Why is Actuarial Valuation Required?

Introduction 

Actuarial Valuation is a type of mathematical analysis performed to assess the present value and future obligations of a financial organisation, mainly related to the human resources of the organisation. This includes liabilities such as gratuity, pension schemes and funds part of employee benefit plans. Most of these benefits are not paid immediately but one must assess the level of assets you need to hold back your employee benefits liability or to know how much your employee is actually costing to the company. A provision must be made to carry out these expenses in future so that the company has enough to pay its employees. There are some legal compliance also to do Actuarial Valuation such as:-

• Indian GAAP (Generally Accepted Accounting Principles) mandates that a liability must be recorded in the financial statements in respect of employee benefit plans in accordance with the Accounting Standard 15 (AS15).
• A MultiNational Company operating in India also has to report under the GAAP applicable to their origin country. Depending upon the origin country, one must report under the US GAAP, IAS 19 (International Accounting Standard) or FRS 17 (Financial Reporting Standard).

One of the reasons why Actuarial Valuation is required is to prepare the year-end financial statements. Reasons other than accounting requirements to carry out an Actuarial Valuation beyond accounting compliance are: 

• To ensure liabilities are adequately matched with assets with the goal of preventing overfunding or underfunding. 
• It helps in identifying the hidden risks that might impact deal terms.
• Provides transparency to employees and their unions regarding the organisation’s financial health.

Importance of Actuarial Valuation for Stakeholders

The stakeholders of Actuarial Valuation are a person or a group of persons who are impacted by the results of the valuation. The different stakeholders are:-

• Employers: Employers who give pension plans, insurance schemes , or employee benefits rely on actuarial valuation to know the big picture impact and funding status to ensure the financial viability and the regulatory compliances of providing employees benefit plans .

• Employees: Employees and also the retirees who are the recipients of pension or insurance benefits to ensure the stability of their benefits and whether the organisation is able to meet its obligation or not .

• Shareholders: Investors in the company might also be interested to know the long-term financial health of the company and the potential liabilities of the company .

• Regulators: This includes government bodies, financial and pension regulators that make sure that the regulations are fulfilled .

• Tax Authorities: Tax agencies that regulate tax laws related to the gratuity, pension plans or any other benefit schemes to make sure that the organisations are fulfilling their obligations.

How is Actuarial Valuation performed?

The first step is gathering all the relevant information to carry out the valuation. The next and one of the most important steps is to make assumptions for factors such as inflation rates, discount rates, future salary increments rate and retirement age. The third step includes liability calculation (as the liability is accrued over a period of time). It also includes the valuation of assets for funded plans (such as pensions). 

Example 1.1: A pension plan with $5 million liabilities and $4.5 million assets has a funding deficit of $0.5 million.

The last step includes reporting the results, this includes summarizing the present value of liabilities, surplus/deficit analysis and key assumptions and their impact.

Like in example 1.1, the company may need to increase contributions or adjust benefits to address a funding deficit.

 What are the benefits of Actuarial Valuation? 

• These valuations clarify an organisation’s financial obligations ensuring Financial Transparency.
• It can help in identifying and mitigating risks such as uncertainty about inflation rates , longevity risk and volatility of the market.
• It ensures adherence to accounting and other regulations (Solvency II , IFRS 17 )
• It provides insights about the strategies required for funding as well as mergers and acquisition .
• It enhances financial stability by aligning the available assets to the liabilities.
• It helps in identifying cost saving opportunities .

A case study demonstrating the successful application of Actuarial Valuation by an actuarial firm which involves their support for a plan made for retirement for University Health System Pension Plan to ensure the sustainable funding for its pension obligations towards its employees.

Process:-

• Data Cleaning: The company conducted a thorough audit of employee data to ensure accuracy.
• Use of Actuarial Models: Models such as RISKAgility and MoSes are used to perform the liability projection.
• Regulatory Compliance: The company insured that the IFRS 19 regulations are met.
• Reports: The company formed tailored reports to explain the big picture impact. 

The valuation helped the plan to reduce its unfunded liability significantly, achieving a better position with a healthier fund status over the passage of time.

It also helped in designing the plan more tax efficient and cost saving.

The reports included: Summary of plan, summary of assets, summary of Actuarial assumptions, a brief discussion of methods used for the calculations.

Conclusion

Actuarial Valuation is essential for organisations having long term obligations such as gratuity, pensions and employee benefits. It provides a provision for future liabilities and allows the firm to take first mover advantage. It also ensures firms meet their future obligations without facing any financial strains. These are not only for regulatory compliance but also serve as a tool for strategic decision making and helps the organisations by providing insights into how economic changes can impact the future liabilities.

Frequently Asked Questions

1) Can actuarial valuation affect profit and loss?
Yes, changes in actuarial assumptions directly affect expenses recognized in profit or loss or other comprehensive income.

2) What is a sensitivity analysis in actuarial valuation?
It shows how variations in key assumptions (e.g., discount rates) impact benefit obligations.

3) How does actuarial valuation align with employee retention?

Accurate valuation ensures benefits are sustainable, strengthening employee trust and retention.

4) What data is required for actuarial valuation?

Employee demographics, salary details, benefit policies, and economic assumptions.

5) How does actuarial valuation help with funding decisions?

It provides insights into whether benefit plans are adequately funded and helps plan future contributions.