Csp Q41

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What Does ASOP 27 Address

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Selection of economic assumptions

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ASOP 27

General Selection Process of Economic Assumptions

Back 2

1) identify components of each assumption and evaluate relevant data
2) Develop best-estimate range
3) Select point within range

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ASOP 27

General Considerations When Identifying and Selecting Economic Assumptions

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1) Purpose and nature of the measurement
2) Characteristics of the obligation
3) Materiality of the assumption
4) Appropriate recent and long-term historical economic data
5) Need to consider expected future trends

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ASOP 27

Specific Considerations When Developing a Range and Selecting a Point

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1) Purpose of measurement
2) Investment policy
3) Reinvestment risk
4) Investment manager performance
5) Investment manager performance
6) Investment expenses
7) Cash flow timing
8) Benefit volatility
9) Expected pan termination or frozen plan
10) Tax status of funding vehicle

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ASOP 27

Should reflect the following investment policy information when developing a range

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1) Current allocation of assets
2) Securities held
3) Risk tolerance
4) Target allocation
5) Permissible range for each asset class

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ASOP 27

Individual Assumptions

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- Each economic assumption should individually satisfy the standard

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ASOP 27

Consistency among Economic Assumptions

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- Each economic assumption should be consistent with every other assumption

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ASOP 27

Should review the following data when creating an interest rate assumption

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1) Fixed income yields
2) Inflation forecasts and total returns for each asset class
3) Historical performance broken by component, inflation, risk-free returns and risk premiums
4) Historical plan performance
5) Obtain SD and correlations if using stochastic simulation to develop range

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ASOP 27

Disclosure of Economic Assumptions Should Include

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1) Descriptions of assumptions used
2) Changes in assumptions
3) Changes in circumstances
4) State source of prescribed assumptions
5) Deviation from standard

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ASOP 27

Methods of Developing an Investment Return Assumption Range

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1) Building-block method
2) Cash Flow Matching Method

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ASOP 27

Reflect the Following when Developing a Compensation Scale

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1) Current comp practice and anticipated changes in comp practice
2) Current comp distributions by age/service
3) Historical comp increases of sponsor, industry, and sponsors in same area
4) Historical wage and productivity increases

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ASOP 27

Additional factors to consider

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1) Compensation practice
2) Competitive factors
3) Collective bargaining
4) Compensation volatility
5) Expected plan termination

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ASOP 27

May use the following instead of a single rate for the compensation increase assumption

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1) Select and ultimate
2) Separate scales for different employee groups
3) Separate scales for different compensation elements (e.g. bonus vs salary)

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ASOP 27

Constructing the Compensation Scale Range

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- Generally use building block method
- Should not simply combine low and high endpoints

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What ares of ASOP 27 and the economic assumptions used by actuaries that have come under great scrutiny?

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1) Actuary's obligation with respect to prescribed assumptions
2) Concept of a "best-estimate range"
3) EROA and discount assumptions under scrutiny

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Advantages of ASOP 27

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1) Elevates the quality of generally accepted actuarial practice across the profession
2) Has eliminated the use of return assumptions that are inconceivable relative to related salary scales
3) They also provide flexibility for professional judgment

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Disadvantages of ASOP 27
(1 and 2 of 2)

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1) Approach is dangerous to the profession and disserves the public
2) Allows for aggressive or conservative selection even if selection is not the best-estimate
3) Entire range does not constitute a best estimate
4) Width of range is arbitrary
5) Range may also allow significant gains and losses to accumulate
6) Wide range could conflict with Code of Professional Conduct
7) Standard is less rigorous than many would consider appropriate
8) Standard fails to apply the lessons of economics
9) Distorts everything it measures
10) Prescribes discount rates that undervalue pension liabilities
11) Projection of salaries is also inappropriate

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Consequences of a flawed standard
(1 and 2 of 2)

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1) Becomes antiquated and presented as science when it is not
a) Provides other professionals the opportunity to take advantage
b) Puts actuaries at a disadvantage versus other financial experts
2) Fails to protect the interest of plan participants, taxpayers and clients
3) Comprise values to the desire of clients to the detriment of others
4) Arms critics of the actuarial profession
5) Inhibits necessary evolution
6) Leads to bad decisions about:
a) Investment
b) Plan design
c) Compensation and financing

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What is best practice position regarding prescribed accounting assumptions?

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- Should state an opinion about assumptions if believe they are unreasonable or misleading
- Should comment on unreasonableness of assumptions selected by a sponsor for FAS 87 if believe they are unreasonable

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Alternative ideas for ASOP 27

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1) Make ASOP 27 more flexible to incorporate financial economics
- To address concerns of allowing "anything at all", could
i) Make best-estimate range tighter
ii) Disclose concepts employed and basis for choosing assumptions
iii) Disclose actuary's opinion if feels prescribed assumption outside best-estimate rate
2) Rewrite ASOP 27 to require following the concepts of financial economics

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Strengthening the standard will bring about:

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1) Better assumption setting
2) Better financial reporting
a) Equity risk premium would be valued as zero
3) Less scandal-prone defined benefit pension system
4) Stronger actuarial profession

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What are the objectives of financial reporting

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1) Objective of financial reporting is to report value-relevant information to interested parties
2) Information about assets and liabilities that alter the price that a buyer would be willing to pay, or seller to accept, for a share of the firm

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When is it appropriate to reflect the equity risk premium?

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- As a calculation of convenience in the budgeting process

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When is it not appropriate to reflect the equity risk premium?

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1) When it is an item of interest for public policy
a) Increases likelihood employer promise not kept in the event of insolvency
b) Someone other than the plan sponsor may bear the risk in case of insolvency
c) When considering intergenerational equity
2) Liability discounting, financial reporting or statutory funding

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What is better approach to conservative funding than arbitrarily selecting a conservative assumption?

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- Should chose a conservative funding method instead of conservative assumptions

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What does ASOP 35 Address

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Selection of non-economic assumptions

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Each Individual Demographic Assumption

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Each individual assumption should satisfy this standard and be consistent with the other assumptions

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Types of Demographic Assumptions

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1) Retirement
2) Mortality
3) Termination
4) Disability and recovery
5) Election of optional benefits
6) Expenses
7) Marriage, divorce, and remarriage
8) Open group assumptions
9) Transfers
10) Hours
11) Assumptions for missing data

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Demographic Assumption Selection Process

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1) Identify types of assumptions
2) Consider the Relevant Assumption Universe
3) Consider the assumption format
4) Select the specific assumptions
5) Evaluate Reasonableness of the Selected Assumptions

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Consider the following when identifying assumptions

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1) Purpose and nature of the measurement
2) Plan provisions that will effect timing and value of benefit payments
3) Characteristics of the obligation measured
4) Contingencies that give rise to the benefits
5) Materiality of each assumption
6) Characteristics of the covered group

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Consider all sources of information for developing assumptions

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1) Experience studies or published tables
2) Plan sponsor experience
3) Studies of effects of plan design, events, economy, or demographic characteristics
4) Studies of general trends

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Should consider measurement-specific factors, which include

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1) Purpose of measurement (use more refined assumption if doing cash flow projection
2) Plan design features that may influence assumption (e.g. ERF subsidy)
3) Appropriate experience
4) Relevant factors that may affect future experience

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Specific Considerations when Selecting Demographic Assumptions
(1-3 of 3)

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a) Materiality
b) Cost Effectiveness
c) Combined effect of assumptions
Retirement Assumption
1) Plan design such as ERF subsidy
2) Commencement dates of social programs
3) Availability of other er-sponsored postretirement benefits
Termination Assumption
1) Occupation, location, work environment, unionization, hazard conditions
2) Plan provisions such as early retirement benefits, vesting, and payout options
Mortality Assumption
1) Possible use different mortality before and after retirement
2) Likelihood of mortality improvement
3) Different mortality for disabled lives
4) Different mortality for different subgroups
Disability and Recovery Assumption
1) Plan's definition of disability
2) Potential for recovery
Optional Form of Benefit Assumption
1) Benefit forms and commencement dates
2) Historical or expected utilization
3) Degree of subsidization

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Communications and Disclosures of Demographic Assumptions Should Include

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1) Assumptions used
2) Changes in assumptions
3) Changes in circumstances
4) Identify prescribed assumptions
5) Justification for deviation from the standard

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SOA Code of Conduct

Back 35

1) Professional integrity - Act honestly, with integrity and competence
2) Qualification standards - Perform services only while qualified to do so
3) Standards of Practice - An Actuary shall follow the standards of practice
4-6) Communications and Disclosure
- Actuarial communication must be clear, appropriate for its circumstances and audience, and satisfy the standards of practice
- Shall identify the principal(s) for whom the communication is issued and the capacity for actuary serves
- Shall disclose compensation received from another party for project if the requested project was completed for another party
7) Conflict of interest - Shall not knowingly be involved in an actual or potential conflict of interest, unless:
a) Can act fairly
b) The conflict is disclosed to all affected parties
c) All parties agree to the performance of services by the actuary
8) Control of work product - Must take reasonable steps to ensure actuarial services are not used to mislead others
9) Confidentiality - Must not disclose confidential information to others unless have permission or required by law
10) Courtesy and Cooperation
- Shall perform services with courtesy and cooperate with others in principal's interest
- Previous or current actuary should provide requested information to new or additional actuary
11) Advertising
- Must not advertise or solicit activities that the actuary knows are false and misleading
12) Titles and Designations
- Can use titles and designations if conforms with the practices authorized by organization
13-14) Violations of the Code of Professional Conduct
- Should try to discuss and resolve material violation by another actuary with other actuary
- If unsuccessful then should disclose to appropriate disciplinary body
- Shall respond promptly, truthfully, and fully to any request from the disciplinary body

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AAA Code of Professional Conduct

Back 36

- The SOA's Code of Professional Conduct is identical to the AAA's Code of Professional Conduct