Estimating Pension Costs and Measuring Assets
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Actuarial cost methods help actuaries estimate pension costs and inform how those costs will be funded. The
Pension Funding PDF will help you learn more at your own speed.
An actuarial (or smoothed) value of assets is often used to limit volatility in contribution rates and funded ratio measures. The
Asset Smoothing PDF will help you learn more at your own speed.
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No one can predict the future with absolute certainty, so all of our actuarial measurements rely on assumptions to estimate future events. Given the long-term nature of benefits like pensions, the goal of actuarial assumptions is to estimate future experience over a long-term horizon, sometimes 50 years. Ultimately, the actual costs for benefits will depend on actual experience, but the assumptions we use set the stage and help estimate what those costs will be.
- Why are assumptions important?
- As mentioned above, actual costs for benefits will depend on actual experience, and a reasonable set of assumptions will provide a good framework in helping to understand how much and when benefits will be paid. From there, decisions are made regarding how to pay for these benefits. For the primary state retirement systems, contribution rates are typically adopted every two years as the rates adjust to actual experience that is different than assumed or to reflect a change in assumptions.
- What kind of assumptions are there?
- At a high level, assumptions are divided between economic and demographic assumptions. Economic assumptions typically predict estimate the amount of future benefits while demographic assumptions typically estimate the timing of future benefits.
Key economic assumptions for pension benefits include the discount rate for measuring present values, which is often based on the investment rate of return, and future salary growth. For more information, please see our
Economic Experience Study.
Key demographic assumptions for pension benefits include turnover, which estimates how long employees are expected to work for WA state; retirement, which estimates when they are expected to start collecting their benefit; and mortality, which estimates how long they are expected to live. For more information, please see our
Demographic Experience Study.
- How does OSA set an assumption?
- When performing an actuarial experience study, which is a formal review of assumptions, we rely on historical experience and professional judgment about the future to see if our current assumptions are reasonable. Where appropriate, we collect information from experts, including other state agencies. We must comply with Actuarial Standards of Practice (ASOP) when setting assumptions, which provide professional guidance when preparing actuarial information, including selecting economic (ASOP 27) and demographic (ASOP 35) assumptions.
- How often does OSA review assumptions?
- While OSA reviews all assumptions for reasonableness with each work product, statutes require OSA to perform actuarial experience studies on a regular basis.
RCW 41.45.030 requires a review of long-term economic experience every two years and
RCW 41.45.090 requires a review of demographic assumptions at least once in each six-year period.
How Do Key Measures Change If Experience is Different Than Assumed? Back to Top |
Risk assessments demonstrate and assess the effect of unexpected experience on our pension plans. They recognize volatility in actual experience and give insight into the likelihood of possible future outcomes.
Report on Financial Condition includes sections that highlight not only where the Retirement Systems are headed, but how the future can look different.
Actuarial Fiscal Notes
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The Office of the State Actuary provides actuarial fiscal notes on certain pension bills introduced in the Legislature and amendments that are offered. OSA may also provide an actuarial fiscal note for any bill that changes retirement behavior or impacts assumptions used in pricing pension benefits.
Actuarial fiscal notes are
statutorily required to include:
- The statutorily required contribution for the biennium and the following twenty-five years;
- The biennial cost of the increased benefits if these exceed the required contribution; and
- Any change in the present value of the unfunded accrued benefits.
Fiscal Notes and bill information can be found on the
Legislature's public website. OFM-approved fiscal notes may be accessed through the legislative site or directly from the
OFM website. For more information on our actuarial fiscal notes please see our
Fiscal Notes page.
What are Actuarial Equivalence and Admin Factors? Back to Top |
Actuarial equivalence means two sets of future cash payments have the same current value based on specific assumptions. These assumptions typically include life expectancy and thus the term ‘actuarial’ is used.
Actuarial equivalence is often applied in administrative factors where members can elect optional forms for their pension payments and those options are intended not to create additional costs to the plan. If actual experience is consistent with the assumptions used to determine actuarial equivalence, then the values will be equal. Since experience won’t be known in full until many years in the future, the actuarial equivalence is established based on the assumptions in place at the time the member choice was made. This approach is often referred to as “no expected cost”.
Administrative factors are used by the plan administrator to adjust pension payments for optional forms allowed under the plan. If the optional forms are designed to be identical in terms of their present value, then actuarially equivalent factors will be applied.
Example: At the time of a member’s retirement, they are eligible for a pension benefit paid for the remainder of their life. An optional payment form available under the plan is a Joint & Survivor benefit that will pay the pension benefit for the member’s lifetime and the same amount (or less if selected) to the surviving spouse. In this case, the optional payment form is expected to be more valuable since it will pay out benefits on the life expectancy of two people instead of one. In order to create no expected cost to the plan for this optional payment form, an actuarial equivalent administrative factor is used to reduce the original benefit amount.
Administrative factors are based on actuarial equivalence. The
Administrative Factors PDF will help you learn more at your own speed. More information about Washington administrative factors can be found on the
DRS Website Admin Factors Page.