Newly Required Risk Assessment Could Help DB Plan Sponsors With Decisions

A new Accounting Standards Board Standard of Practice requires actuaries to identify risks that, in the actuary’s professional judgment, may reasonably be anticipated to significantly affect the defined benefit plan’s future financial condition.

Actuarial Standard of Practice No. 51, Assessment and Disclosure of Risk Associated with Measuring Pension Obligations and Determining Pension Plan Contributions, went into effect on November 1.

The Actuarial Standards Board explains that “This actuarial standard of practice (ASOP) provides guidance to actuaries when performing certain actuarial services with respect to measuring obligations under a defined benefit pension plan and calculating actuarially determined contributions for such plans, with regard to the assessment and disclosure of the risk that actual future measurements may differ significantly from expected future measurements. Examples of future measurements include pension obligations, actuarially determined contributions, and funded status.”

According to Eric Keener, senior partner and chief actuary of Aon’s U.S. Retirement practice in Norwalk, Connecticut, ASOP 51 applies when actuaries are performing what is referred to as a funding valuation, in which the actuary calculates the actuarially required contribution (ARC) for a defined benefit (DB) plan. He says these valuations are typically performed annually for private-sector DB plan sponsors. ASOP 51 also applies to projections of cash flows—for example, contributions that may be required several years in the future.

Risks to be assessed

ASOP 51 says the actuary should identify risks that, in the actuary’s professional judgment, may reasonably be anticipated to significantly affect the plan’s future financial condition. Examples of risks include the following:

  • investment risk (i.e., the potential that investment returns will be different than expected);
  • asset/liability mismatch risk (i.e., the potential that changes in asset values are not matched by changes in the value of liabilities);
  • interest rate risk (i.e., the potential that interest rates will be different than expected);
  • longevity and other demographic risks (i.e., the potential that mortality or other demographic experience will be different than expected); and
  • contribution risk.

“At the most basic level, the ASOP is asking actuaries to identify particular risks that could affect a plan’s funded status in the future, such as not meeting market assumptions,” Keener says. “The ASOP is not very prescriptive, so there is a fair amount of judgment the actuary may take. He may use a qualitative analysis and description or, on the other hand, he could do something more numerical, such as projections about how much the funded status could change depending on market and interest rate movements.” He adds that plan sponsors could have different views about how the actuary should carry out the assessment—whether they want a full asset/liability study or a more qualitative assessment.

Keener says he thinks some actuaries are doing some of these things already. “Very often they are doing projections of funding contributions over several years using different scenarios—that can be part of ASOP 51,” he says. “There’s a bit of change in practice across the board, but how much change depends on how sophisticated an analysis an actuary was already doing.”

According to Keener, right now, there is no requirement that the risk assessment be filed or reported to anyone but plan sponsors. However, he says that usually an auditor prepares financial statements annually for DB plan sponsors, and it might be that he would ask for this information, but that remains to be seen over time as things develop.

A best practice

Keener says an actuary who is a member of an actuarial organization, for example, the American Academy of Actuaries, is bound by the codes of conduct of the Actuarial Standards Board and will have to perform the risk assessments required by ASOP 51. This is the majority of actuaries that are performing funding valuations.

But, he thinks this will be considered a best practice for every actuary even if not a member of one of the actuarial organizations. Sometimes an enrolled actuary performs the funding valuation for a DB plan. Keener says he believes all will be somewhat following best practices.

“Hopefully, what the ASOP will do is enable plan fiduciaries to understand the risks their plans may face and what those will mean for future contribution scenarios. The more informed plan sponsors are, the more they can avoid adverse actions,” Keener concludes.