Understanding an Actuarial Valuation
Many scenarios create the need for a company to obtain an actuarial valuation. But what is an actuarial valuation and why does a company need one? What is a company’s responsibility relating to the information used to generate the valuation? How does the company assess if the output of the report is accurate? Although this article will not address all the details of an actuarial valuation report, we will discuss these key questions to help readers understand and obtain accurate actuarial analysis for your company.
An actuarial valuation is a mathematical analysis performed using various inputs and assumptions in order to estimate a future liability or asset as of a different point in time, typically at the company’s year-end date. Examples are establishing the liability of a defined benefit pension plan or other post-retirement benefit, a self-funded workers’ compensation or malpractice insurance plan. The assumptions used are generally derived from long-term data and based on a mix of statistical information and previous experience. Professional actuaries should be engaged to assist companies with this analysis.
One of the most important aspects of hiring an actuary is selecting one that has the necessary skills and background to make the proper assumptions needed in the valuation itself. An actuary that typically performs pension plan valuations may not be best suited to perform a valuation of medical malpractice claims. Doing some due diligence such as searching for an actuary’s credentials and primary areas of practice through the Society of Actuaries or asking for references will assist in this process. Be sure that you are comfortable that the actuary selected is competent to perform the specific calculations needed by your company.
The next step is to provide the necessary information that will be used as inputs into the actuarial calculation. Some examples include providing a census of participants for a pension plan valuation or providing a listing of outstanding malpractice claims and related information for a self-funded malpractice plan. This is one of the most important steps in obtaining an actuarial analysis because if the information that is used as an input into the calculation is not correct, the valuation results will also not be correct. Typically, actuaries take the data provided to them at face value and use it without verifying its accuracy. It is the company’s responsibility to ensure accuracy of the information. Implementing strong internal controls over the generation of this information is critical. Controls such as reconciling the information to source documents or reviewing the information prior to providing it to the actuary could help mitigate headaches later in the process.
It is important to work directly with the actuary to ensure a thorough understanding of all inputs and assumptions used in the valuation. It is crucial to understand items such as the valuation date, discount rate, return on assets, mortality tables, retirement age, and confidence levels; some or all of which may factor into the analysis. In certain situations, it may even be appropriate to reach out to other advisors, such as the external auditors, to review these inputs for reasonableness before the calculation and report are finalized.
One of the most important responsibilities you have in the actuarial valuation process is to ensure that the valuation makes sense. The report will ultimately be used to record a liability (or asset) on the financial statements. The amount recorded can be substantial and have a significant impact on the financial statements. On behalf of the company, you are entitled to ask questions on the inputs used and the ultimate outcome of the valuation report. Be sure you are comfortable with the report as a whole, prior to recording the impact in the financial statements. This may include reconciling the data originally provided to the actuary to the valuation report to verify its accuracy.
In summary, be sure to use a qualified actuary with relevant experience, provide accurate input data to the actuary, have an understanding of the inputs used, and ask questions when necessary to understand the valuation. This will ensure the most accurate and useful actuarial valuation.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, investment, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.