The assumed rate of return will not be reduced below the bottom of the range. The forecast projects three-month Treasury Bill rates, 10-year Treasury Note rates, CPI-U, gross domestic product, and unemployment rates. Details are available online: If the current assumed rate of return is at or above the mid-point in the range, the full amount of excess gains will be used to lowerthe assumption. Economic assumptions have a significant effect on any pension obligation measurement. These data may include consumer price indices, the implicit price deflator, forecasts of inflation, yields on government securities of various maturities, and yields on nominal and inflation-indexed debt. The actuary should select economic assumptions that reflect the actuarys knowledge as of the measurement date. The actuary should select reasonable economic assumptions. <> Indeed, assumed long-term rates of return are approximately 30 basis points higher for firms that are acquiring other firms. The actuary should not assume that superior or inferior returns will be achieved, net of investment expenses, from an active investment management strategy compared to a passive investment management strategy unless the actuary believes, based on relevant supporting data, that such superior or inferior returns represent a reasonable expectation over the measurement period. The investment return assumption used for the Hazardous plan is 6.25 percent. That compares with 14% of operating revenue . National Association of State Retirement Administrators. For example, the present value of expected future payments could be calculated from the perspective of an outside creditor or the entity responsible for funding the plan. 34, Actuarial Practice Concerning Retirement Plan Benefits in Domestic Relations Actions, that relates to the selection and use of economic assumptions. e. it is expected to have no significant bias (i.e., it is not significantly optimistic or pessimistic), except when provisions for adverse deviation or plan provisions that are difficult to measure are included (as discussed in section 3.5.1) or when alternative assumptions are used for the assessment of risk, in accordance with ASOP No. The discount rate is the most significant economic assumption used to calculate a plan's liability. For example, a collective bargaining agreement ratified after the measurement date may lead the actuary to change the compensation increase assumption that otherwise would have been selected. 4, 23, Data Quality, 25, 35, 41, and 51. Nonetheless, such a change should be accompanied by a sound rationale in support of the change. Some specific points to consider include: In recent years, some actuarial firms have proposed various approaches to change the calculation of an entitys service cost and/or interest cost by using multiple (e.g., disaggregated) discount rates or spot rates reflective of varying employee demographics and timing of benefit payments. Only in those years in which the cap is not expected to be reached would the employer's obligation need to be calculated by making projections of future per capita health care costs. At each measurement date, the actuary should determine whether the economic assumptions selected by the actuary for a previous measurement date continue to be reasonable. Compensation is a factor in determining participants benefits in many pension plans. Obtaining this information may require the employer to acquire a subscription from the organization that produced the bond index or from a financial information service. For example, an employer may agree to bear annual costs equal to a specified dollar amount multiplied by the number of plan participants in each future year. Among the 131 funds that NASRA measured, more than half have reduced their investment return assumption since fiscal year 2020 as . The focus on solvency in the private single-employer plan arena has come along with prescribed economic assumptions that are linked to capital market indices. Examples of how the actuary may observe estimates inherent in market data include the following: a. comparing yields on inflation-indexed bonds to yields on equivalent non- inflation-indexed bonds as a part of estimating the markets expectation of future inflation; b. comparing yields on bonds of different credit quality to determine market credit spreads; c. observing yields on U.S. Treasury debt of various maturities to determine a yield curve free of credit risk; and. Assumptions such as compensation increases or cash balance crediting rates are often used to determine projected benefit streams for valuation purposes. For pay-related plans, the calculation of the benefit obligation would reflect expected compensation levels, including changes attributable to inflation, seniority, promotion, and other factors. Because most publicly traded bonds included in the various models bear interest at a stated coupon, it would generally be appropriate to adjust the yields in the model (most likely upward) to reflect this difference. In some circumstances, consistency may be achieved by using the same inflation, economic growth, and other relevant components in each of the economic assumptions selected by the actuary. This might be the case when the employer has changed actuarial firms and the previously used spot-rate yield curve is no longer available, or the employer's actuary or an outside vendor develops a new curve that produces a discount rate that the client believes more appropriately reflects the characteristics of its benefit obligation. The PBO and APBO will also be immediately affected by discount rate changes. %%EOF However, it may not be appropriate to assume that future contracts will provide the same level of compensation changes as the current or recent contracts. Rate of increase in pensions, both in deferment and in payment; . In that case, the facts and circumstances of each plan will need to be assessed, including past practices and cost sharing arrangements, in order to determine the substantive plan of each employee group. f. Cash Flow TimingThe timing of expected contributions and benefit payments may affect the plans liquidity needs and investment opportunities. In 5 years, you'll have $11,000. The Chair also reminded the Board that the actuary performs an experience study every five years, so this issue will be revisited. <> d. Compensation VolatilityIf certain elements of compensation, such as bonuses and overtime, tend to vary materially from year to year, or if aberrations exist in recent compensation amounts, then volatility should be taken into account. Company name must be at least two characters long. yEM$] O|ivO,j7+6[ VV_fX)cv(GNY1=(O{t.ZQJc:U`%vqwT7`=I"7aa1 Hw3Up$x"c0FbB1QcPT~sz~Ev,K86,:Q]ju}${|TRVHrcL[]TWD! This standard applies to actuaries when performing actuarial services that include selecting economic assumptions to measure obligations under any defined benefit pension plan that is not a social insurance program, as described in section 1.2, Scope, of ASOP No. b. any such assumption that the actuary is unable to assess for reasonableness for the purpose of the measurement (section 3.14). b. A 2019 amendment to the Mississippi PERS funding policy stipulates that the investment return assumption will be reduceduntil it reaches the rate recommended by the actuary in the most recent experience study using investment gains based on the following parameters: 2% excess return over assumed rate, lowerassumption by 5 basis points, 5% excess return over assumed rate, lowerassumption by 10basis points, 8% excess return over assumed rate, lowerassumption by 15basis points, 12% excess return over assumed rate, lowerassumption by 20basis points, The assumed rate of return for the Nebraska School Retirement System will decline by 10 basis points each year until reaching 7.0 percent effective FY 24., Chart: Latest distribution of investment return assumptions, Chart: Historical distribution of investment return assumptions, Chart: Historical change in median and average investment return assumption, Issue Brief: Investment Return Assumptions, Looking Forward: The Application of the Discount Rate in Funding US Government Pensions, September 2018, Asset Allocation and the Investment Return Assumption, American Academy of Actuaries, July 2020. In February 2017 the CalPERS Board adopted a risk mitigation policy, effective beginning FY 2021, that calls for a reduction in the systems investment return assumption commensurate with the pension fund achieving a specified level of investment return. Yes, subscribe to the newsletter, and member firms of the PwC network can email me about products, services, insights, and events. If the actuary learns of an event occurring after the measurement date that would have changed the actuarys selection of an economic assumption, the actuary may reflect this change as of the measurement date. 25, Credibility Procedures, for additional guidance. These ASOPs describe the procedures an actuary should follow when performing actuarial services and identify what the actuary should disclose when communicating the results of those services. The actuary should take appropriate steps to determine the time horizon, the price inflation, and the expenses reflected in the expected returns. e. U.S. Social Security Administration. In making those estimates, employers may also look to rates of return on high-quality fixed-income investments currently available and expected to be available during the period to maturity of the pension benefits. For example, some actuaries have looked to surveys of economic assumptions used by other actuaries, some have relied on detailed research by experts, some have used highly sophisticated projection techniques, and many actuaries have used a combination of these. The rate of return should be managements "best estimate." March and October issues contain long-range forecasts for interest rates and inflation. hb```B eahd0/- n:|x)`#pF]F y! Although less common, an OPEB health care plan may define the retiree's deductible or contribution based on similar criteria. Compound frequency. 5 0 obj The Pension Funding Council (PFC) adopts economic assumptions for all plans/systems, except LEOFF 2 which are adopted by their Board; these assumptions are then subject to revision by the Legislature. Companies must also disclose other economic assumptions: the expected rate of return on plan assets, the expected rate of salary increases, The actuary should not give undue weight to recent experience. Ifthecurrent assumed rate of return is below the mid-pointin the range, half of the excess gains will be used to lower the assumption. If the current assumed rate of return is at or above the mid-point in the range, the full amount of excess gains will be used to lowerthe assumption. The year-on-year changes of expected rates of return assumptions vary even within developed countries both in . The actuary should also include a disclosure of any explicit adjustment made in accordance with section 3.5.1 for adverse deviation or plan provisions that are difficult to measure. In it, the fund's actuary projected that pension costs would likely exceed $220 million annually by 2038, eating up 32% of the T's operating revenue. In February 2017 the CalPERS Board adopted a risk mitigation policy, effective beginning FY 2021, that calls for a reduction in the systems investment return assumption commensurate with the pension fund achieving a specified level of investment return. The expected long-term rate of return on plan assets should also reflect the long-term earnings expectations on contributions to the plan expected to be received during the current year. An internal rate of return (IRR) is the interest rate at which the net present value of all cash flows for a corporate or financial investment, including the initial investment, is equal to zero. However, they cost money and require considerable effort. Assumed rates of return on corporate bonds vary from 1 to 4 per cent . Even if there is likely a range of potential returns, using either the most optimistic or most pessimistic assumptions is likely not reflective of the most likely scenario (best estimate). Notionally, that single amount, the projected benefit obligation, would equal the fair value of a portfolio of high-quality zero coupon bonds whose maturity dates and amounts would be the same as the timing and amount of the expected future benefit payments. Compensation data may include the following: a. the plan sponsors current compensation practice and any anticipated changes in this practice; b. current compensation distributions by age or service; c. historical compensation increases and practices of the plan sponsor and other plan sponsors in the same industry or geographic area; and. As expected, there is a positive correlation between expected rate of return and the amount of plan assets Regardless of the approach used traditional bond matching or yield curve approach or a disaggregated yield curve approach the measurement of the projected benefit obligation and the measurement of the ensuing periods service and interest cost must be based on the same discount rate methodology. Projected returns should be reduced by any outflows associated with generating those returns. The types of economic assumptions used to measure pension obligations may include inflation, investment return, discount rate, compensation increases, and other economic factors such as Social Security, cost-of-living adjustments, rate of payroll growth, growth of individual account balances, and variable conversion factors. Contributions expected to be made in future years should not be considered in determining the expected long-term rate of return on plan assets. Also, some actuarial cost methods take into account the present value of future compensation. If the actuary determines that an economic assumption is not reasonable as of the measurement date at which it is applied, the actuary should select a reasonable new assumption. The cap may be defined in the aggregate for the retiree group. However, for some purposes (such as qualified pension plan minimum required contribution calculations), the actuary may be precluded by applicable laws or regulations from anticipating future plan amendments or future cost-of-living adjustments in certain IRC limits. Daily Monthly Annually. If the actuary is using an approach that treats inflation as an explicit component of other economic assumptions or as an independent assumption, the actuary should follow the general process set forth in section 3.3 to select an inflation assumption. Measurements of pension obligations do not generally include individual benefit calculations, individual benefit statement estimates, or nondiscrimination testing. The determination of the assumed discount rate is separate from the determination of the expected rate of return on plan assets whenever the actual portfolio differs from the hypothetical portfolio described in this paragraph. Note: This appendix is provided for informational purposes but is not part of the standard of practice. Whether the assumed rate of return is lowered, and the magnitude of any reduction, depends on the excess gains available and the most recent range of reasonable economic assumptions as provided byMERS' consulting actuary. c. Separate Assumptions for Different Compensation ElementsDifferent compensation increases are assumed for two or more compensation elements that are expected to change at different rates (for example, x% bonus increases and y% increases in other compensation elements). You can set the default content filter to expand search across territories. Because cash inflows would equal cash outflows in timing and amount, there would be no reinvestment risk in the yields to maturity of the portfolio. Figure PEB 2-1 illustrates the calculation of the expected long-term rate of return using a weighted average approach. b. The actuary should also include the following, as applicable, in an actuarial report: a. the disclosure in ASOP No. The service cost component of net periodic benefit cost could be volatile from year to year as a result of using current discount rates because the changes in discount rates will immediately affect the PBO and EPBO, which is the basis for determining service cost. c. Investment VolatilityPlans investing heavily in those asset classes characterized by high variability of returns may be required to liquidate those assets at depressed values to meet benefit obligations. Across all plans in the data, the average return assumptions of pensions has declined from 8.02 percent in 2001 to 7.60 percent in 2015. Blue Chip Financial Forecasts. the investment return assumption that would apply to each of the State's pension plans. Thus, subsequent to the mergers, companies served by those actuarial firms have access to new discount rate methodologies. For example, if $100 is owed in one year and the discount rate is 5%, then the present value of the $100 promise is $100 / (1 + 5 . Similarly, if investment management fees are charged against the actual return on assets, such outflows should be included in the expected return projection. Under this approach, the percentage of total plan assets of each component of the plan asset mix is multiplied by the expected asset return for that component. But many pensions have annual investment return assumptions in the 7-8% p.a. Under ASC 715, the expected return on assets is a component of the employee benefit cost. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. The actuary should follow the general process described in section 3.3 to select these assumptions. Interest rate assumption--Suspension of new supplemental pension contracts--No right to particular price. If the ratio of Actuarial Value of Assets to Market Value of Assets is below 80% or above 120%, excess market gains will not be used to lower or buy down the rate of return, and the normal smoothing method will be applied. For example, if a pension program reduced its . The most common approach to determining the expected long-term rate of return on plan assets is to develop a weighted average based on the mix of plan assets. The investment return assumption used to measure pension liabilities Although there is some latitude regarding the methodology that may be selected to determine the discount rate, the approach selected should be followed consistently. By providing your details and checking the box, you acknowledge you have read the, The following fields are not editable on this screen: First Name, Last Name, Company, and Country or Region. Small changes of 25 or 50 basis points in these assumptions can change the measurement by several percentage points or more. It is used in conjunction with the market-related value of plan assets (see. In practice, this discount rate (return on asset) assumption may be set by the legislative body, plan sponsor, a governing board of trustees, or the actuary. The rate shown applies to Tiers 1 & 2. Statistical Abstract of the United States. The expected rate of return on assets is the long-term expectation of the annual earnings rate on the assets of the pension fund. In some companies, the nonbargained employee group receives the same retiree health benefits as the collectively bargained employee group, and changes to the bargained plan have historically been made to the nonbargained plan at the same time. NY *e The actuary is not required to select assumptions that are consistent with assumptions not selected by the actuary. Section 3.8.3(j), Forward-Looking Expected Investment Returns, was modified to delete the educational material on forward-looking expected geometric and arithmetic returns. The ASB provides guidance for measuring pension and retiree group benefit obligations through the series of ASOPs listed below. However, an employer's plan may have a limit or "cap" on the dollar amount of health care coverage it promises to pay. Therefore, we believe employers should use the actual yields, even if negative, on high-quality corporate bonds throughout the yield curve to measure their benefit obligations. The investment return assumption reflects the anticipated returns on the plans current and, if appropriate for the measurement, future assets. Projected retirement income = 7,000 p.a. UksyqOiiXdQN~[n:)Kp. Box 1453, Alexandria, VA 22313-2053. These data may include the following: a. current yields to maturity of fixed income securities such as government securities and corporate bonds; b. forecasts of inflation, GDP growth, and total returns for each asset class; and. Colorado Springs, CO: McGraw-Hill, 2008. Distribution of Latest Real Return Assumptions Cheiron Survey of California Systems. The actuary should consider preparing and retaining documentation to support compliance with the requirements of section 3 and the disclosure requirements of section 4. Assumed discount rates are used in measurements of the projected, accumulated, and vested benefit obligations and the service and interest cost components of net periodic pension cost. For example, an OPEB life insurance plan may define the amount of death benefit to be received based on the employee's average or final level of annual compensation. The preceding paragraph permits an employer to look to rates of return on high-quality fixed-income investments in determining assumed discount rates. In spite of the counterintuitive outcome, that is the economic reality of a negative interest rate environment. 1788 0 obj <> endobj If these rates were lowered by 1-2 percentage points, the required pension contributions taken from salaries or via taxation would increase dramatically. The top line shows the rate of return assumed on investment in equities, with growth rates ranging from around 4 to 7 per cent. The actuary may assume select and ultimate inflation rates in lieu of a single inflation rate. For example, if pension benefits are a function of base compensation and the plan sponsor is changing its compensation practice to put greater emphasis on incentive compensation, future growth in base compensation may differ from historical patterns. In addition to the demographic and actuarial/economic assumptions discussed in the previous section, pension and OPEB plans require financial assumptions to be made to value the plan obligations. A number of factors may interact with one another and may be components of other economic assumptions, such as inflation, economic growth, and risk premiums. paragraph 28). PwC. For each economic assumption that has a significant effect on the measurement and that the actuary has selected, the actuary should disclose the information and analysis used to support the actuarys determination that the assumption is reasonable.
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