Coping With the Changes to ASOP 35
As we ring in the new year, we also enter that time of year when we focus on providing actuarial services to clients with calendar plan/fiscal years. In preparing for these calendar year clients, the actuary needs to be aware of the revised principles that are now imposed by the Actuarial Standard of Practice (ASOP) No. 35, Selection of Demographic and Other Noneconomic Assumptions for Measuring Pension Obligations. ASOP 35 impacts the selection of demographic assumptions such as retirement, termination of employment, mortality and mortality improvement, disability and disability recovery and the election of optional forms of benefits.
To provide some history, in September of 2013, the Actuarial Standards Board (ASB) issued an exposure draft of ASOP No. 35. Following comments on this exposure draft, the ASB issued the final revision of ASOP 35 during their September 2014 meeting.
The final revision to ASOP 35 is effective for any actuarial work product with a measurement date on or after June 30, 2015, which means that 2015 is the first calendar year cycle subject to the revised ASOP 35 principles.
The most significant revisions to ASOP 35 address the following:
- The guidelines for a reasonable assumption are now consistent with the guidelines contained in ASOP 27, Selection of Economic Assumptions for Measuring Pension Obligations.
- The requirement to disclose the rationale for the demographic assumption selection.
Consistency with ASOP 27
Section 3.3.5 of ASOP 35 which addresses the selection of a reasonable assumption is now consistent with ASOP 27. Under this section, an assumption is reasonable if it has the following characteristics:
- It is appropriate for the purpose of the measurement.
- It reflects the actuary’s professional judgment.
- It takes into account historical and current demographic data that is relevant as of the measurement date.
- It reflects the actuary’s estimate of future experience, the actuary’s observation of the estimates inherent in market data (if any), or a combination thereof.
- It has no significant bias (i.e., it is not significantly optimistic or pessimistic), except when provisions for adverse deviation or plan provisions that are difficult to measure are included or when alternative assumptions are used for the assessment of risk.
In selecting assumptions, the actuary needs to ensure that the combined effect of all nonprescribed assumptions selected by the actuary (both demographic and economic assumptions) are reasonable.
Disclosing Rationale for Assumption Selection
In an effort to create greater transparency, the ASB has imposed more robust communication standards with respect to the selection of demographic actuarial assumptions. Section 4.12 of ASOP 35 details the new requirements for disclosing the rationale used in demographic assumption selection:
“The actuary should disclose the information and analysis used in selecting each demographic assumption that has a significant effect on the measurement. The disclosure may be brief but should be pertinent to the plan’s circumstances. For example, the actuary may disclose any specific approaches used, sources of external advice, and how past experience and future expectations were considered. The disclosure may reference any actuarial experience report or study performed, including the date of the report or study. This section is not applicable to prescribed assumptions or methods set by another party or prescribed assumptions or methods set by law.”
Furthermore, the actuary should include an assumption as to expected mortality improvement after the measurement date. This assumption should be disclosed even if the actuary concludes that an assumption of zero future improvement is reasonable.
The new disclosure requirements imposed by ASOP 35 are only imposed on assumptions that have a significant impact on the measurement. An assumption would have a significant impact on a measurement if its omission or misstatement could influence a decision of the intended user. If there is doubt as to the significance of an assumption, it would be prudent to treat it as significant in order to avoid any questions regarding transparency.
Although the ASOP has always required the disclosure of the rationale for assumption changes, the actuary should refer to Section 4.13 of the ASOP regarding the communication of any changes in assumptions. In communicating an assumption changes:
- The actuary should disclose any changes in the significant demographic assumptions from those previously used for the same type of measurement. The general effects of the changes should be disclosed in words or by numerical data, as appropriate.
- If the assumption is neither a prescribed assumption, method set by another party or method set by law, the actuary should include an explanation of the information and analysis that led to the change.
- The disclosure may be brief but should be pertinent to the plan’s circumstances and may reference any actuarial experience report or study performed.
The normal retirement age for the XYZ Pension Plan is age 65. The plan also provides for early retirement after attainment of age 62 with 20 years of service. The early retirement benefit is the accrued benefit reduced 2% for each year the early retirement age precedes the normal retirement age. Furthermore, the employer provides post-retirement medical benefits from the time that a participant reaches early retirement age until they become eligible for Medicare.
The actuary assumes that the following retirement probabilities:
Age 62 30%
Age 63 20%
Age 64 10%
Age 65 100%
How does the actuary disclose the rationale for this assumption as required by Section 4.12 of ASOP 35?
If the plan is large and the retirement rate assumption is based on a recent experience study, the actuary should disclose the date of the experience study and the fact that the assumption is based on the results of the experience study. Absent an experience study, the actuary could state that professional judgment was used to set the retirement probability assumption. The judgment should be based on the plan design, availability of income from social programs such as Social Security as well as other post-retirement benefits that are available to the retiree.
The actuary may also disclose the sources of any external advice and how past and future experience were considered.
A sample rationale for this assumption for a small plan could be as follows:
“Professional judgement was used to develop the retirement probabilities. It is anticipated that the highest rate of retirement will occur at the point that the early retirement benefit has the greatest actuarial value and medical benefits are available to the retiree. It is anticipated that the retirement rates will decline until full normal retirement benefits are provided by the plan.”
Sharing the Challenge
As we move forward to comply with the revised ASOP 35 principles, the leadership of ACOPA encourages members to share the rationales used for assumption selection through the ACOPA listserv. Sharing the challenges of meeting the revised ASOP 35 principles as we work on plans of varying size, plan design and type of plan sponsors would be a benefit to all ACOPA members.
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