benefits magazine september 201522

Do you find pension plan actuaries baffling at times? You’re not alone in failing to understand their special brand of jargon. Here’s help with terms you’re likely to hear from your actuary.

Why Doesn’t My Actuary Speak English?

by | William J. Ruschau

So, you just came back from a meeting with your pension plan’s actuary. Your head hurts, and you are more confused than you were when you went into the meeting. The good news is that you are not

alone. Each year thousands of trustees have the same experi-ence and the same residual pain. The bad news is that it is not likely to change.

Actuaries go through a rigorous examination process on highly technical issues to be able to affix all those marvel-

Reproduced with permission from Benefits Magazine, Volume 52, No. 9, September 2015, pages 22-27, published by the International Foundation of Employee Benefit Plans (www.ifebp.org), Brookfield, Wis. All rights reserved. Statements or opinions expressed in this article are those of the author and do not necessarily represent the views or positions of the International Foundation, its officers, directors or staff. No further transmission or electronic distribution of this material is permitted.

M A G A Z I N E

september 2015 benefits magazine 23

Why Doesn’t My Actuary Speak English?

ous initials after their names (ASA, FSA, EA, MAAA, MCA, etc.). However, none of those tests are oral exams. In fact, an individual can make it through to the actuarial Promised Land without ever speaking a single sentence of real English. In the process, a whole new language has emerged, which we will refer to as actuarial jargon. This language takes other-wise innocuous words or phrases and assigns to them tech-nical, and often misleading, definitions. It is a language that only other actuaries speak.

Fear not! To paraphrase an old joke, I am an actuary and I am here to help. I have compiled a list of commonly used actuarial jargon and will attempt to translate it into a language that mere mortals can understand. While some of this relates only to multiemployer plans, much of it trans-lates to government plans and corporate plans as well. I will try my best to avoid using other jargon to explain the jar-gon, though as an actuary it is sometimes hard to break old habits.

benefits magazine september 201524

Here, then, is an actuarial jargon dictionary to help you in future en-counters with your plan’s actuary.

ERISAWe will start with the most basic

of terms, as it routinely creeps into al-most every actuarial discussion. The Employee Retirement Income Security Act (ERISA) is the bible for the gover-nance of all pension and employee ben-efit plans. Originally enacted in 1974, ERISA is changed by Congress almost every year to address the new issue of the day. The financial provisions of ERISA are also mirrored in the Internal Revenue Code (the Code). Whenever actuaries have to do things we don’t like, we blame it on ERISA. Also, whenever actuarial work is slow, we can count on Congress to amend ERISA and gener-ate new work (spelled revenue) for your friendly neighborhood actuary.

Actuarial Funding MethodThis is the biggest misnomer in all

of actuarialdom. The actuarial funding method doesn’t determine your plan’s funding—You do, typically through the collective bargaining process. It doesn’t matter what method the actuary uses;

the funding of the plan is determined by the rates you negotiate and the work units the members render. Nothing the actuary does will change that.

To understand the purpose and use of an actuarial funding method, you must first step back to take a look at the pension plan itself. A pension plan does much more than provide a fixed pension for a member who works to normal retirement age (however the plan defines that). There typically are smaller benefits for members who re-tire early and increased benefits for those who retire late. And many (if not most) participants who start in a plan will not work to retirement age. In any year, they may terminate or die or be-come disabled. Each of these events may or may not have a benefit attached. And after the member starts drawing a benefit, it may be payable for life or for the lives of the member and spouse, or it may have a certain minimum num-ber of payments guaranteed. The ac-tuary’s job is to bring order to all this chaos. The way we do this is through the use of an actuarial funding method. There are two methods generally in use for multiemployer plans:

• The entry age normal method

takes all of those possible future benefits, combines them with cer-tain assumptions about future ex-perience and attempts to spread them out as a level annual amount or “cost” for each year from the time the member entered the plan (hence the “entry age” in the name) until the time he leaves it. In other words, if all of the as-sumptions were exactly right (which never happens, but let’s pretend), the amount assigned to each year of service would be ex-actly the same every year. Note that this method is not directly tied to the benefit earned in any year. Rather, it is all about produc-ing a level “cost” for each year.

• The accrued benefit (unit credit) method takes a more direct ap-proach. The amount, or cost, as-signed to each year is the value of benefits the member actually earns in that year. Although the benefit earned may be the same each year, the cost is not level be-cause of a little thing we like to call compound interest. As a mem-ber gets older and closer to retire-ment, the number of years re-maining correspondingly shrinks. Conversely, the “cost” of the ben-efit he earns goes up. For example, with a 7% interest rate, money will double approximately every ten years. So if I need $8,000 in 30 years, I need only $1,000 today. Or I need $2,000 in ten years and $4,000 in 20 years. There are two major differences in this method from the entr y age normal method:

1. The amount (or cost) assigned to

pension plans

takeaways >>•  Despite the term actuarial funding method, a plan’s funding is determined through the

rates negotiated during the collective bargaining process and members’ work units.

•  The term accrued liability applies to several different values but generally refers to the value of expected future plan benefits that is attributed to service already rendered.

•  By determining a plan’s actuarial asset value, an actuary is trying to bring some stability to the plan’s minimum required contribution and funding levels.

•  Actuarial assumptions are an actuary’s best estimates, not those of the plan sponsor or trustees or anyone else, and each assumption must be a best estimate.

•  Among the new terms added by MPRA are an array of zone statuses that describe a plan’s financial situation.

september 2015 benefits magazine 25

each year is directly tied to the benefits earned that year.

2. The amount for each member is not designed to be level from year to year, but to increase. (Note, though, that as members drop out and new members join, the overall age of the active membership may remain fairly stable and thus produce more stable costs.)

Actuarial Cost MethodThis term is synonymous with actuarial funding method.

(We actuaries are so devious we have more than one bit of jargon for the same thing.) And, like funding method, actu-arial cost method is also a misnomer. (That is why the term cost is in quotes above.) The cost of a pension plan is the ben-efits and expenses paid, less the investment income earned. Nothing the actuary does (nor you, nor the Internal Revenue Service (IRS)) can change this basic axiom. The methods, as-sumptions and everything else affect only the timing of cost recognition, not the true cost. They are used to comply with funding rules enacted under ERISA and also to establish some financial guideposts for the plan to measure its prog-ress from year to year.

Accrued LiabilityThis is one of the more confusing terms in an actuarial

valuation because the same term applies to several different values. In general, it refers to the portion of the total value of expected future plan benefits that is attributed to service already rendered. For inactive participants (retirees, termi-nated vested, disabled, etc.), it is the full value of their future benefits. For active participants, the portion assigned to past service depends on which of the above funding methods is being used.

Things get a bit more confusing when you consider a few similar terms that also appear in a typical actuarial valuation report. The first is the value of accrued benefits. This is the same as the accrued liability if the plan is using the unit cred-it funding method, but different if the plan uses the entry age method. Another similar term is the value of accumulated benefits. Actuaries can’t take the rap for this one, though, as this was foisted upon us by the accounting profession. This generally is calculated the same as the value of accrued ben-efits, though the actuarial assumptions may be different (see actuarial assumptions discussion below.)

This plethora of liability values adds a layer of confusion

to any actuarial valuation report. (And we have yet to discuss withdrawal liability.) When you combine this with the use of more than one value of plan assets (see below), it’s no wonder actuaries struggle to answer the simple question “What is my plan’s funded percentage?”

Normal CostThis is another misnomer, as the term has nothing to do

with being normal. Rather, it is the portion of future plan costs that is assigned to the current year of service for active participants. Under the entry age normal funding method, it is that level amount discussed above to spread costs evenly over the participant’s working career. Under the unit credit method, it is the value of future benefits that he or she is ex-pected to earn this year.

Amortization BasesWhenever the plan’s accrued liability or assets change by

an amount that is different than your otherwise astute ac-tuary expects (typically due to experience fluctuations, but may also be caused by assumption, method or plan changes), the plan must establish an amortization base for the differ-ence. These bases may be positive or negative depending on whether the change increases or decreases the plan funding level.

While it would seem logical to offset gains against losses, that is not what Congress, in its infinite wisdom, has decreed. Each base is established independently of any others. The bases are then charged (or credited) to the plan over time until they are eliminated. This is similar to paying off a loan. How much time? It depends. Under the Code, not all amor-tization bases are created equal. Amortization periods used to range up to 40 years, but changes to the law over the years now limit the amortization period for new bases to no more than 15 years.

Funding Standard AccountThis is where the rubber meets the road, at least as far as

ERISA and IRS are concerned. One of the key concerns of Congress when enacting ERISA was to make sure that plan sponsors adequately funded their pension promises. To do that, Congress imposed a minimum required contribution, which is the sum of the normal cost and net amortization charges, adjusted for expected interest. The cumulative dif-ference between these charges and the actual plan contribu-

pension plans

benefits magazine september 201526

tions is monitored through the funding standard account. (Cumulative in this instance goes back to when the plan first became covered by ERISA, which was 1976 for most plans.) If contributions have been greater than charges (called an ac-cumulated funding surplus or credit balance), such excess can be applied to meet the current minimum required contribu-tion. If contributions over the years have been less than the cumulative changes, the plan enters ERISA jail, otherwise known as an accumulated funding deficiency. Bad things can happen if your plan has such a deficiency, so it is best to avoid that if at all possible.

Actuarial Asset ValueAlthough actuaries spend most of their time messing with

plan liabilities, they also like to finagle plan asset values. This is not done to be malicious, though some may think other-wise. Rather, it is an attempt to bring some stability to the plan’s minimum required contribution and to plan funding levels. If investment returns are greater than expected, some of the excess is essentially set aside for a rainy day. If returns are less than expected, some of the shortfall is also set aside for later (which makes much less sense, but IRS requires that we treat both gains and losses the same way).

Actuarial AssumptionsWhile everyone knows what these are, a word is in order

about what they mean. ERISA mandates that each assump-tion be reasonable and represent the actuary’s best estimate of future experience. Two things to note here. First, they are

the actuary’s best estimate, not those of the plan sponsor or the trustees or anyone else. And second, each individual as-sumption must be a best estimate. An actuarial valuation in-cludes dozens of assumptions about what will happen each year from now until the last plan participant dies. Every one of those assumptions will be wrong every year. But it is hoped that, over time, good years and bad years will offset and gains on some assumptions will offset losses on others to produce some overall stability.

There are two places in an actuarial valuation where the assumptions may be different from those used to measure cost levels:

1. The determination of the value of accumulated plan benefits. (These are the values displayed in the back of your audit report.) These values are based on assump-tions determined by the plan sponsor. They need not be the same as those used by the actuary for cost calcu-lations, though you may need to convince your auditor they are appropriate if they do not match.

2. The determination of plan withdrawal liability may use different assumptions. While these are also the plan ac-tuary’s assumptions, evaluating a plan for this purpose is somewhat different from evaluating an ongoing plan, and the assumptions may vary.

Withdrawal LiabilityNow that I mentioned withdrawal liability, I guess I should

say a word about what it is. In general terms it is the value of unfunded vested benefits using whatever actuarial assump-tions the actuary uses for this purpose. What are vested bene-fits? Assume a participant terminates employment tomorrow. If he is entitled to future benefits, those benefits are vested. If not, they are nonvested. (There are a few added wrinkles to this, but we’ll ignore those for this purpose.) What portion of those vested benefits is funded? Some plans use the actuarial value of assets and some use the market value of plan assets to measure this. The allocation of a plan’s withdrawal liability to individual employers may be done in many different ways and is well beyond the scope of this article.

Maximum Deductible ContributionYou might think that any employer contribution made as a

result of good-faith collective bargaining would be automati-cally tax-deductible. However, Congress does not necessarily agree. It included within the Code a limit on the amount of

pension plans

learn more >>EducationTrustees and Administrators InstitutesFebruary 15-17, 2016, Lake Buena Vista (Orlando), FloridaVisit www.ifebp.org/trusteesadministrators for more information.

From the BookstoreTrustee Handbook: A Guide to Labor-Management Em-ployee Benefit Plans, Seventh EditionClaude L. Kordus, editor. International Foundation. 2012.Visit www.ifebp.org/books.asp?7068 for more details.

Multiemployer Plans: A Guide for New TrusteesJoseph A. Brislin. International Foundation. 2014.Visit www.ifebp.org/books.asp?7372 for more details.

september 2015 benefits magazine 27

contributions that would be deduct-ible in any year. Fortunately, Congress learned the error of its ways when sev-eral market downturns severely hurt the financial status of many plans. While there are still limits on deductible con-tributions, those limits are now typically like a gazillion dollars. They may well never again restrict plan contributions.

PPA TerminologyThe Pension Protection Act of 2006

(PPA) added a whole new layer of jar-gon. This was further compounded by the Multiemployer Plan Reform Act of 2014 (MPRA). Together these laws slotted each plan into an array of possi-ble financial situations, or zone statuses. These include the following:

• Safe (green zone): Smooth sailing ahead (the Good Lord willing and the creek don’t rise. Or the markets crash.)

• Safe, sort of (special rule): Things are a little bumpy ahead, but the plan should work its way through without any action on your part.

• Endangered (yellow zone): Some problems on the horizon, but they aren’t too big or are still a ways off.

• Seriously endangered (orange zone): We’re not kidding. We re-ally, really mean there are some problems down the road.

• Critical status (red zone): The road got much shorter. Those problems are right around the corner.

• Critical within five years: The problems are still a few years off, but you can elect to pretend they are here now and start to fix them.

• Critical and declining: Big prob-lems are here; the going will be very rough.

If you fall into any of these cate-gories other than the safe zone, you must adopt a plan to fix them. These

pension repair plans are called ei-ther a funding rehabilitation plan or a funding improvement plan (depend-ing on how much fixing you need to do).

SummaryI hope this guide through the

strange and wacky world of actuarial jargon proves useful. Cut this article out and bring it with you the next time your plan actuary is to regale you with his or her actuarial analysis of the issue of the day. Maybe it will help you trans-late it into something meaningful. Fair warning, however—If all the normal folks start to understand us, we actuar-ies may need to invent new jargon just to stay a step ahead.

pension plans

William J. Ruschau, EA, FSA, MAAA, is a senior consul-tant at United Actuarial Services, Inc., in Columbus, Ohio. He provides consulting advice to multiemployer funds on pension issues. He has been providing actuarial and consulting advice to plan sponsors for over 30 years. Mr. Ruschau is a fellow of the Society of Actuaries, a

member of the American Academy of Actuaries and an enrolled actuary. He earned a B.S. degree in liberal arts and sciences in actuarial science at the University of Illinois.

<<

bio