What is the correct way to calculate past service liability? Two pensions consulting firms are doing this very differently, although both are stating to use Projected Unit Cost Method (PUC). The benefit in the example below is Pension fraction x No. of years of service x last drawn salary. This is just a simple case, most of the pension schemes will have very complicated benefit structures, with service caps and service based pension fractions. Company A: Total Pension Liability = Sum of [Expected Salary x Pension fraction x (past service + counter) x annuity x Probabilities x discount factor] Past service liability = Sum of [Expected Salary x pension fraction x (past service) x annuity x Probabilities x discount factor] - where counter: increases till the member reaches retirement age Company B: Company B calculates Total pension liability the same way as Company A, however after getting the Total liability figure they just pro-rate it over total possible service (retirement age - entry age) Past service liability = (total pension liability x past service)/(retirement age - entry age) Which methodology is correct? both will produce substantially different results, assuming the data and assumptions are kept same. Does Institute offers technical support to its members? who should i email to regarding this?
PSL calculations Hi majestic Thank you for your query. The following response is not intended to be for pensions practice, but is based on Core Reading and is a discussion of the sorts of things that may be worth mentioning if a similar issue came up in the exam. In the real world, the actuary may wish to seek advice from sources such as: their firm’s pensions research team, senior actuary, legal advisers, and/or the Institute and Faculty of Actuaries (although I’m not aware that the Institute and Faculty offers technical support in this area). The Projected Unit method is defined in the SA4 Glossary as: An accrued benefits funding method in which the Actuarial Liability makes allowance for projected earnings. The Standard Contribution Rate is that necessary to cover the cost of all benefits which will accrue in the Control Period following the valuation date by reference to earnings projected to the assumed date service ceases. ie allowance should be made for the value of accrued benefits plus projected earnings. So the debate here is arguably more about: “How is accrued benefits defined”? The SA4 Glossary defines accrued benefits to be: The benefits for service up to a given point in time, whether vested rights or not. They may be calculated in relation to current earnings or projected earnings. (Allowance may also be made for revaluation and/or pension increases required by the scheme rules or legislation.) It seems that one company is defining this as accrual built up so far, another is defining it as total accrual x current service divided by prospective service. Where accrual is uniform the two would be the same, so let’s assume that it isn’t. The question is then “which is right?” and looking at the definition I don’t know that there is a definitive answer. Complicated benefit structures and legislation will affect how the calculation is done in practice. Much depends on the purpose of the valuation, which is key. If for a merger, the two parties can argue for whatever basis/method they choose anyway, this is just another item for negotiation. But it is an important item given that the liability is being settled and money is changing hands on the basis of the calculation. If for SFO, if approximations are used and as a result funds aren’t sufficient there is more scope to correct this later (than for a merger). It would however seem prudent for the trustees to use the approach which gives the highest answer. A definitive answer as to whether there is legislation/guidance that requires one approach over the other should be sought. However, it’s probably also worth noting the following Core Reading, taken from the scheme design chapter: In a DB scheme, the vested member must be offered a deferred pension, payable from NRA. The amount of the pension must be based on the same formula used to calculate pension for those retiring at NRA. In the UK, the principle of “uniform accrual” must apply. which I think would be important to note especially if for individual calculations (such as an individual transfer value). I hope this helps. Best wishes Stuart Underwood ActEd Tutor
Hi Stuart, Thank you for your detailed reply. From what i gathered after googling for the past week, is that Company A is using Projected Unit Credit Method, while Company B seems to be using pro-rata unit credit method. Unfortunately both can be abbreviated as PUC. IFRS specifically requires the use of Projected Unit Credit Method ( Link ). Have you come across any article or a book where any of these methods (projected unit credit or pro-rata unit credit) are clearly defined? I should probably email IFRS, or maybe someone at a pensions consulting firm for further help. Thanks agains for your reply.
PUC method Hi majestics GN26 was the Recommended Practice in this area until almost all the guidance notes were removed (including GN26). Although GN26 is no longer effective, I'm not aware of anything more up to date. Best wishes Stuart Underwood
