Understanding Pension Plan Accounting & Valuations

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We're at two zero two. Got to respect everybody's time. We're gonna go ahead and get started. Once again, thank you all for joining us today for our webinar on understanding pension plan accounting evaluations.

My name is Chuck Stinson. I am with the McGriff retirement practice.

Our presenter today will be Jim Darangowski, and I will hand the stage over to Jim.

Thanks, Chuck.

Hi. My name is Jim Daringowski. I'm a senior vice president and consulting actuary here at McGriff.

I am a fellow in the Society of Actuaries as well as an enrolled actuary and have over thirty four years of experience working with plan sponsors to manage both their defined benefit plans and their retiree medical plans.

I am the manager of the benefits administration team here at McGriff as well, and we work with our clients to help them manage and administer their pension plans.

Next slide, please.

Real quick. Thank thank you, Jim, for the intro, for the backdrop. A few housekeeping items before we get started.

Your chat feature is gonna be turned off and you all will be muted. But if you have any questions, please submit those to the q and a tab, and we will answer those at the end.

As many as we can, time permitting, those we do not get to, we'll be able to email to you as a follow-up. Thank you.

Thanks again, Chuck.

You know, originally, we titled this, Understanding Pension Plan Accounting, but we broadened the scope of today's discussion so that we could help you understand some of the issues that plan sponsors go through when they're managing these benefit programs.

So just to go over a brief summary of what we'll cover, we'll look at actual evaluations, what plans need them. We'll talk about what an actual evaluation is.

Then we'll discuss, how plan sponsors set their contribution funding policies.

And then we'll discuss plan reporting or actual evaluations themselves and why this is important.

We'll talk about issues with inaccurate plan reporting and then take a deeper dive into some of the actual assumptions that we use and help our plan sponsors determine when we do these evaluations.

We'll look at some of the issues of not managing these assumptions appropriately and some common mistakes or challenges that plan sponsors experienced, during the year.

And finally, I think we have some value added ideas that hopefully you could share with your clients and contacts that may generate discussions that lead or at least uncover issues that they may be having with their pension plans.

And then finally, we'll take a few questions at the end if there's time.

Next slide, please.

So, there are basically four types of benefit plans that we help our plan sponsors with. The first is the traditional defined benefit plan.

This is not a DC, a defined contribution or a four zero one ks plan. This is a really a traditional pension plan in that, in the sense.

We also work on cash balance plans, retiree medical plans that are sometimes called OPED. You might hear them referred to as such. There are other post employment benefits such as retired medical or life insurance benefits.

And then finally, some of our plan sponsors offer benefits to their executives that would fall under a non qualified agreement and those are sometimes referred to as SERPs or supplemental employment retirement retiree plans. So these are a type of benefit plans that we do both a funding valuation and an accounting evaluation for our clients.

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So what is an actuarial valuation?

Essentially, we're trying to calculate the present value of the future benefits that are going to be paid out of the plan and then determine if there are assets, there are enough assets that are set aside to meet those obligations.

We start by measuring the liabilities based on the participant data that we receive from our clients.

We reflect the plan provisions of what the client has promised to their participants and pairing those with key actual assumptions to determine the liability of the plan.

Once we have that liability, we compare that to the assets that the employer has set aside for these benefits and determine the funded ratio.

The funded ratio is a direct impact on the annual contribution that employers will have. So, as you can guess, a higher funded ratio will lead to a lower annual contribution and vice versa.

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So one of the important things that plan sponsors have to decide is what is going to be their funding contribution policy.

This is critical to ensure that the plan is sustainable over the long term and that they can meet the promises that they made to their participants.

A well defined policy will determine how these contributions are made, as well as how they're going to achieve their goals over the long term.

Here we've listed out a few examples of the common funding policies that employers set.

The first is the required contribution, and this is really based on the regulations.

It's the minimum amount that employer can, that needs to contribute to ensure that it's adequately funded.

But some sponsors may decide that they want to contribute over this minimum requirement. Some may have funding goals or targets that they want to see set every year. For example, they may decide that this plan we want to be funded at least ninety percent every year.

Or they may want to stabilize their contributions over time to avoid any large fluctuations that can occur due to market conditions.

And finally, they may have contingency plans.

They may look at adverse financial conditions and what those will mean to their funding contributions.

For example, they may, they may look at what if interest rates decrease one hundred basis points over the following year Or what if assets return less than ten percent than what we expected?

These kind of scenarios give the employers and plan sponsors an idea of what the risk is and their contribution scheduling.

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So our evaluation reports are planned reporting.

Some may view those as just merely a compliance exercise that we do every year and we send to our clients. But I think it's much more important than that. It really leads to effective plan management. Our plan sponsors need to understand the funded status of the plan so that they can understand the cost that they're going to pay. And this will help them make better decisions over the long term and lead to benefits that are sustainable.

There are also government accounting standards and regulations that the plan must adhere to. Our reports will document that they are in compliance with those accounting standards as well as the government regulations.

And finally, it helps with prudent investment decisions. It helps them develop an investment strategy and then it can review asset performance over the year and decide if changes are necessary. And that will help lead to asset adequacy over the long term.

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So these valuations are really a snapshot of what our future expectations are. And if they're not managed correctly or inaccurate plan reporting occurs, they could have several issues. First is in your financial reporting.

You could be misrepresenting the financial health of the plan and misleading the stakeholders or investors.

Another is your compliance risks.

Not adhering to the accounting standards could lead to increased audits or even scrutiny from regulators.

And finally, there's an unfunded risk that increased funding volatility can lead to increased contributions, which makes it very difficult for our plan sponsors to manage these plans.

Next slide, please.

So one of the areas that we as actuaries work with our plan sponsors are reviewing and setting the assumptions that go into our evaluations.

It's critical that plan sponsors review this information and select assumptions that will reflect the true experience of the plan.

This helps them make better decisions about their contributions and benefits. It will lead to compliance with the accounting standards and offer transparency in their financial reporting.

All of these are issues that we discussed on the prior slide.

Next slide, please.

So now we're going to take a deeper look at some of the assumptions that we use in evaluation, starting with our economic assumptions. And the biggest one is the discount rate.

This is the interest rate that we use to discount those benefit payments back to today to determine the present value. It will reflect the current market conditions that are out there and will vary over year over year.

For some plans, the benefits are based on the participants pay. Here, it is critical for employers to look at their salary growth assumption and set an expectation of what they really anticipate paying participants in the future because this will have a direct impact on the benefits that are earned and the life and the overall liability in the plan.

And finally, the investment rate of return.

This is our expectation of what assets are going to return over the life of a plan and this is usually set with the assistance of an investment manager.

Next slide, please.

We also have demographic assumptions that are based on the data that we receive from our clients. The The biggest one is the mortality assumption, which measures the life expectancy of our plan participants.

And this will impact the amount of benefits and retirees that will receive benefits from the plan.

We also have retirement age, an assumption on when the plan expects these participants to retire and start receiving their benefit payments.

Some plans may assume that participants all retire at age sixty five, while others may assume that some retire at early ages, for example, age fifty five and trend upwards towards age sixty five.

Employee turnover is another key assumption that we look at where we try to estimate how participants may leave the workforce before they retire since this will impact the number of future retirees will have in the plan.

And for our retiree medical plans, they have a unique assumption for our health care costs.

Here, we're trying to anticipate what health care costs will be in the future. And this one is very important for retiring medical plans because the increased trends can have a significant impact on the benefits and the obligation that we record.

Next slide, please.

There also are actual cost methods. These are methods that try to allocate the cost of these benefit plans over different periods.

Some of these, will some of these are not by choice. They will be dictated by the regulations.

But the three most popular are listed below. Entry age normal, which tries to allocate the cost evenly over an employee's entire career or project a unit credit where the benefit is based on the pay of the participant. And here it's allowed to reflect future salary increases.

And finally, there's an aggregate cost method that looks at the total liability being promised instead of trying to allocate it to a specific year.

There are also a few asset valuation methods that we can apply. One is the current market value of assets, but some plant sponsors choose to use a method that tries to smooth these fluctuations in the market over time that will ultimately help reduce the volatility and the cost of the plan.

Next slide please.

So, these assumptions will impact our future expectations and having incorrect assumptions can have issues, mainly with the plan management that the real cost of this benefit is not being stated correctly. It could be overunderseeing the benefits that you're reporting.

There could be accounting compliance issues that you may not be complying with the regulations or auditors may even challenge assumptions that appear unreasonable upon audit.

There's also financial stability that when these assumptions do not reflect our expectations, the results can be volatile and very difficult for our plan sponsors to manage for and budget.

Additionally, asset managers rely on our cash flows for the plan's liabilities to help them make investment decisions, which is very important.

And finally, for a benefit delivery perspective.

Plan sponsors are relying on these routes to help them manage these programs and deliver competitive benefits to attract and retain talent. So understanding the amount of benefits that you're providing is very important.

Next slide please.

So there are some common mistakes that plan sponsors make with assumptions and in reviewing them. I think the biggest one is just a lack of monitoring.

I don't think plan sponsors focus on reviewing their assumptions on an annual basis to try and understand their impact.

It's also a best practice that we conduct an experience study every three to five years so that you could review your assumptions and if any are out of alignment, make adjustments.

Sometimes global assumptions may be used. This is where a single assumption is used for different demographic populations.

For example, a plan may decide to use a single retirement age for both their hourly and salary employees. However, these these groups may have significantly different historical experiences that may make this assumption unreasonable.

Also, just focusing on your overall results and the change in liability can be dangerous.

From one year to the next, the liability may not change, but some assumptions have offsetting impacts and can easily disguise an underlying issue that the plan sponsor may not be aware of.

And finally, data requirements.

To analyze your assumptions, it is necessary to collect this information every year so that you have the information necessary to review and see if changes are required.

Next slide, please. So we've outlined a few questions here, that you may ask your clients or prospects that could lead to discovery of issues that we could help them with. The first is just benefit cost.

Does the client really understand the cost of the benefits they are providing? Typically, this is represented as a percent of pay and they should know what percent they are providing participants.

And this could change from year to year depending on what their cost structure does.

Also, have they done or reviewed cost projections with what if scenarios? This gets to underlying and understanding of what the future cost of the plan may be.

For cost volatility, a good question is to ask, have they had any surprises lately in their annual cost? And if so, have do they understand what was the root cause of that volatility?

There are ways to help plan sponsors manage the volatility in their plans. It just is a matter of finding the source.

An assumption review is always a good idea. We work with our clients to review our assumptions every year and have a discussion with them, whether they are in alignment or getting out of alignment.

And so it's important to ask sponsors, when was the last time an experience study was done?

And then finally, the amount of benefits being provided. Has this changed over time and is it competitive in the market? Reviewing this information could help plan sponsors understand what they are giving participants and how valuable that really is.

Next slide, please.

So, I hope we have given you an idea of some of the issues that plan sponsors deal with on an annual basis and some of the decisions that they struggle with to maintain these plans. And that if they are having issues, there can be solutions out there. It's just a matter of finding them.

Chuck, do we have any questions?

Yeah. Jim, we've got a couple questions.

Some will probably need to be emailed out, but, one I think can be answered pretty can clearly handle it, I guess, pretty quickly right now.

One is how can you tell if an assumption isn't correct?

Yes. Every year as part of our evaluation, we, analyze the different decrements that plans have. So we'll look at their retirement experience, their withdrawal, their salary scales, their mortality, and do it what we call a gain loss analysis.

And so if any one of those falls out of compliance in one year, there may not be an issue. But what we look for is a trend over a three to five year period where we're seeing either consistent gains or consistent losses in a certain area. And that's usually a key sign that your assumption is getting out of alignment.

Okay. Alright. Thank you. Another one is, how many years of data do you typically look at when you're doing an experience study?

It's always more data is better. We at a minimum, we request clients to have at least five years of credible data, but anywhere between five and ten should give you a good idea, for some of the assumptions that you're looking at.

Okay. Alright. And then, let's see.

This one's pretty good. How many years, do you project out when you're doing a cost study?

Typically, I will will project out cost three to five years. Some employers will even look out ten to fifteen years.

But at a minimum, when we talk with our clients, we'll at least do those what if scenarios on a one year basis. So we'll look at a one year, a one hundred percent basis point change in interest rates and asset returns just so we give them a sensitivity to what the costs can do based on different economic conditions.

Let's see.

Here's another question. So, one of the questions they're asking, how often or how often do you see, providers or sponsors getting an audit done for the work other act other actuaries have done for their plan?

Well, depending on the on the plan, we prepare our accounting or valuation reports. And typically, there is both a plan audit and an accounting audit.

Depending on the size, some plans may not be material to the audit review.

But usually we'll get questions, as far as what assumptions we used and are we in compliant with the regulations.

That's not uncommon.

Okay.

Yeah. That that's pretty much it for the questions. Most of the other ones are kinda in around that same ballpark.

Okay.

Well, without any other questions and, anybody else raising your hand, we are wanna thank you all for your time today. Thank you for, joining us for today's webinar.

And, if you have any questions at all or anything or anything, beyond today or later on, please send us a message or via email. We will follow-up with the recording of this this webinar, via email and, any additional questions we may have missed.

Thanks, everyone.