The actuarial standards applicable to virtually all defined benefit (DB) pension plans in Canada are undergoing two distinct changes in 2011. These updates will affect how actuaries determine the assumptions, apply actuarial methods and prepare their reports for all funding actuarial valuations effective Dec. 31, 2010.
Changes to actuarial valuation standards
The new Standards of Practice for Pension Plans (SPPP) are applicable to all DB pension plan funding valuations that have an effective date on or after Dec. 31, 2010. Actuaries are not permitted to adopt early, as several of the new standards are inconsistent with elements of the current standards.
The changes to the SPPP will have a significant impact on valuation work performed by actuaries. In particular, the SPPP has been clarified to include all funded and unfunded pension plans, including valuations required for the determination of letters of credit. As a result, the reporting requirements typically employed for registered pension plan (RPP) valuations will now need to be extended to most valuations for non-RPP arrangements. Increased disclosure will also be required for actuarial valuations supporting advice on the funding impact of plan amendments.
The SPPP requires that the actuary’s work should take account of the circumstances of the work, including whether the work pertains to advice on the funded status of the plan, advice on the funding of the plan, any applicable laws, the policies of any regulators with jurisdiction on the work of the actuary, and the terms of the engagement between the actuary and the plan administrator. In its most simplified form, the actuary needs to know how the work will be used—this will often create a greater need for the plan administrator and actuary to clearly define the terms of the actuary’s engagement.
Other changes to the SPPP will have an impact on going concern and solvency (hypothetical windup) valuations. Changes that will affect going concern valuations include the following:
- going concern valuations are no longer mandatory unless required for compliance with the law or as part of the engagement;
- going concern valuation assumptions are to be best-estimate assumptions, no longer requiring margins for conservatism, except as required by law or by the engagement;
- the actuary may no longer assume additional potential returns from active investment management unless the actuary can support, based on relevant data, that such incremental returns will be “consistently and reliably earned over the long term”;
- required disclosure of the sensitivity of going concern valuation results, through determination of the impact that a 1% decrease in the discount rate would have; and
- changes in the actuarial cost method or asset smoothing method must now be accompanied by an explanation of the rationale for and the impact of the change.
The ability to exclude going concern valuations where not required by law or the engagement allows plan administrators to determine whether or not the actuary would perform going concern valuations for non-RPP arrangements. Since going concern valuations are required under pension laws in all Canadian jurisdictions, there should be no immediate impact for RPPs.
The net impact of the changes to assumption standards will vary from plan to plan. In particular, it appears that only the largest of plans will have the necessary data and means to appropriately justify the inclusion of additional potential returns from active plan management when establishing the discount rate. For plans where the actuary previously assumed incremental returns from active management, it is likely that going concern liabilities and normal actuarial costs will go up, although this could perhaps be offset by the reduction or elimination of margins for conservatism. It also remains to be seen whether pension regulators will mandate margins or otherwise prescribe certain assumptions now that such margins will no longer be required by the actuarial standards.
Changes that will affect solvency and hypothetical windup valuations include the following:
- the report must now contain a reconciliation of the gains and losses for the plan on a solvency or hypothetical windup basis for the period since the prior valuation, unless such a reconciliation was reported on a going concern basis;>
- for an RPP, the report must disclose the hypothetical windup position under the scenario following plan windup which maximizes the RPP’s benefits/liabilities on windup;
- the actuary must determine an “incremental cost,” a prescribed calculation showing the estimated change in solvency or hypothetical windup liability between the valuation date and the expected ensuing valuation date; and
- required disclosure of the sensitivity of solvency or hypothetical windup valuation results, through determination of the impact that a 1% decrease in the discount rates would have.
The amended standards applicable to solvency valuations should not change the measurement of a plan’s obligations, but will serve to provide more detailed information to readers. Since, in current economic times, the funding requirements for most single-employer pension arrangements are driven by the solvency valuation requirements, the extra level of detail will provide plan sponsors and members with greater insight about the risks and costs of their DB plans.
All of these changes will provide stakeholders with a greater amount of information for pension plans and will require actuaries to adopt an expanded reporting structure for non-RPP work. The changes may come with an increased cost to perform the additional services required by the SPPP.