An actuarial valuation is a type of appraisal of a pension fund's assets versus liabilities, using investment, economic and demographic assumptions for the model to determine the funded status of a pension plan. The assumptions are based on a mix of statistical studies and experienced judgment. Since assumptions are often derived from long-term data, unusual short-term conditions or unanticipated trends can occasionally cause deviations from forecasts. The calculations themselves are (not surprisingly) quite complex and require very sophisticated actuarial software to calculate. One example of this software is GGY AXIS.
- Many variables go into an actuarial valuation model. On the asset side, the actuary must make an assumption about employer contribution rates and the investment growth rate for the portfolio of stocks and bonds (Level 1 and 2-type assets) and other assets (illiquid Level 3-type).
- The calculation of payment liabilities is much more complex. The actuary must make assumptions regarding, but not limited to, the discount rate, employee contribution rates, wage growth rates, inflation rates, mortality rates, service retirement ages, disabled retirement ages and interest on member accounts.
- If all the long-term assumptions are reasonable, then a realistic funding (or funded) ratio can be derived. The funding ratio equals assets over liabilities, with a ratio of over 1.00, or 100%, indicating that pension assets are sufficient to cover liabilities.
Actuarial valuations are conducted in both the private and public sectors. U.S. Steel disclosed in its 2016 annual filing that its funding ratio as of December 31, 2016, was 0.88, or 88% (plan assets of $5.48 billion divided by obligations of $6.21 billion). The company did not have enough plan assets to meet those obligations.
PROCES The valuation techniques are a little different depending on what country you live in and what kind of insurance you're dealing with. In Canada we use a principles-based valuation method called CALM (the Canadian Asset Liability Method) for life insurance. In the U.S. a formula-based reserving method is used (they are moving towards principles-based though).
The primary difference between them is that principles-based valuation allows for more flexibility and actuarial judgment when determining appropriate assumptions to use. Each insurance company will have its own set of assumptions. The formula-based reserving method has standardized assumptions that most insurance companies will use. Furthermore, the assumptions cannot change over time to reflect changes in the economy like they can for principles-based reserves.