Actuarial Standard of Practice No. 44

Selection and Use of Asset Valuation Methods for Pension Valuations

STANDARD OF PRACTICE

TRANSMITTAL MEMORANDUM

September 2009

TO: Members of Actuarial Organizations Governed by the Standards of Practice of the Actuarial Standards Board and Other Persons Interested in the Selection and Use of Asset Valuation Methods for Pension Valuations

FROM: Actuarial Standards Board (ASB)

SUBJ: Actuarial Standard of Practice (ASOP) No. 44

This document contains the clarified version of ASOP No. 44, Selection and Use of Asset Valuation Methods for Pension Valuations.

Background

ASOP No. 44 was issued as a new standard in September 2007, with an effective date of March 15, 2008. The ASB recently became aware of a need for clarification of the wording in section 3.4.1, Bias. The intent of the section is to require disclosure of the existence of systematic bias in the asset valuation method only when such bias is, in the actuary’s professional judgment, significant. While the first sentence of section 3.4.1 accurately communicates this intent, the second sentence does not, creating some confusion among practitioners. Accordingly, the ASB has clarified the standard by adding the word “significantly” before the word “skewed” in the second sentence of section 3.4.1.

The ASB voted to adopt this clarification on September 21, 2009 effective immediately for reports issued after that date

 

Actuarial Standards Board

Stephen G. Kellison, Chairperson

                      Albert J. Beer                                                      Robert G. Meilander

                      Alan D. Ford                                                       James J. Murphy

                      Patrick J. Grannan                                              Godfrey Perrott

                      Thomas D. Levy                                                  James F. Verlautz

 

 

Section 1. Purpose, Scope, Cross References, and Effective Date

1.1 Purpose

This actuarial standard of practice (ASOP) provides guidance to the actuary when performing professional services with respect to the following:

a. selection of an asset valuation method for purposes of a defined benefit pension plan actuarial valuation ; and

b. appropriate disclosures regarding the asset valuation method used.

1.2 Scope

This standard applies to the actuary when performing professional services with respect to selecting or using an asset valuation method for any defined benefit pension plan that is not a social insurance program as described in section 1.2, Scope, of ASOP No. 32, Social Insurance (unless an ASOP on social insurance explicitly calls for application of this standard). Throughout this standard, any reference to selecting an asset valuation method also includes giving advice on selecting an asset valuation method. For instance, the actuary may advise the plan sponsor on selecting an asset valuation method, where the plan sponsor is responsible for selecting the method.

To the extent that the guidance in this standard may conflict with ASOP No. 4, Measuring Pension Obligations and Determining Pension Plan Costs or Contributions, ASOP No. 4 will govern.

If the actuary departs from the guidance set forth in this standard in order to comply with applicable law (statutes, regulations, and other legally binding authority), or for any other reason the actuary deems appropriate, the actuary should refer to section 4.

1.3 Cross References

When this standard refers to the provisions of other documents, the reference includes the referenced documents as they may be amended or restated in the future, and any successor to them, by whatever name called. If any amended or restated document differs materially from the originally referenced document, the actuary should consider the guidance in this standard to the extent it is applicable and appropriate.

1.4 Effective Date

This standard will be effective for any actuarial valuation with a measurement date on or after March 15, 2008.

Section 2. Definitions

The terms below are defined for use in this actuarial standard of practice.

2.1 Actuarial Valuation

The measurement of relevant pension obligations and, when applicable, the determination of the actuarial value of assets, periodic costs, or contributions.

2.2 Actuarial Value of Assets

The value of pension plan investments and other property, used by the actuary for the purpose of an actuarial valuation (sometimes referred to as valuation assets or market-related value of assets).

2.3 Asset Valuation Method

A method used by the actuary to determine the actuarial value of assets.

2.4 Market Value

The price that would be received to sell an asset in an orderly transaction between market participants at the measurement date (sometimes referred to as fair value).

2.5 Measurement Date

The date as of which the actuarial value of assets is determined (sometimes referred to as the valuation date).

2.6 Prescribed Asset Valuation Method

A specific asset valuation method that is mandated by law, regulation, or other binding authority. For purposes of this standard, the plan sponsor would be considered a binding authority to the extent that law, regulation, or accounting standards give the plan sponsor responsibility for selecting such an asset valuation method.

2.7 Principal

A client or employer of the actuary.

Section 3. Analysis of Issues and Recommended Practices

3.1 Overview

The measurement of a pension plan’s assets and the relationship between the plan’s assets and its obligations are integral to the valuation process. The asset valuation method potentially affects the timing and amount of future plan costs or contributions and the plan’s ability to satisfy its benefit obligations. Consequently, the actuary should use professional judgment when selecting an asset valuation method.

3.2 Considerations in Selecting a Method

The actuary should consider the following factors when selecting an asset valuation method:

3.2.1 Purpose and Nature of the Measurement

The actuary should consider the purpose and nature of the measurement when selecting an asset valuation method. It may be appropriate for the actuary to select different methods for different purposes. For example, for purposes of determining contributions to an ongoing plan, the actuary may consider selecting an asset valuation method that smooths the effects of volatility in market value on the pattern of contributions. As a second example, for measurements in conjunction with a plan termination, the actuary should consider selecting an asset valuation method that produces an actuarial value of assets that represents the value of assets expected to be available for distribution (i.e., net of any significant liquidation or surrender charges reasonably expected to be incurred).

3.2.2 Objectives of the Principal

The actuary should consider the objectives of the principal to the extent such objectives have been communicated to the actuary, are relevant to, and not inconsistent with, the purpose of the measurement, and are consistent with the actuary’s responsibilities under the Code of Professional Conduct. For example, when the principal is a plan sponsor and the purpose of the measurement is to determine annual contributions, the actuary should consider plan sponsor objectives such as a desire for stable or predictable costs or contributions, or a desire to achieve a target funding level within a specified time frame.

3.2.3 Multiple Asset Valuation Methods

The actuary may select different asset valuation methods for different classes of assets. For example, the actuary may determine that it is appropriate to use a smoothing method for equity investments and market value for fixed income investments.

3.2.4 Adjustment of Asset Values for Timing Differences

Sometimes asset values as of the measurement date are not available. In these situations, the actuary should select an asset valuation method that adjusts the value of the assets for the time between the date as of which asset values are available and the measurement date. Such an asset valuation method may reference appropriate published asset indices or involve an adjustment using another reasonable method.

3.2.5 Use of Actuarial Assumptions

To the extent that actuarial assumptions are used as part of an asset valuation method, the actuary should be guided by ASOP No. 27, Selection of Economic Assumptions for Measuring Pension Obligations, and No. 35, Selection of Demographic and Other Noneconomic Assumptions for Measuring Pension Obligations, in selecting those assumptions. Furthermore, the assumptions should be consistent with the other assumptions used in the actuarial valuation.

It may be appropriate for the actuary to select different assumptions for different purposes. For example, the actuary may project asset values for a few months using an assumption that differs from a long-term expected return assumption.

3.2.6 Additional Considerations

When selecting an asset valuation method, the actuary should consider other known, relevant factors such as the following:

a. the plan’s investment policy and actual investment practices;

b. the characteristics of the asset classes in which the plan is invested (for example, the volatility of the return of each asset class and the correlation of the return with changes in the value of plan obligations);

c. the plan’s expected future cash flows and liquidity needs;

d. the period of time over which the plan’s assets are expected to be held; and

e. the characteristics of the method used to measure the pension obligation (for example, whether the pension obligation is measured on a mark-to-market basis).

3.3 Selecting Methods Other Than Market Value

If the considerations in section 3.2 have led the actuary to conclude that an asset valuation method other than market value may be appropriate, the actuary should select an asset valuation method that is designed to produce actuarial values of assets that bear a reasonable relationship to the corresponding market values. The qualities of such an asset valuation method include the following:

a. The asset valuation method is likely to produce actuarial values of assets that are sometimes greater than and sometimes less than the corresponding market values.

b. The asset valuation method is likely to produce actuarial values of assets that, in the actuary’s professional judgment, satisfy both of the following:

1. The asset values fall within a reasonable range around the corresponding market values. For example, there might be a corridor centered at market value, outside of which the actuarial value of assets may not fall, in order to assure that the difference from market value is not greater than the actuary deems reasonable.

2. Any differences between the actuarial value of assets and the market value are recognized within a reasonable period of time. For example, the actuary might use a method where the actuarial value of assets converges toward market value at a pace that the actuary deems reasonable, if the investment return assumption is realized in future periods.

In lieu of satisfying both (1) and (2) above, an asset valuation method could satisfy section 3.3(b) if, in the actuary’s professional judgment, the asset valuation method either (i) produces values within a sufficiently narrow range around market value or (ii) recognizes differences from market value in a sufficiently short period.

A plan’s investment policy may provide that fixed-income securities are expected to be held to maturity and holding such securities to maturity is not inconsistent with the plan’s investment practice and expected cash flow needs. In such situations, an asset valuation method that uses amortized cost for such securities is deemed to bear a reasonable relationship to market value relative to those assets.

3.4 Using Methods Other Than Market Value

When using an asset valuation method other than market value, regardless of who selected the method, the actuary should consider the following:

3.4.1 Bias

If the asset valuation method has significant systematic bias, the actuary should disclose such bias in accordance with section 4.1. An asset valuation method has significant systematic bias if, in the actuary’s professional judgment, the method’s design is expected to produce a distribution of actuarial values that is significantly skewed toward understatement or overstatement relative to the corresponding market values.

The following paragraphs are intended to clarify the meaning of bias for purposes of this standard.

a. An asset valuation method does not have significant systematic bias solely because it has one or both of the following characteristics:

1. the asset valuation method would produce actuarial values of assets that are consistently less than (or greater than) the corresponding market values during sustained periods of increasing (or decreasing) market values; or

2. the asset valuation method would produce actuarial values of assets that approach the corresponding market values asymptotically, assuming the investment return assumption is realized in future periods.

b. Examples of asset valuation methods that have significant systematic bias include the following:

1. an asset valuation method that is designed to produce a value consistently below market value if, in all time periods relevant to the application of the asset valuation method, the actual return on market value of the assets subject to the asset valuation method were equal to the actuary’s expected return on those assets (such as a method that immediately recognizes interest and dividends but defers recognition of realized and unrealized capital gains and losses); and

2. an asset valuation method that produces an actuarial value of assets equal to a smoothed value that is subject to an asymmetrical corridor around market value, such as not more than 105% of market value or less than 80% of market value.

3.4.2 Different Treatment of Realized and Unrealized Gains and Losses

If the asset valuation method treats realized gains and losses differently from unrealized gains and losses, the actuary should disclose this difference in accordance with section 4.1. An asset valuation method treats realized gains and losses differently from unrealized gains and losses if it would produce different results depending upon whether an asset is sold or held. When such a method is used, an increase in asset turnover, as might happen if the plan changes investment managers, can cause a significant change in the actuarial value of assets.

Examples of asset valuation methods that treat realized gains and losses differently from unrealized gains and losses include the following:

a. an asset valuation method that uses the average of book value and market value;

b. an asset valuation method that immediately recognizes realized gains and losses and gradually recognizes unrealized gains and losses; and

c. an asset valuation method that uses the product of the book value of assets on the measurement date multiplied by a five-year average of the ratio of market value to book value.

3.5 Assets that are Difficult to Value

Some assets do not have a readily established market value, such as certain insurance contracts, real estate, or other property. In determining the value of such assets, if audited financial statements do not provide an appropriate market value, the actuary may consider appraisals by qualified independent experts, recent sales of similar assets, the present value of reasonably expected future cash flows, or other appropriate methods. The value, so determined, may be treated as market value for purposes of this standard.

3.6 Reviewing the Asset Valuation Method

Once an asset valuation method has been selected for a particular purpose, at each subsequent measurement date, the actuary should consider whether the selected asset valuation method continues to be appropriate for that purpose. The actuary is not required to do a complete reassessment at each measurement date. However, if a significant change in the principal’s objectives has been communicated to the actuary (see section 3.2.2), the actuary should review the appropriateness of the asset valuation method. Furthermore, if the asset valuation method is other than market value, the actuary should review the appropriateness of the asset valuation method if an event such as the following has occurred:

a. a significant change in the plan provisions affecting cash flow (such as adding a lump sum payment option, or freezing or terminating the plan), in the actuarial cost method or funding policy, or in participant demographics;

b. a significant change in the plan’s investment policy (such as adding a new asset class or significantly changing the proportion of assets invested in each class);

c. a prolonged significant deviation from market value; or

d. changes in relevant law, regulations, or accounting guidance.

3.7 Level of Refinement

The actuary should exercise professional judgment in establishing an appropriate balance between refined methodology and materiality. The actuary is not required to use a particular type of valuation method or to select a highly refined method when it is not expected to produce materially different results than would a less refined method. For example, it may be reasonable to assume that benefit payments are evenly distributed throughout the year, rather than reflecting the actual timing of each payment.

3.8 Reliance on Data or Other Information Supplied by Others

When relying on data or other information supplied by others, the actuary should refer to ASOP No. 23, Data Quality, for guidance.

3.9 Documentation

The actuary should prepare and retain documentation in compliance with the requirements of ASOP No. 41, Actuarial Communications. The actuary should also prepare and retain documentation to demonstrate compliance with the disclosure requirements of section 4.1.

Section 4. Communications and Disclosures

4.1 Disclosures in Actuarial Reports

When issuing an actuarial report, as defined in ASOP No. 41, the actuary should follow the applicable disclosure requirements in ASOP No. 4, Measuring Pension Obligations and Determining Plan Costs or Contributions, and ASOP No. 23. In addition, the actuary should disclose the following:

4.1.1 Asset Valuation Method

The actuary should describe each asset valuation method used in the measurement in sufficient detail to permit another actuary qualified in the same practice area to reproduce the calculation if the actuary were provided with the necessary asset data.

4.1.2 Market Value and Actuarial Value of Assets

The actuary should disclose the market value and actuarial value of assets. If multiple asset valuation methods are used, in accordance with section 3.2.3, the actuary should disclose the market value and actuarial value of the assets subject to each asset valuation method. With respect to assets whose market value is determined under section 3.5, disclosure shall include the amount of such assets and a description of how the value of such assets was determined.

4.1.3 Changes in Asset Valuation Method

The actuary should describe changes, if any, in the asset valuation method from the method previously used for the same measurement purpose and the reasons for those changes. The actuary should disclose the general effects of any such changes in words or by numerical data, as appropriate.

4.1.4 Bias

If, in the actuary’s professional judgment, the asset valuation method has significant systematic bias toward understatement or overstatement relative to market value, as described in section 3.4.1, the actuary should disclose the direction of the bias. For example, if the asset valuation method used to determine the plan’s contribution requirements is one of the methods described in section 3.4.1(b), the disclosure might state the following:  “A characteristic of this asset valuation method is that, over time, it is more likely to produce an actuarial value of assets that is less than the market value of assets.”

4.1.5 Different Treatment of Realized and Unrealized Gains and Losses

If the asset valuation method treats realized gains and losses differently from unrealized gains and losses, the actuary should disclose this characteristic and the possible consequences of the use of such an asset valuation method. For example, the disclosure might state the following: “This asset valuation method treats unrealized gains and losses differently from realized gains and losses. Thus, asset turnover can cause a significant change in the actuarial value of assets.”

4.1.6 Additional Disclosures

The actuary should include the following, as applicable, in an actuarial report:

a. the disclosure in ASOP No. 41, section 4.2, if any material assumption or method was prescribed by applicable law (statutes, regulations, and other legally binding authority); however, if the assumption or method was passed, adopted, or promulgated by the plan sponsor (or by the same governing body that establishes plan benefits or provides for plan funding) then this guidance does not apply and the actuary should follow guidance of paragraph b. below instead:

b. the disclosure in ASOP No. 41, section 4.3, if the actuary states reliance on other sources and thereby disclaims responsibility for any material assumption or method selected by a party other than the actuary; and

c. the disclosure in ASOP No. 41, section 4.4, if, in the actuary’s professional judgment, the actuary has otherwise deviated materially from the guidance of this ASOP.

4.2 Disclosures in Other Actuarial Communications

The actuary should be guided by ASOP No. 41 when considering which of the disclosures in section 4.1 should be included in an actuarial communication that is not in the form of an actuarial report.

Appendix 1 – Background and Current Practices

Note:  This appendix is provided for informational purposes, but is not part of the standard of practice.

Background

Historically, actuaries have selected various methods to determine the actuarial value of pension plan assets for different measurement purposes.

Current Practices

Actuaries use both market value and asset valuation methods other than market value. The latter asset valuation methods are usually used for smoothing the effects of volatility in market value on plan costs or contributions, or achieving consistency between the valuation of assets and obligations.

An asset valuation method that is intended to smooth the effects of market volatility typically reflects the market value of plan assets in some fashion. This is accomplished through a variety of commonly used techniques, such as the following:

a. smoothing some components of the return on market value or the difference between actual returns on market value and expected returns;

b. requiring that the actuarial value of assets fall within a specified range, such as 80% to 120%, of the market value; or

c. recognizing differences between the actuarial and market values of assets over a specified time schedule.

Actuaries often select different asset valuation methods for different purposes, such as for determining cash contribution requirements, determining employer accounting costs, or assessing the plan’s funded status upon plan termination.

Asset valuation methods have been the subject of growing attention, influenced by regulatory trends and consideration of the concepts of financial economics. Actuaries who apply a financial economics approach generally advocate the use of market measurement of assets, while traditional actuarial practice includes both the use of market value and the use of a variety of asset valuation methods other than market value.

Appendix 2 – Comments on the Fourth Exposure Draft and Responses

The fourth exposure draft of this proposed ASOP was issued in August 2006 with a comment deadline of March 1, 2007. Five comment letters were received, some of which were submitted on behalf of multiple commentators, such as by firms or committees. For purposes of this Appendix, the term “commentator” may refer to more than one person associated with a particular comment letter. The Pension Committee carefully considered all comments received, and the ASB reviewed (and modified, where appropriate) the proposed changes.

Click here to view Appendix 2 in its entirety.