impact liabilities.
* Benefit changes: Introducing or modifying benefits affects the scheme’s liabilities.
* Demographic experience: Actual experience deviating from assumed rates, such as higher-
than-expected longevity, can impact liabilities.
* Employer contributions: Regular and sufficient contributions from the sponsoring employer
are crucial for maintaining or improving the funding level
- What is the funding position of a pension scheme?
The funding position indicates the scheme’s overall financial health. It is determined by comparing
the total assets with the total liabilities:
* Surplus: If the assets exceed the liabilities, the scheme is considered to have a surplus.
* Deficit: If the liabilities exceed the assets, the scheme is considered to have a deficit.
The funding position is often expressed as a percentage, representing the proportion of liabilities
covered by the assets
- What are the implications of a pension scheme deficit?
A deficit indicates that the scheme may not have sufficient assets to meet its future obligations. This
can lead to several consequences:
* Increased employer contributions: The sponsoring employer may need to make higher
contributions to address the deficit.
* Benefit reductions: In severe cases, the scheme may be forced to reduce benefits to improve
its funding position.
* Financial strain on the sponsor: Significant deficits can strain the sponsoring employer’s
finances, potentially impacting their business operations.
* Concern for members: Members may worry about the security of their future benefits if the
scheme is underfunded
- What measures can be taken to address a pension scheme deficit?
Addressing a deficit requires a multifaceted approach, which may involve:
* Increased contributions: The sponsoring employer and members may need to increase
contributions.
* Investment strategy review: Reviewing the investment strategy to potentially improve
returns while managing risk.
* Liability management exercises: Strategies to reduce or mitigate liabilities, such as offering
lump sum payouts to members.
* Benefit restructuring: Modifying future benefit accrual rates or other benefit provisions to
lower liabilities.
* Mergers or consolidations: Merging with or transferring liabilities to another scheme can
improve efficiency and potentially enhance funding
