Proposed Actuarial Standard Would Require Disclosure of Market-Based Liability
The Actuarial Standards Board (ASB) has proposed changes to Actuarial Standard of Practice No. 4 (ASOP 4) entitled "Measuring Pension Obligations and Determining Pension Plan Costs or Contributions." ASOP 4 is an existing standard of practice that guides actuaries in performing work for pension plans. This alert describes a significant proposed change applicable to all defined benefit plans.
While the proposed ASOP revision includes changes to a number of technical items relating to funding calculations, the most significant proposed change is the addition of a requirement to calculate and disclose an "Investment Risk Defeasement Measure," which is the value of liabilities using a risk-free interest rate. We will refer to this measure as the IRDM. The IRDM is to be calculated as part of the actuarial valuation of a pension plan for funding purposes using:
- Benefits accrued as of the valuation date;
- The unit credit cost method;
- Discount rates that are either
- U.S. Treasury yields; or
- rates at which pension obligations can be effectively settled. (This can be yields on fixed-income debt securities that receive one of the two highest ratings given by a recognized ratings agency); and
- Assumptions, other than discount rates, used in the valuation or other reasonable assumptions based on estimates in market data.
The IRDM is described in the proposal as a measure "to reflect the cost of effectively defeasing the investment risk of the plan." However, the prescribed method for calculating the measure means that it is essentially a settlement cost for benefits earned to date. Under the prescribed unit credit method, the benefits accrued to date would not include expected salary increases. The actuary is required to use current market interest rates to calculate the value of benefits earned to date. Therefore, we regard this measure as a market-value of liabilities disclosure.
Because it is based on current interest rates for bonds, the IRDM will be a volatile measure that will fluctuate from year to year as market interest rates change. In addition, the actuary will need to ascertain the accrued benefit (benefit earned to date) for each participant even where the plan does not contain such a definition, as is common for public plans.
The purpose of the IRDM is not stated in the proposed ASOP. As discussed in our recent alert1, ASOP 51 requires the assessment and disclosure of risks facing defined benefit pension plans. The proposed ASOP 4 is at odds with the new ASOP 51 (see below).
Plans Subject To ERISA
The IRDM is a somewhat redundant calculation for plans subject to the Employee Retirement Income Security Act of 1974 (ERISA). There are already a number of required measures of liability that are based on current market interest rates. Actuaries determine a "current liability" for multiemployer plans that is based upon an average of recent 30-year Treasury rates. For single-employer plans, actuaries determine a "funding target" based upon three "segment rates." The segment rates are based upon average yields for fixed income securities. The funding target is used for both plan funding purposes and plan benefit limitations purposes.
Both the current liability and the funding target are regarded as market rate calculations. For single-employer plans, the required use of the segment rates has introduced much volatility into the minimum funding requirements. As such, we believe that it is one of the more important reasons that plan sponsors have frozen such plans, and sought to either terminate or de-risk the plans. The IRDM will add another such calculation that will cause confusion because actuaries will still need to determine the current liability or funding target (as the case may be) for the plan for purposes of ERISA. Given the existing disclosures, there appears to be no additional benefit to the disclosure of the IRDM.
Public Sector Plans
For public plans, the IRDM will require additional work and is not used for either funding or accounting purposes. It does not measure the level of investment risk to which a plan is exposed, and the cost of settling current benefits is rarely relevant to a public plan. Actuarial valuations for public plans use discount rates consistent with the expected return on plan investments over future years. The goal is orderly funding of the plans over time. Thus, funding calculations are based upon projected benefits. The current value of benefits accrued to date does not play a role in the funding of a plan over time.
The long-term aspect of public plan funding has been recognized by the Government Accounting Standards Board (GASB) in statements 67 and 68 (GASB 67 and GASB 68). These statements require that the expected rate of return on plan assets be used to the extent the plan assets, including future contributions intended to pay for benefits already earned, are projected to be sufficient to pay benefits. A current market interest rate is only used to the extent plan assets are not projected to be sufficient.
The idea of using a measure such as the IRDM for public plan accounting purposes was thoroughly discussed and rejected by GASB. The ASB, however, is proposing to require that actuaries calculate and disclose such a measure whenever a funding valuation is performed. We see little value in such a disclosure for a public plan.
We expect that critics of public plans will likely seize on any IRDM as evidence that public plans are underfunded. The critics will point to the IRDM as the "true" measure of plan underfunding and claim the plans are not affordable. They will (as now) overlook the fact that the immediate payment of any underfunding is not required.
ASOP 51 Requires Risk Disclosure
New ASOP 51 will soon be effective for most plans. We believe that the framework ASOP 51 establishes is the appropriate structure in which to assess and disclose risks. Under ASOP 51, a minimal-risk present value that corresponds to the present value used for funding purposes is one permissible method to disclosing risks, but there are other methods, such as stress testing, that may better disclose risks.
Comments Due By July 31
The ASB has issued the proposed changes as an exposure draft. All interested parties may submit comments to the ASB, however, they must be submitted by July 31. Cheiron pension consultants can assist you in drafting comments.
Cheiron is an actuarial consulting firm that provides actuarial and consulting advice. However, we are neither attorneys nor accountants. Accordingly, we do not provide legal services or tax advice.
1 Issued on July 10, 2018. You can find it at https://cheiron.us/cheironHome/viewArtAction.do?artID=246.