Actuarial Valuation Details

An actuarial valuation measures a pension plan's present assets and liabilities in the private or public sector. They then project these current conditions into the future. To make this valuation, an actuary will use statistics and their judgment to arrive at a valuation. In addition, they will take into account relevant demographics, economics, and investment strategies.

The statistical methods the actuary uses are sophisticated. Nevertheless, the valuation of future status is an assumption that may or may not be accurate. Even so, actuarial valuations are necessary because they can highlight weaknesses in investment strategies, which may lead to a shortfall in funds when liabilities have to be met.

If it appears that there may not be sufficient funds in a pension plan, the company may have to revise its investment strategy or inject extra funds into its system.

Actuarial Valuation Example

Diana works for Mega and is the beneficiary of a pension plan which the company funds. The type of plan which covers Diana is a defined benefit plan in which Mega has contractually guaranteed a certain amount of benefits among Diana's retirement in twenty years. The company that handles Mega's pension plans calculates the payments, which Diana will receive based on her projected earnings and years of service. If the pension plan does not have enough assets to cover Mega's obligation to Diana, then Mega will have to make up the difference.

To calculate the liability that Diana's pension plan represents to Mega, an actuary will consider her projected salary upon retirement and her total years of employment. The International Accounting Standards Board states that the actuary should use the Projected Unit Credit Method, which predicts her retirement salary based on a salary growth scale. Having a standard model for actuarial valuations allows for greater clarity and transparency. A pension plan provider should perform actuarial valuations regularly so that the provider is aware of potential problems.

In Diana's case, the actuarial valuation reveals that, when Diana retires, there may not be enough money in the fund to pay the full amount that Mega owes her. As a result, the pension plan provider looks closely at its investment strategy and portfolio. It discovers that a high percentage of its investments are in safe institutions that pay a low interest rate. Therefore, it believes that it can broaden its portfolio to include a wider spread of vehicles. These vehicles pay a higher rate of interest but are likely to be secure.

Significance of Actuarial Valuation

The key to understanding future obligations is information. An actuarial valuation may not be able to consider every variable which affects the future performance of a pension fund, but it can highlight weaknesses in current strategies that need to be addressed so as to provide as secure a future as possible for the plans on which its beneficiaries rely. Actuarial valuations focus attention on both the strengths and weaknesses of a pension plan and ensure that the current health of the plan is regularly under review.