Report
Feedback on the Statement of
Principles for Revised Actuarial
Standards of Practice for Reporting
on Pension Plan Funding
Committee on Pension Plan Financial Reporting
October 2005
Document 205105
Ce document est disponible en français
© 2005 Canadian Institute of Actuaries
Memorandum
To:
All Fellows, Affiliates, Associates and Correspondents of the Canadian
Institute of Actuaries
From :
Stephen Butterfield, Chairperson
Committee on Pension Plan Financial Reporting
Date :
October 5, 2005
Subject:
Feedback on Statement of Principles for Revised Actuarial Standards
of Practice for Reporting on Pension Plan Funding
The Committee on Pension Plan Financial Reporting (PPFRC) has received considerable
feedback on our Statement of Principles for Revised Actuarial Standards of Practice for
Reporting on Pension Plan Funding. This feedback was obtained through formal written
submissions and through verbal submissions at such venues as the CIA Pension Seminar,
the CIA Annual Meeting, presentations given at local actuarial clubs and to union and
industry groups.
Some of the submissions generally support the concepts underlying the Statement of
Principles while others are more critical. However, a number of the submissions also
expressed concern about various concepts espoused by the Statement of Principles and
asked for more detail or clarification.
While there are many issues and topics where further discussion is desirable, based on the
feedback received, the PPFRC has identified six primary topics where we believe further
clarification or justification is warranted and for which we would like to obtain more
feedback from the membership. The six topics are as follows:
1. What valuations should be required – wind-up and/or going concern?
2. What is the actuary’s responsibility?
3. Reconciliation with the principles inherent in financial economics.
4. How to determine best-estimate assumptions?
5. Whether to include a wind-up incremental cost and wind-up gain / (loss).
6. Rationale for permitting smoothing of assets.
The PPFRC has prepared discussion documents on each of these topics. These discussion
documents generally explain the rationale underpinning the Statement of Principles,
summarize the submissions received related to the topic and ask critical questions for
which we would appreciate the further views of practitioners.
The PPFRC has established a discussion forum on the CIA Discussion Board for each of
these topics. Before embarking on the next phase of this project, we would like to obtain
your views on these topics and generate a productive on-line debate. We are interested in
your views as to why our standards should include or exclude certain items and why you
believe this. Note that this is not an on-line survey, but a forum for discussion. The
PPFRC will monitor the forums and will participate as appropriate. Note, however, that
our intent is to participate by way of answering questions or providing clarification,
rather than to further espouse the views expressed in the Statement of Principles.
The discussion forum in the Members section of the CIA website can be accessed at
<http://forums.actuaries.ca/viewforum.php?f=2>.
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TOPIC 1: WHAT VALUATIONS SHOULD BE REQUIRED - WIND-UP AND/OR
GOING CONCERN?
1.
Position Espoused by the Statement of Principles
The Statement of Principles states that an actuary conducting a funding valuation must
report the financial condition of the plan on both a wind-up valuation basis and a going
concern valuation basis.
2.
Clarification/Justification of Position
The Statement of Principles is premised on two key objectives - benefit security and
contribution stability. Obviously benefit security is paramount to a successful pension
plan and the delivery on the pension promise. While the Statement of Principles espouses
the objective of contribution stability, based on comments received, this objective may be
better described as “providing the parties to the plan with information to assist in the
future budgeting of the plan”, or “providing the parties to the plan with information to
assess the long-term sustainability of the plan”.
By having access to this information, the Funder/regulator may make more informed
decisions to enhance contribution stability. The ability to make reasonably stable budget
plans is something that is viewed as quite desirable for many pension plan sponsors and
assists plan members and regulators in better understanding the future health of the plan.
The wind-up valuation provides a test of whether there are sufficient assets in the Plan to
meet wind-up liabilities as at the date of the valuation, and is the key measurement item
proposed for benefit security. The going concern valuation may be seen as a long-term
financial plan (“budget”) for funding of benefits. The going concern valuation is intended
to promote both contribution stability and benefit security. However, it is recognized that
the Funder will have a significant impact on how much the going concern valuation
promotes these two objectives through the funding policy of the Plan. Nonetheless,
pension plans are long-term in nature and a well conceived long-term financial plan
should help promote the long-term well being of the pension plan.
The term “benefit security” need not be interpreted as applying only to accrued benefits
in case of plan wind-up, but may be extended also to long-term security of expected
benefits. So, if a sponsor eventually prematurely winds up a plan as a result of
unacceptable or volatile costs, we can consider this as detrimental to the security of
benefits.
The Statement of Principles is intended to apply to funding valuations for all types of
pension plans, including SERPs, even though a valuation report is not even required by
law for such plans. The intention is that in cases where a SERP administrator requests a
funding actuarial valuation, it could be considered useful to the reader to see the results
under both bases, even though the purpose of the report might not encompass this. This
would still leave the possibility for an actuary to prepare a valuation report that does not
include all the information required under AAP, if the report includes a qualified opinion
that states how the report deviates from AAP.
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3.
October 2005
Summary of Comments and Submissions Received
Wind-up Valuation
The concept of a wind-up valuation on a pure market basis was generally well received
and most submissions agreed that users of actuarial reports would benefit from this
valuation and disclosure. This pure wind-up position is considered more useful than the
solvency position that reflects various adjustments permitted depending on applicable
legislation.
There were concerns expressed on behalf of Public Sector Plans where wind-up benefits
are not well-defined, wind-up is highly improbable and the settlement mechanism would
likely take into consideration many factors that would need to be clarified in the event of
wind-up, and the actuary would not be in a position to make such clarifications for the
purpose of a valuation. Further, concerns were expressed about the alternative of having
to make any form of a qualified opinion with the funding valuation report.
There were also concerns expressed in regard to reporting for multi-employer plans given
their different governance structures and legislative environments.
The other main comment was that wind-up results without PfADs do not make provision
for adverse deviation in the financial markets, in particular, in regards to asset/liability
mismatch. Therefore, some argued that a PfAD was necessary to promote benefit security
in a mismatch situation. Some of the comments that supported this approach also
questioned the continued use of a mandatory going concern valuation (see comments
below). We note the Report of the Task Force on Pension Plan Funding had advocated
such an approach in its January 2003 report, which stated:
“The results of our modeling demonstrated that a 10% margin would be sufficient for
a fund with 50% equity content and 50% immunized portfolio.”
(see http://www.actuaries.ca/publications/2003/203012e.pdf)
Going Concern Valuation
There were considerable comments received with respect to the purpose and nature of the
going concern valuation.
Many comments were supportive of the continued use of a going concern valuation, but
wanted to see guidance on best estimate assumptions and PfADs before expressing
greater support.
Some respondents commented that defining an objective as stability of contributions is
too narrow, and that we should focus instead on predictability of contributions. They
contend that sponsors may be willing to accept costs that do not remain unchanged, but
what they find harder to accept are unexpected changes.
There were those that argued that the going concern valuation is not meeting the
objectives of stability or predictability of contributions and benefit security with any
material consistency. For example, many flat benefit plans and career average plan
funding costs are currently being driven by current market interest rates applicable to
solvency valuations and the going concern valuation has limited impact for many of these
plans. It was pointed out that, in the current economic environment, the going concern
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valuation may be more relevant in promoting contribution stability and benefit security in
final pay plans.
The continuation of this argument was that going concern valuations should not be a
mandatory part of our standards, but only performed if required by regulators or a
funding policy.
Others mentioned that regardless of how useful a going concern valuation might be in
pursuing a Funder’s objective of stable or predictable costs, it should not be part of the
minimum requirements of AAP. They would prefer that AAP require only the basis that
focuses on benefit security, since this objective is preferable for our profession to pursue
as a matter of public interest.
Other Considerations
Under current legislation, an actuarial valuation report is required to present results on a
going concern basis and on a solvency basis. So we may note that if AAP does not
require going concern valuation results, all reports for registered plans will still need to
include them under current legislation. However there is no guarantee that pension
legislation will continue to require this, especially since some have already suggested that
legislators should focus strictly on the solvency basis in the future.
4.
Your Views
The PPFRC would like to get your views on this issue. In particular:
a)
Should a wind-up valuation be mandatory when reporting on pension plan funding
or should a wind-up valuation only be required when requested by a regulator or a
funding policy?
b)
Should going concern valuations be mandatory when reporting on pension plan
funding or should a going concern valuation only be required when requested by a
regulator or a funding policy?
c)
If you feel that one of the two valuation basis should not be mandatory under AAP,
should AAP state that the actuary may use any basis that is required by a Funder or
regulator, and then AAP for such basis would be applied when used?
d)
Should the valuation bases required by AAP differ depending on the type of plan
being valued?
e)
Is there merit in changing terminology from going concern liabilities and surplus to
something new to avoid misinterpretation by external stakeholders and decision
makers regarding surplus and the going concern valuation?
f)
Does the going concern valuation, as proposed, promote the goals of contribution
stability and benefit security? Are these reasonable and attainable goals for the
going concern valuation?
g)
What is meant by contribution stability? Would it be preferable to redefine this
objective as promoting future costs that are reasonably stable and in accordance
with the long-term financial plan?
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h)
October 2005
For plans where only one of the two suggested bases is required by a regulator or a
funding policy, is it acceptable to ask the actuary that such a valuation conclude
with a qualified opinion that states why both bases were not used?
TOPIC 2:
1.
WHAT IS THE ACTUARY’S RESPONSIBILITY?
Position Espoused by the Statement of Principles
The Statement of Principles states that the role of actuaries is to measure and report plan
liabilities and costs to users of actuarial reports and to disclose pertinent risks. Decisions
on the appropriate levels of conservatism and the level of contributions to be paid should
rest with the Funder, as documented in the funding policy, subject to constraints imposed
by regulators and legislators.
2.
Clarification/Justification of Position
The Statement of Principles is premised on the fundamental principle that the Funder
should develop its own funding objectives to suit the pension “deal” for that particular
plan as well as its own risk management approach. The plan’s funding policy, including
components such as PfADs and AtUMs would be the responsibility of the Funder. AAP
should then stipulate how to measure and report particular funding objectives. AAP
would also require the actuary’s valuation report to comment on the risks, including those
arising as a consequence of the funding policy adopted by the Funder.
The Statement of Principles recognizes that the Funder will likely require the assistance
of an actuary (not necessarily the same actuary who performs the valuation) in the
development of the funding policy. It recommends that the Institute develop and maintain
both standards and guidance for actuaries to follow in such instances. But the Statement
of Principles was intended to focus only on the subset of AAP dealing with reporting
requirements.
3.
Summary of Comments and Submissions Received
Most of the comments received called for a greater involvement, if not a greater
clarification of the involvement, of actuaries in the development of the funding policy.
Some members said that the Statement of Principles was shifting important funding
responsibilities away from the actuary to the Funder leaving the actuary with only the
responsibility of reporting on the valuation results. Some even suggested that this
“number cruncher” role would devalue our services, skills, and image.
Some people believe that in order for AAP to serve public interest, we should ask
actuaries to be responsible for determining in the actuarial valuation an appropriate level
of PfAD to promote benefit security. Note that this is already the case under current
AAP, though the current guidance is not prescriptive and the range of practice may be
wide. However, current AAP does not require explicit identification of the PfADs, nor
comments on the risks involved, whereas the proposed AAP would.
Some people believe, as mentioned in the Statement of Principles, that if it’s up to the
Funder to decide, then we can expect many, if not most, funding policies to minimize
contributions, which would be to the detriment of benefit security. This may be expected
especially in the current regulatory context, which some have qualified as asymmetrical
in the treatment of surpluses and deficits.
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October 2005
Some people argued that there could be a potential conflict of interest in having the same
actuary act as a consulting actuary to the Funder in setting up its funding policy and as a
valuation actuary. Others argued that we should not delineate between the two roles.
Some people agreed with the role of the actuary and the Funder as described in the
Statement of Principles, stating that this is what a minimum standard should dictate, even
though specific situations will require a greater involvement by the actuary. Others also
agreed with the responsibility of the Funder as described but called for an actuary to
either “audit” the Funder’s policy or be actively involved in its development.
In the absence of legislation, some representatives of pension regulators question the
legal authority of the actuary to require a funding policy from the Funder and the
actuary’s options if the Funder refuses to provide one. Would the actuary refuse the terms
of engagement, or would the actuary issue a qualified actuarial opinion? Some regulators
also raised concerns related to the actuarial profession’s responsibility to the public if it
relinquishes responsibilities to the Funder for elements of the funding policy that affect
benefit security (i.e., PfADs, AtUMs). They also raised the issue of potential conflicts
between the roles of the consulting actuary and the valuation actuary.
4.
Your Views
PPFRC would like to get your views on this issue. In particular:
a)
b)
As part of minimum funding standards, what should the role of the actuary be in the
establishment of:
i)
a plan’s Funding Policy;
ii)
PfADs and AtUMs?
Does the Statement of Principles properly cover the actuary’s professional and legal
responsibilities to:
i)
the plan members;
ii)
the Funder;
iii)
the public in general?
If not what are the shortcomings in the Statement of Principles?
c)
Compared to current AAP, would benefit security be compromised by having the
Funder adopt the funding policy and its components (including PfADs and
AtUMs)?
d)
Does the Statement of Principles water down the role of the actuary compared to
current AAP? If so, is this appropriate? Or was it acceptable for that document to
focus only on the subset of AAP that deals with reporting requirements, knowing
that other parts of AAP may deal with other requirements?
e)
How should a standard deal with a situation where the Funder does not, or is not
willing to, adopt a written funding policy? And how should we deal with a situation
where there is one but the actuary considers it inadequate?
f)
Should the standard outline separate roles for the valuation actuary and the actuary
consulting to the Funder in developing its funding policy? If yes, would the same
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October 2005
actuary be allowed to fulfill both roles or should the standard require distinct
actuaries?
g)
How should the CIA assist the practising actuary in fulfilling his or her role to the
plan stakeholders?
TOPIC 3: FINANCIAL ECONOMICS
VALUATION REPORTS
1.
AND
PENSION
PLAN
FUNDING
Position Espoused by the Statement of Principles
The Statement of Principles stipulates that Accepted Actuarial Practice should require
that a funding report “… must always include the unbiased measurement of the plan’s
current status on a wind-up basis and on a going concern basis.” The Statement then
enunciates principles that describe how a funding policy must be developed with
consideration to at least two objectives: benefit security and stability of contributions.
This funding policy is intended to specify how to arrive at such unbiased measurement
and how to adjust such measurement explicitly with Provisions for Adverse Deviations
(PfADs) and other relevant Adjustments to Unbiased Measurements (AtUMs), although
the actuary also needs to take into consideration applicable legislation.
2.
Clarification/Justification of Position
In calculating the unbiased measurement of liabilities on a going-concern basis, it is
specified that “the assumed discount rate must reflect the rate of return expected to be
produced by the plan’s investments over the long term.” This aspect is addressed in the
following footnote (on page 9):
“The expected rate of return should include an expected equity risk premium. The
inclusion of an equity risk premium is expected to be somewhat controversial in light
of the arguments being advanced by financial economists. That said, the PPFRC is
advancing this approach as the objective being discussed relates to the development
of funding targets and recommendations considering the Funder’s given investment
policy, and not for the purposes of measurement and disclosure of the pension plan’s
liabilities and costs in any entity’s financial statements.”
This showed that the PPFRC took the position that the going concern valuation does not
follow financial economics principles, but that this valuation is not meant to follow those
principles because of its objective.
In calculating the unbiased measurement of liabilities on a wind-up basis, it is specified
that “liabilities must be measured on a pure settlement basis” and “cannot exclude any
benefits to which members are legally entitled.” The wind-up settlement basis is to reflect
the CIA’s Commuted Value Standard of Practice (CV-SOP) in the case of members who
would receive a lump sum settlement, and is to reflect the price to be charged by an
insurer in the case of members who would receive an annuity. The CV-SOP became
effective February 1, 2005 and includes a discount rate assumption that is based on the
market yields of mid-term and long-term Government of Canada benchmark bonds, with
adjustments, including a 50 basis-point premium.
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The price for insured annuities may be estimated by following guidance issued by the
PPFRC, based on the results of a survey of group annuities sold in the Canadian
marketplace in the previous year, unless a bona fide annuity quote is available.
Some views within the PPFRC note that the wind-up valuation essentially does follow
financial economics principles, since the unbiased measurement of the wind-up liabilities
represents the best estimate of the pure economic value of the plan’s liabilities at the
valuation date. However, adjustments to this unbiased measurement made in accordance
with the funding policy or applicable legislation may deviate from financial economics
principles, reflecting the objective of those adjustments. The fact that those adjustments
are required to be disclosed explicitly ensures that readers will still see the unbiased
measurement.
Another aspect of the Statement of Principles that may be linked to financial economics
principles is the question of risks faced by the pension plan, including especially the
mismatch between the plan’s assets and liabilities. The Statement of Principles mentions
that the funding policy “must include a description of the key risks faced by the pension
plan and the extent to which such risks are addressed by PfADs”, and it mentions that the
actuary’s report must include, along with the results on a going concern basis, “an
analysis of the key factors and risks faced by the plan that could lead to funding
challenges and contribution volatility.” The disclosure section includes the following
requirement:
“A discussion on the expected stability of contributions and potential funding risks,
including any asset/liability mismatch. Degree of details will depend on extent to
which this information is available in the Funder’s funding policy.”
It should be noted that there is a CIA task force that is currently reviewing how financial
economics principles should be addressed in actuarial practice, including pension plan
valuation reports. This task force had given some preliminary input to the PPFRC when
the Statement of Principles was developed, and continues its work. It is expected to
produce a report in the near future, and this might include specific comments and
recommendations on pension plan funding valuation reports.
3.
Summary of Comments and Submissions Received
Not much of the feedback received was critical of the approach outlined with respect to
the treatment of financial economics principles.
It seems most observers recognize that the going concern basis is not meant to follow
financial economics principles, while the unbiased measurement under the wind-up basis
is meant to follow financial economics principles.
However, certain comments were received to suggest that in some cases, valuation
reports should not present wind-up results, in which case there might be no disclosure
that follows financial economics principles. However, it is noted that many of these
comments related to public sector plans, where the requirement to follow financial
economics principles may be open to debate
In addition, certain comments on the disclosure to be made regarding risks alluded to the
fact that it may be advisable to highlight how the going concern liabilities, including
PfADs and AtUMs, relate to liabilities that would be measured with a discount rate
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October 2005
reflecting a “minimal risk portfolio” (i.e., high quality bonds with a duration and other
payment characteristics comparable to the liabilities). Such a “minimal risk portfolio”
approach is closely linked to financial economics principles (although it may deviate
because of the inclusion of future salary increases). In fact, it has even been argued that
such a new measurement might be more relevant than the “unbiased measurement”
required by the Statement of Principles in order to assess the magnitude of the PfADs
included in accordance with the funding policy or applicable legislation. Even though the
PPFRC can understand how such a new measurement might interest the Funder and
certain readers, it may not be appropriate for the standards of practice to require this
information to be disclosed in a valuation report in all cases, although the standards of
practice would not forbid such additional disclosure on a voluntary basis. It may be left
up to the judgement of the actuary to determine whether it is useful to review this
information with the Funder when developing the funding policy (or with the
administrator when developing the investment policy).
4.
Your Views
The PPFRC would like to get your views on this issue. In particular:
a)
Is the unbiased measurement of liabilities on a wind-up basis consistent with all
financial economics principles? If not, how should it be modified?
b)
Is it acceptable for the going concern basis to disregard financial economics
principles, inasmuch as the going concern basis may be viewed simply as a kind of
budgeting exercise?
c)
Is it appropriate to require an “unbiased measurement” of liabilities that reflects the
equity risk premium assumed for the plan’s investments? (Note: this topic is
addressed further elsewhere)
d)
Is it a problem for going concern results to present “liabilities” that may not
represent an economic value that is relevant for financial markets, and if so, should
we use a different term for this calculation? If so, what term should be used?
e)
If we end up not requiring the disclosure of wind-up valuation results in some cases
(given the feedback received on another topic), then would it be acceptable for the
valuation report to include no results that are consistent with financial economics
principles?
f)
For the risk analysis to be disclosed in the valuation report, would it be appropriate
to require the disclosure of liabilities reflecting a minimal risk portfolio? If so,
should this be in addition to, in lieu of, or as an alternative to the “unbiased
measurement” required in the Statement of Principles?
g)
Are there any other aspects of financial economics that need to be addressed in the
Standards of Practice for Reporting on Pension Plan Funding?
h)
Should the going concern valuation provide more information on the liability
structure and risk management of the plan so that it better links with the
funding/investment policy, or should this be left to other processes?
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TOPIC 4: DEVELOPMENT OF UNBIASED MEASUREMENTS, ATUMS AND
PFADS
1.
Position Espoused by the Statement of Principles
A basic premise of the Statement of Principles stipulated that a funding valuation report
should disclose an unbiased measurement of actuarial liabilities and current service or
incremental cost, on both a going concern basis and on a wind-up basis.
2.
Clarification/Justification of Position
The unbiased approach is intended to represent the actuary’s best estimate. For the going
concern valuation, the discount rate assumption is intended to reflect the equity risk
premium expected on the plan’s assets. Conservatism, if required by legislation or the
Funder’s funding policy, would be added through the inclusion of Provisions for Adverse
Deviations (PfADs). Other adjustments to the best estimate basis, if required by
legislation or the Funder’s funding policy, where the intent is not necessarily to add
conservatism, would be effected through the inclusion of Adjustments to Unbiased
Measurements (AtUMs).
The Statement of Principles requires separate disclosure of liabilities and costs before and
after inclusion of PfADs and AtUMs. It also requires the actuary’s comments on risks,
including the extent to which the PfADs and AtUMs reflect and mitigate the risks.
3.
Summary of Comments and Submissions Received
Not much of the feedback received was critical of the approach outlined. That said, some
of the feedback, including from regulators, questioned whether the separate presentation
of the unbiased measurement or best estimate basis provided any real value to users of
the reports, especially in light of the additional complexity introduced.
Regulators also commented that until now, the level of conservatism built into actuarial
assumptions has been unclear and sometimes questionable, so they would welcome more
transparency.
The preponderance of the feedback regarding this issue expressed scepticism that
consensus on best estimate assumptions could be achieved. Others felt the final position
would be arbitrary while some were less sceptical and believe the task can be
accomplished. A large number of respondents indicated that the guidance should be
developed in conjunction with the standards such that their support or disapproval could
be provided on an informed basis.
Surprisingly, there were not significant comments on the issue of whether a funding
valuation should provide more information in respect of the liability structure of the plan
and risk management for the pension plan. The PPFRC has debated the concept of
requiring disclosure of the going concern results using “a minimal risk portfolio” (as
mentioned also under another topic).
This would give report users information on “minimal risk” liabilities from which to take
funding/investment decisions. It would also provide the plan’s liabilities prior to
inclusion of the equity risk premium. Dissenting views within the PPFRC note that the
primary purpose of a going concern valuation is not to assist in making investment
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decisions, but to provide budgeted costs based upon the decision already taken. If a
Funder wishes to measure the risks associated with investing in equities by comparing the
liabilities to the liabilities using a ”minimal risk portfolio”, then the Funder is free to
request this additional information. It was also pointed out that an additional disclosure
requirement for a going concern valuation would not be popular, given that a best
estimate basis is already proposed prior to and after adjustments.
Some comments were received stating a discomfort with disclosing best estimate results
without PfADs on the basis of it being potentially misunderstood by some report users or
from a risk management perspective..
4.
Your Views
The PPFRC would like to get your views on this issue. In particular:
a)
Is there a difference between a best estimate assumption and an unbiased
assumption? Which terminology is preferable?
b)
How would best estimate or unbiased measurements relate to the current CICA and
FAS accounting requirements, or to financial economics?
c)
How prescriptive should be the guidance that will be provided and how much room
for judgment should remain? Should absolute limits be included? How should we
reflect the equity risk premium?
d)
Should a list of acceptable PfADs and AtUMs be defined? Which ones should be
included? Which ones require guidance? How should we measure adverse
deviations and to what extent should we cover them?
e)
Is the terminology PfADs abnd AtUMs appropriate, or what other terms may be
preferable?
f)
How should PfADs and AtUMs reflect the plan’s investment policy or current asset
mix? What type of restrictions would be required to prevent “short-term”
adjustments to the plan’s investment policy or current asset mix around the times
valuations are completed and filed?
g)
Should PfADs be dictated by the Funder’s funding policy, the actuary, or by law?
h)
What should our guidance state regarding PfADs and AtUMs? What should it state
regarding risk assessment and comments?
i)
Are actuaries comfortable signing a report on best estimate assumptions without
PfADs, if the purpose of the going concern valuation is to provide a long-term
financial plan that promotes contribution stability and benefit security?
j)
Should the wind-up valuation include PfADs? Should the regulators determine
through their solvency rules whether or not to apply PfADs?
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TOPIC 5: INCREMENTAL WIND-UP COST AND WIND-UP GAIN/(LOSS)
1.
Position Espoused by the Statement of Principles
The Statement of Principles requires that the incremental annual cost be determined and
reported on the wind-up valuation basis and that a simplified gain/(loss) analysis be
included in the valuation.
2.
Clarification/Justification of Position
A)
Incremental Wind-up Cost
The Statement of Principles is premised on the thought that the reporting of an
incremental wind-up cost would be valuable to plan sponsors, plan members and
regulators in determining the appropriate future funding levels for many pension plans.
For many plans, particularly in today’s economic environment, past service contribution
requirements are driven by the wind-up/solvency valuation and are expected to continue
to be driven by the wind-up/solvency valuation for the foreseeable future. In such cases,
it may also be appropriate to fund for current service accruals on a wind-up/solvency
basis, depending on the requirements of regulation/legislation and the Funder’s funding
policy. However, current AAP provides for the current service cost to be determined only
on a going concern basis (i.e., the normal actuarial cost).
The PPFRC believes that the concept of calculating and reporting an incremental wind-up
cost is sound. We believe that the debate about whether it should be a requirement under
AAP is not based on whether the calculation has any application, but is based on whether
the differences between the incremental wind-up cost and the normal actuarial cost are
significant enough to warrant the calculation and reporting of this additional amount. Put
another way, will the additional information be useful to the reader or will the additional
information merely confuse the reader?
The PPFRC envisages that the incremental wind-up cost would be defined as the
expected increase in the wind-up liability, net of interest, during the one year period
following the valuation date, using demographic assumptions consistent with those used
in the going concern valuation (including provision for expected new entrants, if
appropriate in the circumstances). We note that this amount is mathematically
determinable, although it is recognized that the result may be negative in certain
circumstances.
It can easily be shown that, for an individual plan member, the incremental wind-up cost
may be quite different than the normal actuarial cost.
Consider the following example:
Plan Provisions
Plan formula: 1% of final salary rate
Unreduced retirement: Age 62
Early retirement: Age 55, reduced 3% per year from age 62
Termination prior to Age 55: Pension deferred to age 65
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Form of pension: Life Only
Actuarial Assumptions
Going concern interest rate = 7%
Solvency interest rate = 5%
Rate of future salary increases = 4%
Mortality: UP94, projected to 2015 (no pre-retirement mortality)
Retirement: Age 62
Withdrawal prior to retirement: Nil
The following table illustrates the development of the liability and incremental annual
cost under both a going concern basis (assuming projected unit credit) and on a wind-up
basis.
Age
Going concern Normal
liability
actuarial cost
Wind-up
liability
Incremental
wind-up cost
30
$
0
$
2,126
$
0
$
1,101
40
$
42,013
$
4,201
$
25,518
$
3,675
50
$ 165,289
$
8,264
$ 123,056
$ 11,321
54
$ 259,993
$ 10,833
$ 209,978
$ 153,440
55
$ 289,788
$ 11,592
$ 381,588
$ 19,222
61
$ 539,263
$ 17,396
$ 652,475
$ 19,661
The above table clearly illustrates that the normal actuarial cost and the incremental
wind-up cost can be significantly different.
It is acknowledged that, in many cases, the distribution of the plan membership is such
that the differences between the total normal actuarial cost and the total incremental
wind-up cost are relatively small. However, there are likely to be numerous situations in
which the total normal actuarial cost and the total incremental wind-up cost would be
sufficiently different so as to be material to the funding of the pension plan.
B)
Wind-up Gain/(Loss)
The Statement of Principles proposes to require the reporting of a gain/(loss) analysis for
the wind-up liability. There are many situations where the wind-up position of a plan
changes dramatically from one valuation date to the next. In fact, the “perfect storm” of
2001/2002 resulted in many plans simultaneously incurring large investment-related
losses and large liability-related losses, the latter due to declining interest rates. However,
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Report
October 2005
valuation reports typically merely reported this often dramatic decline in the wind-up
status without any explanation of the reasons for the decline.
A high level gain/(loss) analysis on the wind-up financial position may be viewed as
being beneficial to the readers of a funding valuation report. The PPFRC envisages this
gain/(loss) analysis to require only the following components as a minimum:
Interest on wind-up surplus/(deficit)
Contributions/use of surplus
Effect of change in assumptions
Investment gain/(loss)
Other gain/(loss)
For a going concern valuation, the “Other gain/(loss)” is typically broken down further to
include such items as retirement experience, mortality experience, salary experience, etc.
We do not propose that such detail be required to be included in a wind-up gain/(loss).
C)
Additional Comment
The Statement of Principles envisages that a going concern valuation remain a
requirement under AAP. However, many actuaries believe that only a wind-up valuation
should be required. If this were to be the case, then the arguments for including both an
incremental wind-up cost and a wind-up gain/(loss) analysis would grow stronger.
3.
Summary of Comments and Submissions Received
The majority of submissions on this topic were related to the increased cost and
complexity associated with determining and reporting the incremental wind-up cost and
wind-up gain/(loss) and whether this increased cost/complexity was necessary, or
whether it would simply confuse the reader of the report. Many of these submissions
asked for clarification of how the incremental wind-up cost would be calculated and how
much detail would be expected in a wind-up gain/(loss).
Concern was also raised with respect to this requirement vis-à-vis plans with significant
solvency surplus or special types of plans such as IPPs and SERPs. Finally, there was one
submission which expressed concern that this calculation could be very complex for
certain multi-employer plans.
4.
Your Views
The PPFRC would like to get your views on this issue. In particular:
a)
Do you believe that the reporting of the wind-up incremental cost in a funding
valuation should be a requirement under AAP?
If “yes”, why?
If “no”, do you believe that it should be completely absent from AAP, or should it
be required only under certain circumstances? What circumstances?
b)
Do you agree with that the proposed method of calculating a wind-up incremental
cost?
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October 2005
c)
If the incremental wind-up cost is “net of interest”, what interest rate should be used
in the calculation? The solvency discount rate or the best estimate expected rate of
return?
d)
Do you believe that the reporting of a simplified gain/(loss) on a wind-up basis
should be a requirement under AAP? Do you agree with the proposed components?
TOPIC 6: SMOOTHING OF ASSETS
1.
Position Espoused by the Statement of Principles
The Statement of Principles envisages that AAP continue to permit the use of asset
smoothing methods, but also requires that the amount of any adjustment to the asset value
be explicitly disclosed as an Adjustment to Unbiased Measurement (AtUM).
2.
Clarification/Justification of Position
The PPFRC is of the opinion that smoothing of assets is a valid actuarial technique that
can be used to smooth fluctuations in costs/contribution requirements. In particular, asset
smoothing techniques, if used properly, can smooth increases or decreases in contribution
requirements resulting from investment-related gains or losses. Therefore, AAP should
continue to permit the smoothing of assets.
This can be illustrated through the following example:
Plan assets at time 0 = $1,000
Assumed rate of return for ensuing year = 0%
Actual rate of return for ensuing year = -15%
Assume that investment-related losses must be funded annually over five years.
The table below illustrates the required contributions assuming the use of no asset
smoothing and assuming the use of a three-year asset smoothing technique (where $50 of
the investment-related loss is recognized immediately, $50 is recognized in one year’s
time and the remaining $50 is recognized in two years’ time):
Year
Contributions Using Market
Value
Contributions Using
Three-Year Smoothing
1
$ 30
$ 10
2
$ 30
$ 20
3
$ 30
$ 30
4
$ 30
$ 30
5
$ 30
$ 30
6
$
0
$ 20
7
$
0
$ 10
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The above illustrates that a smoothing technique can be effective in smoothing
contribution requirements.
The PPFRC does not believe that smoothing is appropriate for illustrating the funded
position of a pension plan. To report the funded status of a plan using a smoothed value
of assets may be misleading to the reader. In particular, it can leave the reader with the
impression that the plan is expecting to incur future investment-related gains or losses
equal to the difference between the smoothed value of assets and the market value of
assets. This normally would not be a fair impression.
We note that both CICA and FAS accounting standards permit the use of asset smoothing
techniques for the purposes of determining the annual expense, but that the disclosure
must be based on the market value of assets. This is consistent with the PPFRC’s opinion
described above.
In summary, the PPFRC believes that asset smoothing is a valid technique for managing
costs/contribution requirements, but that assets smoothing should not be permitted when
showing the funded status of a pension plan.
3.
Summary of Comments and Submissions Received
There were very few comments received with respect to the appropriateness of using
asset smoothing methods. However, the PPFRC believes that this topic needed to be
addressed now as this is an area where the Statement of Principles deviates from the
Report of the Task Force on Public Policy Principles of Pension Plan Funding.
As a further point of interest, the PPFRC is currently developing an educational note with
respect to asset smoothing methods.
4.
Your Views
The PPFRC would like to get your views on this issue. In particular:
a)
Do you believe that AAP should continue to permit the use of appropriate asset
smoothing methods?
b)
Do you agree that the funded status of a pension plan should always be shown using
market value, with any adjustment due to smoothing being explicitly disclosed as an
AtUM?
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