What is an actuarial valuation?

An actuarial valuation is a determination of the costs and liabilities of a System as well as the assets of a System. A valuation relies on data for current active and retired members as of a given date called the valuation date. Some of the required data to perform a valuation for active members includes date of birth, pay, and credited service. For retired members, date of birth, monthly benefit, and benefit option are some of the required data elements.

For active members, the valuation projects expected benefits at retirement based on estimated pay and service, and the plan’s benefit formula. The valuation determines the present value of the liability associated with service to date (past service). For retirees, the valuation determines the present value of payments expected to be made for the retiree’s lifetime. These items are known as the Actuarial Accrued Liability. The Actuarial Accrued Liability less plan Assets produces the Unfunded Actuarial Accrued Liability.

The valuation also develops Normal Cost (or Current Cost) which is the present value of benefits expected to be earned during the current year.

What are the basic assumptions used in an actuarial valuation?

There are two types of assumptions used in an actuarial valuation. Economic assumptions usually have a greater impact on the values determined in the valuation. Two key economic assumptions are investment return (used to determine present values) and salary increases (used to project current pay until retirement). Demographic assumptions deal with the likelihood of retirement, death, disability, or termination of employment at each age.

What is actuarial funding?

Actuarial funding determines an annual cost to fund both the current benefits (Normal Cost) and Past Service liability (Unfunded Actuarial Accrued Liability). Under a funding schedule, a series of payments is determined to amortize the Unfunded Actuarial Accrued Liability over a period of years, as well as pay the annual Normal Cost.

What is the difference between amortizing the Unfunded Actuarial Accrued Liability on a level dollar or increasing percentage basis?

Under the level dollar approach, payments remain level each year for the period specified in the funding schedule (much like a mortgage). Under an increasing percent schedule, payments increase by a set percentage (4.5% is the maximum allowed) each year over the life of the schedule. Under an increasing percentage schedule, however, the payment in the early years of the schedule is not large enough to even pay the interest on the outstanding principal. Thus, level dollar is the approach required of private sector plans under federal law.

What is the difference between a pay-as-you-go system and actuarial funding?

Under a pay as you go system, appropriations are made each year to equal the amount of benefits expected to be paid out to retirees. There is no provision for advance funding for benefits to be paid in the future. One of the main principles of advance or actuarial funding is the premise that the cost of retirement benefits for current employees should be paid during the years of service of that employee - the period for which the taxpayers are receiving the benefits of the services of the employee.