Background information for pension actuarial material

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Background information for pension actuarial
material

• RMI 339

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The choice of a particular set of assumptions

• The choice of assumptions will affect the cost
  allocated to a given year, but the ultimate cost
  is primarily dependent on actual experience over
  the life of the pension plan
• The relative magnitude of actuarial gains and
  losses under the plan will vary, but the end
  result will be an approximately similar ultimate
  cost picture
• except to the extent that investment earnings are
  affected by the incidence of contributions
  produced by the funding assumptions chosen

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Number of employees who will be eligible for
benefits under a pension plan

• Mortality rates among active employees
• Rates and duration of disabilities among active
  employees under a plan that offers a disability
  benefit
• Layoffs and voluntary termination of employment,
  assuming the absence of full vesting
• Rates of retirement at different ages

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Problems in using the current market values of
securities

• Market values will generally be relatively high
  in periods of high corporate earnings
• thereby reducing the apparent need for
  contributions (and also the tax deductible
  limits)
• at times when the employer may be best able to
  make large contributions toward the pension fund
  
• Measuring a plan's unfunded liabilities on any
  given date by the current market values of the
  fund's equities could produce a very irregular
  funding pattern
• the antithesis of the orderly procedure, which is
  an essential characteristic of a satisfactory
  pension funding program.

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Actuarial valuation of assets

• The value of a plan's assets must be determined
  by a reasonable actuarial valuation method that
  takes into account fair market value
• Generally, the Internal Revenue Service has taken
  the position that this condition is satisfied if
  the asset valuation method generates an asset
  value which is within 20 of the fair market value

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Actuarial cost method

• Technique for establishing the amounts and
  incidence of the normal costs and supplemental
  costs pertaining to the benefits of a pension
  plan

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Advance funding approach

• Funds are set aside on a systematic basis prior
  to the employee's retirement date
• Periodic contributions to the plan are made on
  behalf of the group of active employees during
  their working years
• Plans operating under this funding approach
  invariably are qualified with the Internal
  Revenue Service

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Advance funding can provide a buffer during
periods of financial stress

• During a period of low earnings or operating
  losses, an employer may find it advisable to
  reduce or eliminate pension contributions for a
  year or even a longer period
• This can be done in those cases where the
  pension fund is of sufficient size that a
  temporary reduction of contributions does not
  violate the minimum funding requirements imposed
  by ERISA
• This financing flexibility does not necessitate
  any reduction in or termination of pension
  benefits
• unlike defined contribution plans

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Choice of an actuarial cost method and the
ultimate cost of a pension plan

• Having different actuarial cost methods to
  accumulate annual pension costs is analogous to
  having different methods for determining the
  annual amount of depreciation of plant and
  equipment charged against operations
• Similarly, the various actuarial cost methods
  will produce different levels of annual cost, but
  the choice of a particular actuarial cost method
  will not affect the ultimate cost of the plan
• However, if an actuarial cost method is chosen
  that produces higher initial contributions than
  other methods, the asset accumulation will be
  greater in the early years of the plan
• thereby producing greater investment income

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Types of acms

• Actuarial cost methods can be broadly classified
  into accrued benefit and projected benefit cost
  methods.

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Normal cost and supplemental cost

• The normal cost of a plan is the amount of annual
  cost, determined in accordance with a particular
  actuarial cost method, attributable to the given
  year of the plan's operation.
• If the normal cost under the particular cost
  method is calculated on the assumption that
  annual costs have been paid or accrued from the
  earliest date of credited service (when in fact
  they have not), the plan starts out with a
  supplemental liability.
• At the inception of the plan, the supplemental
  liability arises from the fact that credit for
  past service is granted, or part of the total
  benefit is imputed, to years prior to the
  inception of this plan.
• The supplemental cost is the portion of the
  annual cost that is applied toward the reduction
  of a plan's supplemental liability.

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steps in the calculation of (a) the normal cost
and (b) the supplemental liability at plan
inception under the accrued benefit cost method.

• determine the present value of each participant's
  benefit credited during the plan year for which
  costs are being calculated.
• determine the normal cost for the plan as a whole
  by summing the separate normal costs for the
  benefit credited for each participant.
• The supplemental liability at the inception of
  the plan under this method is simply the present
  value of the accrued past service benefit
  credited as of that date.
• The supplemental liability for the plan as a
  whole at the inception would be the sum of the
  supplemental liabilities for each of the covered
  employees.

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A projected benefit cost method differs from an
accrued benefit cost method in two important
respects

• (1) the normal cost accrual under a projected
  benefit cost method is related to the total
  prospective benefit credited by the retirement
  date rather than the benefit amount credited to a
  particular year or specific period of service
  and
• (2) a projected benefit cost method is applied
  with the objective of generating a normal cost
  which is a level amount or percentage of earnings
  for either the individual participants or to the
  participants as a group.

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Distinguish between the individual level and
aggregate level cost methods.

• Under the individual level cost method, the
  normal cost accruals are determined separately
  for each employee as a preliminary step to the
  determination of total plan cost.
• under the aggregate level cost method, the normal
  cost accruals are calculated for the past as a
  whole without associating any portion of these
  cost accruals with the projected benefits of
  specific individuals.

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IRC Section 415 limits may influence the
deduction of employer contributions.

• No deduction is allowed for the portion of a
  contribution to a defined benefit plan to fund a
  benefit for any participant in excess of the
  Section 415 annual benefit limitation for the
  year.
• In calculating the contribution to a defined
  benefit plan, anticipated cost-of-living
  increases in the allowable annual retirement
  benefit cannot be taken into account before the
  year in which the increase becomes effective.