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New content coming to your annual valuation report in 2023 and beyond

New content coming to your annual valuation report in 2023 and beyond

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In December 2021, the Actuarial Standards Board (ASB) adopted a revised version of Actuarial Standard of Practice No. 4 (commonly referred to as ASOP 4), Measuring Pension Obligations and Determining Pension Plan Costs or Contributions.  

The new version will be effective for valuations performed as of dates (and completed) on or after February 15, 2023 and reflects a number of technical changes designed to improve the quality of information provided in actuarial valuation reports. For the most part, these changes may not be obvious to non-actuarial readers. There is one conspicuous exception: Reports on actuarial valuations made for the purpose of determining funding requirements will have to include a disclosure of a low-default-risk obligation measure for the plan. 

What is LDROM? 

A low-default-risk obligation measure (LDROM) is a calculation of the value of the benefits attributed to past service as of the valuation date. The assumptions used in calculating the LDROM will generally be the same as those used in the calculation of funding requirements, except that the interest rate used to discount future benefits is to be “derived from low-default-risk fixed income securities whose cash flows are reasonably consistent with the pattern of benefits expected to be paid in the future.”  The revised standard provides five examples of potential discount rates: 

  1. US Treasury yields 
  2. Rates implicit in settlement of pension obligations including payment of lump sums and purchases of annuities from insurance companies 
  3. Yields on corporate or tax-exempt general obligation municipal bonds that receive one of the two highest ratings given by a recognized ratings agency 
  4. Non-stabilized ERISA funding rates for single employer plans  
  5. Multiemployer current liability rates 

Public retirement systems affected 

While plans subject to the funding requirements of ERISA already calculate liabilities that could be used to satisfy this requirement, public-sector plans have almost never had a need to calculate liabilities on such a basis. For both funding and accounting purposes, liabilities for public retirement systems have generally been based on discount rates equal to long-term expected returns on the assets they hold. Calculating an LDROM for public retirement systems will likely entail recalculating their accrued liabilities using a discount rate that meets the criteria above. 

Background: A long and winding road 

Why did the ASB incorporate this new requirement in the revision to ASOP 4?   

In 2018, when it released the first exposure draft of the revised standard, it went much further. It would have required that actuarial reports in which funding requirements are developed incorporate a disclosure of an “investment risk defeasement measure.” This was to be calculated as the present value of accrued benefits at the valuation date, using a discount rate based on either (a) yields on Treasury securities or (b) bonds receiving one of the two highest ratings awarded by a recognized ratings agency. The latter option was intended as an approximation of the rates at which the liabilities of a retirement system for accrued benefits could be settled (i.e., covered by a highly secure dedicated bond portfolio or by purchases of annuities from an insurer).  

The proposal to require the disclosure of a such a liability was influenced by the so-called “financial economics” school of thought, which has long argued that settlement liabilities provide valuable information about the “true value” of pension obligations. Public-sector retirement systems and their advocates have rejected this argument, primarily on the basis that they rarely, if ever, settle benefit obligations.  

Compromise reached 

After a long and intense debate on the first exposure draft, subsequent drafts replaced the requirement to disclose a settlement obligation with required disclosure of an LDROM instead. This may be calculated as the plan’s accrued liability under any immediate-gain actuarial cost method. If the actuarial cost methods used by the vast majority of public retirement systems to establish contributions are employed for this purpose, the result will certainly not be a settlement obligation. However, the difference between the LDROM and the actuarial liability calculated for funding purposes can be seen as the degree to which a public retirement system has lowered its liabilities by investing in non-low-risk assets. 

ASB’s rationale 

In the transmittal memorandum accompanying the adopted version of the revised ASOP 4, the ASB stated its rationale for the LDROM disclosure requirement as follows: 

The ASB believes that the calculation and disclosure of this measure provides appropriate, useful information for the intended user regarding the funded status of a pension plan. The calculation and disclosure of this additional measure is not intended to suggest that this is the “right” liability measure for a pension plan. However, the ASB does believe that this additional disclosure provides a more complete assessment of a plan’s funded status and provides additional information regarding the security of benefits that members have earned as of the measurement date. 

In requiring the disclosure of the LDROM, the revised standard emphasizes the importance of accompanying it with “commentary to help the intended user understand the significance of the low-default-risk obligation measure with respect to the funded status of the plan, plan contributions, and the security of participant benefits” and adds that the actuary “should use professional judgment to determine the appropriate commentary for the intended user.”

Plan sponsors and their actuaries should collaborate to develop appropriate language to frame LDROM disclosures in future valuation reports, to minimize the risk that they will be misconstrued by readers of the reports.