Actuarial Methods in the EU Groupe Consultatif

Paul Thornton David Collinson Michael Lucas

Format of the Groupe Consultatif report

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Commentary and overview of retirement benefits and funding vehicles, actuarial methods and assumptions Country by country description Definition of actuarial methods

Pension plan financing

Direct Pension Promise (internal financing)
Sponsor Company

External Sponsored Institution

Insurance

Sponsor Company

Plan Members Contributions

Sponsor Company

Plan Members Contributions

Benefits

Benefit providing institution Beneficiaries Benefits Beneficiaries Examples

Benefit providing institution Benefits Beneficiaries

Germany Sweden Austria

United Kingdom Netherlands Ireland

Belgium Netherlands Spain

Typical actuarial calculations

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Calculation of past service funding position Calculation of cost and contributions Analysis of demographic and economic experience Calculation of early retirement factors Calculation of commutation factors Asset/Liability modelling

The focus for today's session

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The calculation of the past service funding position.influenced by

Regulation/supervision Tax Accounting Funding vehicle eg life assurance or pension fund

The past service funding position is a comparison of

Technical provisions Fund assets
The funding target in each country is a result of a mixture of The funding target in each country is a result of a mixture of influences, not least common practice. There is variation both influences, not least common practice. There is variation both within and between countries.

Valuation of assets
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Market value - Austria, Belgium, Netherlands (some funds), Norway (accounting purposes), Portugal, Spain, UK Discounted income value - Cyprus, Ireland, UK (use is generally declining) Average market value - Cyprus, Ireland, UK (not common) Book value - Denmark, Finland, Germany
From an actuarial perspective the valuation of assets should be From an actuarial perspective the valuation of assets should be consistent with the valuation of the liabilities (technical provisions) consistent with the valuation of the liabilities (technical provisions) and the expected return on assets assumption and the expected return on assets assumption

Technical provisions
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The amount of the technical provisions is dependent on

Actuarial funding method Economic assumptions (Discount rate, salary inflation, price inflation, social security inflation) Demographic assumptions (Retirement age,mortality,turnover,disability,partners issues) The benefits valued eg discretionary benefits

Most commonly used actuarial funding methods

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Projected Unit Method Belgium, Cyprus, Germany (commercial accounting), Ireland, Netherlands (commercial accounting), Spain and United Kingdom and IAS/US GAAP Current Unit Method - Finland, Netherlands, Norway, Switzerland Attained Age Method - Austria, Germany (infrequent), Ireland (infrequent) Entry Age Method-Germany and Austria (Infrequent)

Pension accrual
Salary Projected
DBO

Service cost

Benefit

Current

X+1

Service

Comparison of funding methods

300 250 200 150 100 50 0
AGE 35 AGE 45 AGE 55 AGE 60

CU PU Entry Age 1 Entry age 2

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Entry age method can be the strongest or weakest, depending on how it is applied All 4 of these approaches are used in the EU At age 35, the strongest method has a funding level of 388% of the weakest Under Entry age 2 increases in benefits are funded over the remaining service period-a common approach in insured plans

Factors affecting choice of method

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Tax restrictions eg Germany, maximum funding in Netherlands Supervisory minimum funding levels eg Netherlands, Belgium, UK Accounting standards eg FRS17, IAS19, FAS87, local accounting rules Nature of fund eg 'open' or 'closed' Funding vehicle eg pension fund or life insurance Past custom and practice
The role and responsibilities of the actuary varies across the EU, with The role and responsibilities of the actuary varies across the EU, with significant variation in the extent to which actuaries have professional significant variation in the extent to which actuaries have professional freedom or must follow detailed rules and regulations

Economic assumptions
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Single defined discount rate used eg Germany, Netherlands, Sweden, Finland, Switzerland Full set of assumptions applied eg Belgium, Cyprus, Ireland, UK and Spain plus applications of US GAAP and IAS19

Example single discount rates

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Austria - 6.0% for book reserve tax calculations Finland - 3.5% to 4.25% for pension funds Germany - 6.0% for book reserve calculations Netherlands - 4.0% Slovenia - 4.0% Norway - 3.0% or 4.0% Sweden - 3.75% Switzerland - 4.0%

The impact of the net discount rate

1 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0

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2.00% 4.00% 6.00%

The 6% provision is less than 25% of the 2% provision at age 35 The impact of different discount rates reduces with age

Age Age Age Age 35 45 55 60

Demographic assumptions
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Practice ranges from full complete set of demographic assumptions to considering mortality and retirement only Practice varies from using standard tables specified in regulations to complete freedom of choice for the actuary (eg UK/Ireland) In most countries standard mortality tables developed either through population or other censuses are used

Comparison of pensioner mortality

16 15.5 15 14.5 14 13.5 13 12.5
Begium Italy Germany France Sweden Spain UK NL

PV of pension at 65

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What benefits are valued?

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Under many pension plans there are options available for the employee eg retirement age Under many pension plans there are options available for the employer/fund eg discretionary pension increases
The extent to which these options/choices are built into the The extent to which these options/choices are built into the calculation of the technical provisions will affect the security provided calculation of the technical provisions will affect the security provided to members to members

The possible impact of valuing options (early retirement and pension increases)
16 15 14 13 12 11 10 9 8 Provision at age 60 Deferred pension from 65 Deferred pension with increases Immediate pension Immediate pension with increases

The development of accounting standards

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10 years ago - only SSAP24?? Now - currently IAS19 gaining wide recognition and use Expanded use of US GAAP by European companies listed on the New York Stock Exchange Further development of country specific accounting standards, for example, RJ271 in the Netherlands and Swedish accounting standards Replacement of SSAP24 by FRS17 Increasing emphasis on 'Transparancy' of accounting information on pension plans

Overall trend of accounting standards

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Move to market based approach for valuing assets Move to market related discount rate that reflects long-term, high quality corporate bond yields Move to straight line approach for amortisation of gains and losses Move to Projected Unit Method Move to more complete actuarial assumptions sets with each assumption specified individually rather than implicitly through the use of a net discount rate

Conclusions
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Different actuarial funding methods Different approaches to setting actuarial assumptions Different assumptions used Different approaches to valuation of assets Different approaches to setting demographic assumptions Different approaches to valuing options and choices

Conclusion
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Being fully funded under the new EU directive on pensions will mean different things in different countries

Actuarial Methods in the EU Groupe Consultatif

Paul Thornton David Collinson Michael Lucas