What is the actuarial valuation?
An actuarial valuation is a type of Evaluation of a pension fund’s assets to liabilities, using investment, economic and demographic aspects of the model to determine the level of funding of a pension plan. The assumptions are based on a mixture of statistical studies and experienced judgement. Since assumptions are often derived from long-term data, unusual short-term conditions or unforeseen trends can sometimes cause deviations from forecasts.
Key points to remember
- Actuarial valuations are used to assess the funded status of a defined benefit pension fund.
- Unlike market values, actuarial values rely on statistical inferences and assumptions built into a model.
- Actuarial models are based 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 on the employer contribution rates and investment growth rate for the portfolio of stocks and bonds (level 1 and 2 assets) and other assets (illiquid type level 3) . The calculation of payment obligations is much more complex.
The actuary must make assumptions regarding, but not limited to, the discount rate, employee contribution rates, salary growth rates, inflation rates, mortality rates, age in-service retirement age, disability retirement age and interest on participants’ accounts. If all long-term assumptions are reasonable, then a realistic capitalization (or capitalization) ratio can be derived. The funded ratio is equal to assets over liabilities, with a ratio greater than 1.00, or 100%, indicating that there are sufficient retirement assets to cover the liabilities.
Implications of Actuarial Valuation
Actuarial valuations are carried out in the private and public sectors. US Steel disclosed in its 2021 annual filing that its funded ratio as of December 31, 2021 was 0.32, or 32% ($2.09 billion plan assets divided by $6.6 billion obligations) .
Some states are in dire straits due, in large part, to significantly higher worker compensation commitments (past negotiations with state employees have resulted in greater pension payment guarantees). A 2019 study by The Pew Charitable Trusts shows that the 20 least-funded states funded just 56% of their pensions in 2017. Overall, US states funded 69% of their obligations, according to the study. States that have funded more than 100% of their pension obligations include South Dakota, Tennessee and Wisconsin. However, New Jersey, Kentucky and Illinois funded less than 40% of their obligations.
