- Seeking Good Governance in Gainesville
Dear Seeking:
Actuarial reviews, often referred to as actuarial audits, can be an important component of a retirement board’s governance and due diligence of its pension plan. This following discussion will provide an overview of the many potential perspectives for an actuarial review as well as the possible levels of detail for the review.
Actuarial audit or review?
When you hear the terms ”audit” and ”findings,” you may feel anxious or defensive. These words often imply that something was incorrectly accounted for or that someone made a mistake. However, when it comes to actuarial valuations and experience studies, a better way to think of the process is as an actuarial ”review” with ”recommendations.” Actuarial valuations are complex and technical processes that employ many acceptable approaches and methods. The goal of a review is not primarily to find faults, but to suggest improvements and enhancements for future iterations.
What areas are reviewed?
The scope of an actuarial review may vary depending on the type and size of the plan, but some common areas of review include:
- Reconciliation of census data: This involves checking the accuracy and completeness of the census data used to calculate the liabilities and contributions.
- Review of assumptions and experience study: Actuarial assumptions are a key input that drives the actuarial model and reflects the expected future experience of the plan. The review may assess the reasonableness, consistency, and appropriateness of the assumptions, as well as the methodology and results of the experience study that was used to develop the assumptions.
- Review of actuarial methods: These methods include the cost method and the asset smoothing method, which determine how the plan’s liabilities and assets are measured and allocated. The review may evaluate the suitability and compliance of the methods with the plan provisions and relevant actuarial and accounting standards.
- Review of liabilities: This involves verifying the calculations of the present value of future benefits, the actuarial accrued liability, and the unfunded actuarial accrued liability. The liability verification typically involves either a full replication of the liability for all plan members, or a very detailed review of the liability for a representative sample set of plan members.
- Review of contribution calculations: This involves checking the derivation of the normal cost, the amortization of the unfunded liability, and the total contribution rate. The review may also examine the sensitivity and stability of the contribution rate with respect to changes in assumptions and methods.
- Review of valuation report: This involves reviewing the content, format, and presentation of the valuation report, as well as the compliance with the disclosure and reporting requirements.
Are there different levels of review?
The depth of the actuarial review can also vary. The depth of the actuarial review will generally be related to the reason for the actuarial review and the budget for the actuarial review. The levels of actuarial reviews are traditionally broken into three categories:
- Level 1 Actuarial Review: A Level 1 Actuarial Review involves a complete replication of all plan liabilities based on the same data, assumptions, and methods that were used for the most recent actuarial valuation. This level of review can provide the stakeholders with the greatest confidence that the plan liabilities are calculated in a reasonable manner by the plan’s retained actuary.
- Level 2 Actuarial Review: A Level 2 Actuarial Review involves a detailed liability calculation for a representative cross-section of actual plan members. This process can require less time than the complete replication of a Level 1 Actuarial Review, and therefore can be less expensive to perform. However, issues with the actuarial valuation could be missed during a Level 2 Actuarial Review if the selected sample records are not impacted by a previously unknown issue (e.g., miscoding of benefits or assumptions).
- Level 3 Actuarial Review: A Level 3 Actuarial Review generally just involves a review of the actuarial valuation report and supporting documentation. A replication of plan liabilities is generally not included in this level of actuarial audit. This level of actuarial review can provide helpful insights regarding the inputs to the actuarial model, but it is generally not recommended because it provides no insights into the reasonableness of the liability calculations.
All three levels of actuarial audit should include a review of the assumptions and actuarial experience study.
What else can be reviewed?
The actuarial review provides an opportunity to draw on the experience and expertise of an independent actuary and consultant. In addition to the traditional areas of review discussed above, there may be some less common but equally important areas that could be included in the scope of the review, such as:
- Actuarial equivalence factors: These are the factors that are used to adjust benefits for different payment options, such as joint and survivor, lump sum, or early retirement. The review may check the consistency and accuracy of the factors relative to the plan provisions and the assumptions.
- Qualified domestic relation order (QDRO) procedures: These are the procedures for handling QDROs, which are court orders that assign a portion of a member's benefit to a former spouse or other dependent. The review may evaluate the compliance and efficiency of the procedures with the plan rules and applicable legal requirements.
- Benefit calculation audit: This is an audit of a sample of benefit calculations performed by the plan administrator or the actuary. The review may verify the correctness and timeliness of the calculations, as well as the quality of the documentation and communication. This process can also review the administration of nonlevel benefit provisions such as Social Security offsets and lifetime caps on cost-of-living adjustments.
- Governmental Accounting Standards Board (GASB) reporting: This is the reporting of the plan's financial information in accordance with GASB standards. The review may assess the completeness and accuracy of the data, assumptions, and methods used for the GASB reporting, as well as the consistency and clarity of the report.
- Other complex actuarial processes: These processes may include any other specialized or advanced actuarial processes that are relevant to the plan, such as risk analysis, stochastic modeling, asset-liability management (ALM), or plan design. The review may appraise the validity and robustness of the processes, as well as the usefulness and reliability of the outputs.
- Census data audits: This process would focus on the underlying demographic and benefit for the plan. Census data audit could include: reviewing the census data extract provided to the retained actuary, a ”death audit” on current annuitants and beneficiaries to determine whether a benefit should still be payable, and missing participant searches.
How to communicate effectively
Communication is a vital part of the actuarial review process. It is important that all parties involved, such as the plan sponsor, the retirement board, the retained actuary, and the reviewing actuary, stay in regular contact and exchange information and feedback throughout the process. This proactive communication can help avoid misunderstandings, resolve issues, and ensure alignment of expectations and objectives. Moreover, because the actuarial review may attract the attention of various stakeholders, such as the plan members, the participating employers, the taxpayers, and the elected officials, it is essential that there are no surprises or misunderstandings when the final report is presented to the retirement board. The report of the actuarial review should be clear, concise, transparent, and highlight the main findings and recommendations of the review.
What if there are mistakes?
Although the actuarial review is not intended to find errors, sometimes they do surface during a review. In such cases, it is important for the reviewing actuary to work closely with the retained actuary to understand the nature and materiality of the mistake and discuss the best way to correct it. Depending on the impact and significance of the mistake, it may require an adjustment of the liabilities, assets, or contributions, or a restatement of the valuation report or the GASB reporting. The mistake should also be disclosed and explained to the retirement board and the stakeholders, and the appropriate actions should be taken to prevent it from happening again.
Your Milliman Actuary
For more information about defined benefit pension plans, see prior letters here.
Do you have a question about your defined benefit pension plan? Write to us at [email protected].
This edition of Dear Actuary was written by Ryan Falls, FSA. Ryan and his fellow consulting actuaries that serve the public sector are happy to answer any additional questions you have regarding actuarial reviews and general consulting services. You can contact Ryan at [email protected] or 214-863-5635.