Understanding Actuarial Results
    A Pension Accounting Primer


     Johnson, West & Co., PLC
      Van Iwaarden Associa...
Outline

1. Goals of the presentation
2. Orientation
     –   DB pension plans
     –   Strings attached
3. Actuarial spee...
Presentation Goals
 Basic understanding of:
   – How pension liabilities are calculated
   – What pension liabilities mea...
Non-Aspirations
 Make you all actuaries
    – Details are important for actuaries; clients usually just need to
      und...
Orientation
 We’re all here because you sponsor a DB pension
plan or are involved with these plans.

 Defined Benefit (D...
Orientation
 Purposes of pension plan
  –   Attract and retain employees; reward service to company
  –   Orderly success...
Orientation
“Strings Attached”      IRS
                        • Benefit Equality
                             • Plan des...
Actuarial Speed Dating
  Basic Premise of All Actuarial Pension Calculations

 A promise has been made to make a stream o...
Actuarial Speed Dating

Data       Census data for all participants   Economic:
                                          ...
The Actuarial Model
  Data        Assumptions               Methods                Plan Provisions




                   ...
Actuarial Speed Dating
          Determining the value of pension payments

                                              ...
Actuarial Speed Dating
                   Term structure of interest rates


6%
Return




3%




         5 years        ...
Actuarial Speed Dating
                          Segment interest rates


         6%


         4%
Return




         2%...
Actuarial Speed Dating
       Calculating the present value of benefits
                                                  ...
Actuarial Speed Dating
   We can calculate a present value – Now what?

   Liability calculations:

       Liability Mea...
Actuarial Results
   We now know the basic process for calculating liabilities

   Similarities for most actuarial calcu...
Actuarial Results
   Funding
    – IRS requirements (most methods mandated)
    – Funding policy (often overlooked due to...
Actuarial Results
                        PPA           GAAP                FAS 35                 PBGC
    Inputs        ...
Actuarial Results
   FAS #35 Accounting
    – Plan Accounting
    – Focus on long-term COST to Plan of providing benefits...
Actuarial Results
                   GAAP Accounting Highlights
   Balance sheet liability
    – Also known as Funded Sta...
Actuarial Results
                    GAAP Accounting Highlights
   FAS Expense
    – Amount recognized in earnings each ...
Actuarial Results
            GAAP Accounting Highlights
          Sample reconciliation of funded status
A.   Projected B...
Actuarial Results
       “Specialty” Accounting Calculations (FAS #88)
   Settlement
    – Event that eliminates plan spo...
Summary
 DB plans (like any qualified retirement plan) have
   complexities.
    – But they don’t need to be overwhelming...
Discussion
   and
Questions




     24
Additional Information
Contact Information:

Mark Schulte, FSA, EA, MAAA
marks@vaniwaarden.com
612.596.5971

Van Iwaarden ...
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Pension accounting primer

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Presentation of basic actuarial concepts for pension plan sponsors. Comparison of various actuarial liabilities and results.

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Pension accounting primer

  1. 1. Understanding Actuarial Results A Pension Accounting Primer Johnson, West & Co., PLC Van Iwaarden Associates June 16, 2010 Mark Schulte, FSA, EA, MAAA 612.596.5971 marks@vaniwaarden.com
  2. 2. Outline 1. Goals of the presentation 2. Orientation – DB pension plans – Strings attached 3. Actuarial speed dating 4. Actuarial Results 5. Summary/Q&A 1
  3. 3. Presentation Goals  Basic understanding of: – How pension liabilities are calculated – What pension liabilities mean and how they are similar/different – How to convert liabilities in to “usable” results – What to do with the results.  Become conversant/comfortable with: – What actuaries are preparing for you – What accountants want from you – Explaining it all to your peers  Know when to get involved and when to let actuaries and auditors “hash it out”. 2
  4. 4. Non-Aspirations  Make you all actuaries – Details are important for actuaries; clients usually just need to understand the concepts – But maybe you can be an armchair actuary  Make actuarial science exciting – Simply not possible in many situations – It should be understandable  Make me an accountant – I have never been an accountant, and likely never will be – All statements in this presentation will be from an actuarial perspective 3
  5. 5. Orientation  We’re all here because you sponsor a DB pension plan or are involved with these plans.  Defined Benefit (DB) vs. Defined Contribution (DC) – DB: Employer has promised a benefit and must make variable contributions. – DC: Employer has promised a contribution and employee gets variable benefits. 4
  6. 6. Orientation  Purposes of pension plan – Attract and retain employees; reward service to company – Orderly succession of employees – Tax deductions – Paternalism (?)  Since tax deductions are involved and promises are being made, DB pension plans come with “strings attached”  The “strings” are usually the aggravating part of a DB plan, but all qualified retirement plans have them in some form. – Fiduciary responsibilities for fund selection – ADP/ACP testing 5
  7. 7. Orientation “Strings Attached” IRS • Benefit Equality • Plan design (benefit accruals) • Nondiscrimination in coverage and benefits • Annual Contributions • Minimum required • Maximum deductible • Reporting (Form 5500, participants) Pension Plan PBGC • Pension insurance premiums • Flat rate • Variable rate (VRP) • Reporting (to PBGC, to participants) Accounting/FASB • Company liability for benefit promises • Many nuances to accrual accounting 6
  8. 8. Actuarial Speed Dating Basic Premise of All Actuarial Pension Calculations  A promise has been made to make a stream of payments (or lump sum) at some point in the future.  Given assumptions about projected benefit amount and likelihood of receiving payments, what is the value of the benefit in today’s dollars? 7
  9. 9. Actuarial Speed Dating Data Census data for all participants Economic: • Discount rate(s) • Expected return on assets • Pay increases Assumptions • Inflation • Regulatory (wage base, comp limits) Methods Asset methods Demographic: • Turnover, disability, retirement, Liability methods death • Marriage, spouse age Plan Provisions How benefits • Form of payment • Participation (OPEB) are defined 8
  10. 10. The Actuarial Model Data Assumptions Methods Plan Provisions Actuarial Model Present Value of Benefits Liabilities Accrued Projected Future Costs Accounting Funding Other • PBGC • Benefit Restrictions • Nondiscrimination compliance • Benefit distributions 9
  11. 11. Actuarial Speed Dating Determining the value of pension payments Period of Annuity Payments 35 45 65 95 Start Current Retirement Death Working Age Age 10
  12. 12. Actuarial Speed Dating Term structure of interest rates 6% Return 3% 5 years Time 30 years 11
  13. 13. Actuarial Speed Dating Segment interest rates 6% 4% Return 2% Segment 1 Segment 2 Segment 3 Time 12
  14. 14. Actuarial Speed Dating Calculating the present value of benefits 6% 4% 35 45 65 95 Hire Current Retirement Death Age Age Age Example: $100 x (1+.04)^(-20) = $46 $100 x (1+.06)^(-50) = $5 13
  15. 15. Actuarial Speed Dating  We can calculate a present value – Now what?  Liability calculations: Liability Measure Acronym Pay Service Present Value of Benefits PVB Projected Projected Projected Benefit Obligation PBO Projected Current Accrued Benefit Obligation ABO Current Current Vested Benefit Obligation VBO Current Vested 14
  16. 16. Actuarial Results  We now know the basic process for calculating liabilities  Similarities for most actuarial calculations: – Data – Assumptions: Demographic – Assumptions: Some economic – Plan provisions  Differences between actuarial calculations – Assumptions: Certain economic • Discount rates/segment rates/yield curves • Inflation/regulatory increases/salary scale – Methods • Liability methods (i.e., pattern for recognizing liabilities) • Asset methods (smoothing) 15
  17. 17. Actuarial Results  Funding – IRS requirements (most methods mandated) – Funding policy (often overlooked due to PPA requirements)  Accounting – GAAP accounting for plan sponsor/employer (ASC 715) • FAS 87 expense • FAS 158 disclosures • FAS 88 curtailment/settlements – FAS 35 accounting for Plan  Other – PBGC variable rate premiums – Plan benefit calculations – Nondiscrimination testing 16
  18. 18. Actuarial Results PPA GAAP FAS 35 PBGC Inputs Funding Accounting Accounting Premiums Data Participants at beginning of plan year Participants on last day of prior plan year Assumptions - Demographic Same - Economic  Segment rates  Single rate Expected return  PBGC segment (24 month avg.)  Pay increases on plan assets rates (snapshot)  Regulatory  Option to use  EROA funding rates Methods - Liability  ABO  PBO, ABO  ABO, VBO  VBO - Asset  MVA, AVA  MVA, MRVA  MVA  MVA Plan Provisions Same 17
  19. 19. Actuarial Results  FAS #35 Accounting – Plan Accounting – Focus on long-term COST to Plan of providing benefits • How much money does plan need today to pay benefits, based on assumed return on assets? • Benefit cost perspective means we use Expected Return on Assets as liability discount rate – Disclose: • Benefit liabilities (vested and non-vested) and reconciliation • Funded status  GAAP Accounting – Corporate accounting – Focus on LIABILITY to the plan sponsor • If company was sold, what would be “cost” of pension liability today? • Liability cost is similar to a plan termination calculation (i.e., cost to purchase bonds or annuity contracts to satisfy liabilities) 18
  20. 20. Actuarial Results GAAP Accounting Highlights  Balance sheet liability – Also known as Funded Status or Unfunded PBO – Previously known as (accrued)/prepaid pension cost – Move to mark-to-market, but use PBO liability  Change in balance sheet liability – Also known as change in Funded Status – Two components • Amount recognized in earnings (FAS expense); plus • Amount recognized in Other Comprehensive Income 19
  21. 21. Actuarial Results GAAP Accounting Highlights  FAS Expense – Amount recognized in earnings each year (accrual accounting) – Liability “earned” during year, plus adjustments for: • Interest on balance sheet liability • Offset for expected return on assets • Amortization of unrecognized prior service costs, gains/losses.  Additions to Other Comprehensive Income – Items not yet recognized in earnings – Includes: • New unrecognized amounts (prior service costs, gains/losses); minus • Amortization of unrecognized amounts  Auditors will check that balance sheet liabilities reconcile! 20
  22. 22. Actuarial Results GAAP Accounting Highlights Sample reconciliation of funded status A. Projected Benefit Obligation (PBO) $ (1,000) B. Fair value of assets 800 C. Funded status (A. + B.) $ (200) D. Unrecognized transition obligation $ 0 E. Unrecognized prior service credits/(costs) (50) F. Unrecognized gains/(losses) (110) G. Accumulated OCI (D. + E. + F.) $ (160) H. (Accrued)/Prepaid Pension Cost (C. – G.) $ (40) 21
  23. 23. Actuarial Results “Specialty” Accounting Calculations (FAS #88)  Settlement – Event that eliminates plan sponsor risk and responsibility for PBO • Example: Large lump sum payments (one or many) • PBO reduction > SC + IC – Shortens lifespan of plan – Immediate recognition of UGL, in proportion to reduction in PBO • Example: Settle 20% of PBO, then recognize 20% of UGL  Curtailment – Event that significantly reduces rate of benefit accrual (e.g., plan freeze) – Shortens amount of “future service” over which we amortize prior service costs – Immediate recognition of UPSC, in proportion to reduction in future service  Curtailments and settlements often occur in tandem! 22
  24. 24. Summary  DB plans (like any qualified retirement plan) have complexities. – But they don’t need to be overwhelming – Frozen plans have special responsibilities  Most actuarial calculations are based on similar principles, but there are a few adjustments based on the intended use of the result.  If results are unclear, be sure to ask your actuary or auditor! 23
  25. 25. Discussion and Questions 24
  26. 26. Additional Information Contact Information: Mark Schulte, FSA, EA, MAAA marks@vaniwaarden.com 612.596.5971 Van Iwaarden Associates 840 Lumber Exchange 10 South Fifth Street Minneapolis, MN 55402 www.vaniwaarden.com 1.888.596.5960 25

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