What Is Actuarial Valuation?
An actuarial valuation is a type of appraisal of a pension fund's assets versus liabilities, using investment, economic, and demographic assumptions for the model to determine the funded status of a pension plan. The assumptions are based on a mix of statistical studies and experienced judgment. Since assumptions are often derived from long-term data, unusual short-term conditions or unanticipated trends can occasionally cause deviations from forecasts.
- Actuarial valuations are used to assess the funded status of a defined-benefit pension fund.
- Unlike market values, actuarial values rely on statistical inference and assumptions that are plugged into a model.
- Actuarial models rely on long-term projections that include interest rates, demographic changes, and inflation.
Understanding Actuarial Valuation
Many variables go into an actuarial valuation model. On the asset side, the actuary must make an assumption about employer contribution rates and the investment growth rate for the portfolio of stocks and bonds (Level 1- and 2-type assets) and other assets (illiquid Level 3-type). The calculation of payment liabilities is much more complex.
The actuary must make assumptions regarding, but not limited to, the discount rate, employee contribution rates, wage growth rates, inflation rates, mortality rates, service retirement ages, disabled retirement ages and interest on member accounts. If all the long-term assumptions are reasonable, then a realistic funding (or funded) ratio can be derived. The funding ratio equals assets over liabilities, with a ratio of over 1.00, or 100%, indicating that pension assets are sufficient to cover liabilities.
Implications of Actuarial Valuation
Actuarial valuations are conducted in both the private and public sectors. U.S. Steel disclosed in its 2016 annual filing that its funding ratio as of December 31, 2016, was 0.88, or 88% (plan assets of $5.48 billion divided by obligations of $6.21 billion). The company did not have enough plan assets to meet those obligations.
Some states are in tough shape due in most part to sharply higher liabilities for worker pay. (Past negotiations with state employees resulted in greater pension payment guarantees.) Notably, 2016 data from state-issued Comprehensive Annual Financial Reports (CAFR) and compiled by Bloomberg L.P. show that the median funding ratio for U.S. states was only 71% as of that year. New Jersey had the worst ratio at approximately 31%, while Washington D.C. and Wisconsin were the only funds at 100%.