Risk Analysis in Valuation Reports – FSRA’s Looking for More
In recent weeks, FSRA has caused a bit of a stir in the actuarial community with their recent guidance on the contents in an actuarial valuation report in light of the COVID-19 pandemic. In their (recently updated) Q&A #7, FSRA is expecting valuation reports prepared as at December 31, 2019 (and thereafter) to include sensitivity disclosures that go above and beyond the minimum reporting requirements that are currently outlined in actuarial standards of practice. While FSRA’s guidance will need to be considered by plan sponsors and actuaries as they prepare valuation reports this year, the actuarial profession at large, and the Actuarial Standards Board in particular, will need to consider if actuarial standards need to be updated yet again to provide additional, and arguably more meaningful, risk analysis in the funding valuation report.
The purpose of a valuation report
The question that should be asked is “what is an appropriate minimum standard for disclosures in a funding valuation report?” Is the purpose of a valuation report simply to illustrate how the minimum and maximum contribution requirements were derived? Or is the purpose of the valuation report to also provide readers with a deeper understanding of the risks inherent in the plan?
In recent years, the actuarial profession in Canada has been moving from the former to the latter and increasing the amount of sensitivity analysis that is required to be disclosed in a valuation report. The most recent iteration of updates to the standards, made effective March 1, 2019, required the disclosure of the effects of “plausible adverse scenarios” on the going concern valuation results, whereby “plausible adverse scenarios” are “scenarios of adverse but plausible assumptions, relative to the best estimate assumptions selected for the valuation, to which the plan’s financial condition is sensitive”.
Interestingly, at the time this new standard was implemented – which let me remind you was not that long ago (March 1, 2019) – the actuarial profession purposefully limited this “plausible adverse scenario” analysis to only the going-concern valuation results (namely, the funded status and service cost). Specifically, this analysis did not extend to the solvency, wind-up, or contribution requirement results. This limitation was done, in part, as a compromise to enhance its practicality, and it was also noted that many elements of these additional disclosures could be extrapolated to the solvency/wind-up valuation results by interested users.
More information is nice but…
While more risk analysis and disclosures in a valuation report is nice to have, there is a cost/benefit analysis that needs to be weighed.
While some may argue that a risk analysis is a consulting exercise that needs to be performed outside of the regulatory valuation report, others argue that a valuation report is semi-public document and provides an opportunity for both plan members and regulators to obtain a better understanding of the risks inherent in a pension plan. No matter the argument, consideration needs to be given to the complexity of the calculations, the perceived value of the additional information provided, and the cost to prepare the analysis.
In my opinion, the current version of the “plausible adverse scenarios” in the actuarial standards of practice provide useful information. However, I tend to agree with FSRA’s assessment that there is a net-positive to the cost/benefit of extending the analysis of the “plausible adverse scenarios” to the solvency, wind-up, and contribution requirement disclosures in a valuation report.
With that said, one of the biggest threats to a pension plan’s financial condition is the ability of the plan sponsor to continue making contributions. This is contemplated in FSRA’s recent guidance, as they note it may be appropriate for the “plausible adverse scenarios” to consider the financial stresses to the plan sponsor that may affect its ability to make required contributions when due. Unfortunately, measuring this risk is not something an actuary can easily assess; and as such, requiring any additional disclosure on the ability of the plan sponsor to continue making contributions should not, in my opinion, be an additional disclosure in a valuation report.
What is an actuary/plan sponsor to do…
When reading Q&A #7, FSRA is effectively stating that they are now expecting valuation reports to extend the “plausible adverse scenarios” analysis to include their impact on the solvency, wind-up, and special payments calculations.
As such, actuaries and plan sponsors preparing valuations in 2020 and beyond will need to consider if they will include the additional sensitivity information requested by FSRA in their valuation reports – and if they decide against including this additional information, it appears that FSRA may come looking for it after the fact.
What is an actuarial profession to do…
The actuarial profession, and in particular the Actuarial Standards Board, will need to consider FSRA’s Q&A #7 and determine if it is now time to make these enhanced disclosures a minimum requirement in our standards of practice.
Coincidently, the Actuarial Standards Board had already started the process of reviewing its pension standards – so now is a great time to be having this debate.
However, with FSRA releasing their guidance on this topic now, instead of attempting to influence the profession during the standards review process, they have strong-armed their position – and forcing actuaries and plan sponsors to consider updating their valuation reports with these additional disclosures sooner rather than later.