Introduction to Role of Actuaries in Pensions
Actuaries are skilled professionals expert in dealing with matters like setting up premium prices for Insurance Companies, forecasting future claims and unforeseen liabilities that may arise and setting aside a pool of money to be utilized in case of such contingencies. That is why they play a key role in Insurance companies which we covered in Role of Acturaries in General Insurance earlier or you can read Carrer Outlook of an Actuary, where they look at a broader picture of the company’s inflows and outflows and perform calculations based on some assumptions to set up a balanced condition which allows the companies to maintain their solvency margins but the role of Actuaries in Pensions & Scheme Handling is no less of insuring, the company, from bankrupting while pension payments.
Let us dive deeper into the role actuaries play in pension funds in different areas :
- The pension schemes are ‘funded’ i.e. the employers and employee contribute regularly into a fund which is separate from employer’s assets and not under his control.
- These contributions are invested so that the proceeds can be used to pay for the benefits as and when they arise.
- There is a minimum level of funding known as the Minimum Funding Requirement (MFR) for funds.(although not all schemes are subjected to this)
- This does not imply that the pension fund must be subjected to this minimum level contribution only, also note that if the contributions are more than this minimum level then many years hence, the fund will surely be able to meet all the liabilities arising out of it.
- Actuaries in pensions here come into the picture as they set up this MFR and revise it from time to time as various market forces that affect it change.
- Also, Actuaries in pensions will also keep a check that all the money coming into fund, all the investments made out of that fund and other movement of cashflows (such as payment of benefit to the beneficiary of the scheme ) is as per the laws and regulations of the country whose pension fund is being valued
- Atleast once in every three years (as per UK laws) the employers needs to ask the actuary to complete a valuation of the pension fund. This valuation is necessary to revise the contribution rate as required so that the fund meets its future liabilities.
- The primary role of Actuaries in Pensions is to provide a formal report to the employer or the trustee( key personnel in charge of specifically handling the pension fund for the company).The employers or the trustees can also ask for additional information if necessary.
- Also , an actuary is legally responsible to be notified about the significant events that might lead to changes in assets and liabilities of the pension fund. Such changes are proposed by the employer but can be implemented only when the actuary gives in writing that they will not negatively impact the pension fund.
- A major function of the trustees or the employer is to have a systematic plan of how the contributions received in the pension fund would be invested to meet the future liabilities as and when they arise. This is a work that an Investment Manager has to perform.
- An employer may ask the actuary himself to be an investment manager or appoint his colleague or any other independent investment analyst. However, in this case the actuary’s task is to assist the investment manager by intimating him about all the expected liabilities that could arise out of the pension fund so that he can devise his investment plan in the required manner.
- In such a case there is a division of responsibilities between the investment manager and an actuary but both have to act in coherence with one another for the long term financial health of the company they are working for.
- Also, role of Actuaries in Pensions is to also keep a check that all the money coming into fund, all the investments made out of that fund and other movement of cashflows (such as payment of benefit to the beneficiary of the scheme ) is as per the laws and regulations of the country whose pension fund is being valued
Individual transfer values:
- Sometimes, there are discretionary benefits offered to an individual when he or she transfers his or her benefits into another pension scheme (may be on change in company or generous early retirement terms ). If there is an established practice of providing such benefits to the individuals then this factor must be considered by the actuaries in creating pension models. This is known as transfer value calculation.
- However, an employer or a trustee might instruct an actuary in writing not to consider the transfer value calculation while valuing the pension funds even if such a benefit is provided by the company. In such case , the legal and financial implications of such an action in the long run will be borne by the employer or the trustee of that organization and not the actuary.
- Also, an actuary may advice the employer about the amount of any transfer value that would be appropriate for the pension scheme to pay or whether the amounts it offers are sufficient to cover any additional liabilities arising out of the scheme.
Additional Voluntary contributions :
- An actuary in pensions is required by law to consider all the voluntary contributions on the part of the employer in form of insurance policies , deposits or other investment funds earmarked for the members concerned with the pension fund.
- This is necessary to prevent the employer from getting tax benefit by having such schemes in the name of pension seeking employees and on the other hand, not linking it with the pension fund at all.
- Whenever an employer gets away in dealing with the pension liability all by himself or through a trustee, he /she buys an insurance policy to take care of pension contributions and the liabilities arising out of it.
- These pension contributions are now paid as premium to the insurer in return for a benefit paid each time an individual is eligible for pension.
- Then in such a case the same role of an actuary will be played by an actuary appointed by the insurance company for the valuation of the pension fund of an employer.
- Now the actuary does not have a direct accountability to the employer but is legally accountable for the decision he makes for the insurance company in regard to managing its funds.
If permitted by the way a pension scheme is set up, sometimes (mostly in case of deferred pensioners), the employer might transfer the current value of the future pension liability to the concerned persons. ( as it would be difficult to trace them x years hence) In such a case the employer is legally bound to ask his scheme actuary or the insurance firm he is associated with before making any such a move.
In case of discontinuance of a pension scheme, an advice from an actuary and investment advisor has to be seeked for the consequent financial implications of such an action on the existing pension seeking employees.
This happens when there are multiple employers of the same company and one of the employer leaves for a defined time period, in such a case the other existing employers have to take assistance from their scheme actuary regarding the financial implications and the deficits created in the fund thereof.
Misinterpreting Pension Scheme Benefits
Many actuaries in Pensions value the pension scheme liability as the expected present value of an annuity policy under which the payments replicate that of scheme benefits.
This may lead to erroneous pension liability obligation because of the reasons stated below
- The annuity rate chosen may be independent of the annuity rates provided by the insurers as the it will generally be lower than that assumed by the actuary to reflect the various costs and bonus loading for the insurance company.
- Even if the annuity rates chosen closely replicates that offered by the insurer there will be additional risk associated which includes the following:
- When the obligation becomes due, the insurer may not be willing to offer favorable rates.
- There might be any insurer present to provide the annuity policy when the obligation gets due.
Incorrect Allowance for Inflation linked Benefits
Many schemes offer pension payments that are linked to inflation in some form.
In the case, where Actuaries in Pensions reports the Defined Benefit Obligation under a pension valuation scheme that offers inflation linked benefits assuming that the cost of pension reflects the cost of purchasing annuity policy from the insurer at retirement or exit, there is often a risk that the reported figure may not be right as it is not always possible to find annuity contracts that exactly replicates the inflation linked benefits as provided under the pension scheme.
Some Final Thoughts
We should understand that actuaries are highly skilled and responsible professionals who might face repercussions and legal consequences because of careless, biased and significant errors while performing their duties. That is why the actuarial societies worldwide stress upon ethical and professional conduct of these fellows because if they aren’t following these standards it might have devastating impact upon the overall solvency of the company.
Let us know if you want to go ahead with the Pension Actuary in future in the comments below or share your thoughts on our forums to discuss about it.