How ASOP 51 Will Affect Future Actuarial Valuations Shelley Johnson, ASA, MAAA Consulting Actuary

How ASOP 51 Will Affect Future Actuarial Valuations What are ASOPs? Recent Changes to Current ASOPs New ASOP 51 Current Proposed ASOP Revisions Foster & Foster

I. What are ASOPs? ASOPs = Actuarial Standards of Practice Set by the Actuarial Standards Board (ASB) Describe procedures an actuary should follow when performing actuarial services Identifies what should be disclosed when communicating the results of those services Assures the public that actuaries are professionally accountable Provides a basis for evaluating an actuarial work product Currently 53 ASOPs in effect Typically of little interest to those outside of theprofession Foster & Foster

How are ASOPs developed? Set by vote of 6 out of 9 members of the Actuarial Standards Board ASB members represent a broad range of backgrounds and areas of practice ASB reviews and evaluates current and emerging practices, and solicits a wide range of ideas and perspectives, then develops a standard draft for exposure Proposed ASOP “Exposure Draft” is made public: Distributed to all members of the actuarial organizations governed by the ASOPs Distributed to other individuals who have expressed an interested in the ASOPs, such as state insurance commissioners. Posted on ASB website Comment period is usually a minimum of 60 days If more complex, then may have longer comment periods and/or public hearing May issue second exposure draft Foster & Foster

ASOPs that generally apply to all actuarial work: ASOP 1 – Introductory ASOP ASOP 17 – Expert Testimony by Actuaries ASOP 23 – Data Quality ASOP 25 – Credibility Procedures ASOP 41 – Actuarial Communications Foster & Foster

ASOPs specific to pensions: ASOP 4 – Measuring Pension Obligations and Determining Pension Plan Costs or Contributions ASOP 27 – Selection of Economic Assumptions for Measuring Pension Obligations ASOP 34 – Actuarial Practice Concerning Retirement Plan Benefits in Domestic Relations Actions ASOP 35 – Selection of Demographic and Other Noneconomic Assumptions for Measuring Pension Obligations ASOP 44 – Selection and Use of Asset Valuation Methods for Pension Valuations ASOP 51 – Assessment and Disclosure of Risk Associated with Measuring Pension Obligations and Determining Pension Plan Contributions Foster & Foster

II. Recent Changes to Current ASOPs Pension Committee has been reviewing all pension-related standards Long-standing language: ASOP 41 states “the actuary should consider what cautions regarding uncertainty or risk in any results should be included in the actuarial report.” Recent changes to ASOP 4: Requires disclosure that future pension measurements may differ significantly from the current measurement Requires actuaries to provide the potential range of future measurements if included in the assignment, or state that such an analysis was not performed due to the limited scope of the assignment Actuary “should consider the uncertainty or risk inherent in the measurement assumptions and methods and how the actuary’s measurement treats such uncertainty or risk.” Foster & Foster

III. New ASOP 51: Assessment and Disclosure of Risk Associated with Measuring Pension Obligations and Determining Pension Plan Contributions Developed as part of the larger review process to help plan sponsors better understand and manage risk Expands on current language regarding risk in other current ASOPs Provides guidance to actuaries in determining and communicating the risks that the actual cost of a pension plan may differ from expected cost Measuring pension obligations and calculating actuarially determined contributions require the use of assumptions regarding future economic and demographic experience. Users of such measurements may not understand the effects of these assumptions not matching actual future events. Foster & Foster

III. New ASOP 51 Effective for any actuarial work product with a measurement date on or after November 1, 2018. Applies to funding valuations, projections and pricing of proposed plan changes, and risk assessments unrelated to funding or pricing Defines risk as “potential of actual future measurements (such as pension obligations, actuarially determined contributions, and funded status) deviating from expected results due to actual experience that differs from the actuarial assumptions” 2 Key Requirements of ASOP 51: Assessment of Risk Disclosure of Plan Maturity Measurements Foster & Foster

1. Assessment of Risk The actuary should identify risks that may affect the plan’s future financial condition. Actuary should assess the identified risks. ASOP defines each risk pertaining to public pension plans as follows: Investment risk – the potential that investment returns ≠ expected returns Longevity and other demographic risks - the potential that plan demographics (mortality, disability, retirement, etc.) ≠ expected experience Contribution risk – potential of future contributions deviating from expected future contributions. Examples: Actual contributions are not made in accordance with plan’s funding policy Withdrawal liability assessments or other anticipated payments to the plan are not made Other material changes occur in the anticipated number of covered employees, covered payroll, or other relevant contribution base Foster & Foster

1. Assessment of Risk Actuary, in discussions with system, will decide which type of analysis is most valuable. Additional cost will likely result, particularly with quantitative assessments. In selecting the method to use, the actuary should use professional judgement and should consider: The degree to which the methods and models reflect the nature, scale, and complexity of the plan, and Practical considerations such as usefulness, reliability, timeliness, and cost efficiency. One size does not fit all! Foster & Foster

1. Assessment of Risk Quantitative Risk Assessments: Scenario testing – Assesses the impact of one possible event, or several simultaneous or sequentially occurring possible events Sensitivity testing – Assesses the impact of a change in an actuarial assumption on an actuarial measurement Stochastic modeling – Generating numerous potential outcomes by allowing for random variation in one or more inputs over time for the purpose of assessing the distribution of those outcomes Stress testing – A process for assessing the impact of adverse changes in one or relatively few factors affecting a plan’s financial condition. Comparison to minimal-risk investments – Comparison of an actuarial present value using a discount rate derived from minimal-risk investments to the actuarial present value using the funding valuation or pricing valuation discount rate. Foster & Foster

1. Assessment of Risk Quantitative Risk Assessments (continued): Deterministic modeling involves a specific set of assumptions. Scenario testing - Project future contribution requirements and/or funded ratio over a given period, such as 20 years, assuming investment returns are consistently higher or lower than expected. Examples: Attain expected return, plus/minus 0.5% annually Greater than expected improvement in life expectancy Disability experience doubles Compare to a baseline projection (assumes all current assumptions will be realized). Stochastic modeling is much more sophisticated, using random variables for specific inputs to develop a range of outcomes; more sophisticated = more costly. Foster & Foster

1. Assessment of Risk Quantitative Risk Assessments (continued): Should select “plausible” inputs, using actuary’s professional judgment. The purpose is not to feed gentle scenarios into the model to “prove” the System is “sustainable”. Likewise, the purpose is not to find an extreme set of scenarios to “prove” System is not sustainable. The purpose is to learn where potential stressors to the System are and to optimize policies and procedures (assumptions, funding procedures and methods, and perhaps even benefits) to improve sustainability and educate stakeholders of those potential risks. The focus is not on the outcomes, but on the decisions that should be considered based on the outcomes of the test. Foster & Foster

1. Assessment of Risk Qualitative Risk Assessment (Non-numerical): Has plan sponsor made the actuarially required contribution over the last 10 years? Is funded ratio higher than it was 10 years ago? Based on current assumptions/methods, is UAL expected to be lower in 10 years? Does amortization method result in negative amortization (payment < interest due), open amortization, back-loaded schedules? Likelihood of meeting/exceeding the expected return assumption Annual percentage change in active population in the last 10 years Any liabilities contingent on future experience? Are these accounted for in the assumptions and/or liabilities? Current and historical active to retiree ratios Foster & Foster

1. Assessment of Risk Additional Assessment of Risk When considering whether to recommend a more detailed study, the actuary should consider certain factors, including but not limited to: Findings of the actuary’s risk assessment Size of plan, and size of plan relative to the size of the plan sponsor Maturity of the plan Funded status of the plan Plan’s asset allocation Characteristics of the contribution allocation procedure (e.g. significantly backloaded) Extent known by actuary that future recommended contributions may not be made Length of time since last assessment Significant changes since last assessment Foster & Foster

2. Disclosure of Plan Maturity Measures The actuary should calculate and disclose current plan maturity measures that, in the actuary’s professional judgment, are significant to understanding the risks associated with the plan, such as: Ratio of market value of assets to payroll Ratio of cash flow measure to market value of assets Ratio of benefit payments to contributions Ratio of retired liability to total liability Duration of the actuarial accrued liability Actuary should include discussion of the significance of these measures Foster & Foster

2. Disclosure of Plan Maturity Measures Historical information (such as 10 year history) Plan maturity measures listed on previous slide Funding Ratios Actuarially determined contributions Gains/Losses Historical Normal Cost Participant Count Covered Payroll Plan Settlement Liability (if applicable) Foster & Foster

IV. Current Proposed ASOP Revisions ASB recently issued exposure drafts with potential changes to 3 other ASOPs applicable to public pensions: ASOP 4 – Measuring Pension Obligations and Determining Pension Plan Costs or Contributions ASOP 27 – Selection of Economic Assumptions for Measuring Pension Obligations ASOP 35 – Selection of Demographic and Other Noneconomic Assumptions for Measuring Pension Obligations Comments were due July 31, 2018 Response was “particularly robust”, with over 100 comments in total Foster & Foster

IV. Current Proposed ASOP Revisions The most significant change is the requirement for actuaries to include “Investment Risk Defeasance Measure” (IRDM) in funding valuations, with obligation measure determined using: Benefits accrued as of the measurement date Unit credit cost method Discount rate to reflect either U.S. Treasury yields or the rates at which pension obligations may effectively be effectively settled Received many more comments in opposition than in support. Foster & Foster

IV. Current Proposed ASOP Revisions ASOP 4 (continued) Comments in support: The use of U.S. Treasury yields would provide a measure to help evaluate the level of investment risk being taken by a pension plan. Society of Actuaries: The Investment Risk Defeasement Measure provides important information to assess the degree of risk in a plan’s funding and investment policy that, when accompanied by an actuarial report that provides context for its meaning, improves pension plan sustainability. Foster & Foster

IV. Current Proposed ASOP Revisions ASOP 4 (continued) Comments in opposition received from: Steering Committee of the Public Plans Committee of the Conference of Consulting Actuaries Numerous actuaries/consulting firms with substantial public pension experience Comments in opposition: Market-based alternative liability measurements: Are not decision-useful to public-sector stakeholders and policymakers Not directly related to developing and implementing funding policy. Will likely be misused politically to argue in favor of abandoning the defined benefit (DB) plan. IRDM “seriously flawed” because “it only attempts to assess the cost of avoiding the investment risk”, and “may undermine the importance of the measures described in ASOP 51”. Foster & Foster

IV. Current Proposed ASOP Revisions ASOP 4 (continued) Comments in opposition (continued): National Public Pension Coalition: We have “grave concerns that the process being used to formulate these proposed changes is a political one and that the outcome…would be to provide a political weapon to opponents of public pension plans. The proposed requirement .. is both unnecessary and potentially harmful.” And “ … the only purpose for calculating an IRDM for public plans is to give political fodder to opponents of public pensions who seek to scare politicians into eliminating public pensions for future generations of teachers, firefighters, police officers, sanitation workers, and other public employees.” Foster & Foster

IV. Current Proposed ASOP Revisions ASOPs 27 and 35: Proposed language would add the following: When/If phasing in assumptions over multiple measurement dates, the actuary should select an assumption that is reasonable at each measurement date. Actuary should determine whether assumptions continue to be reasonable at each measurement date. For each economic and demographic assumption that has a significant effect on the measurement, the actuary should disclose the information and analysis used to support the actuary’s determination that the assumption is reasonable. Actuaries should consider the use of recently published mortality tables. Foster & Foster

Questions? Foster & Foster