May 2013

Observations on our Observations

By Joseph J. Silvestri

Following the release of our first Rapid Retirement Research report, The Rising Tide of Pension Contributions, the SOA decided to begin an investigation of ways to address the volatility of statutory funding requirements for U.S. private sector defined benefit plans. The Rising Tide report discussed perceptions of volatility in the funding rules and identified potential stress to the single-employer system in the form of cash contributions that would be required of plan sponsors. Consequently, we believed there would be demand for greater smoothing of contribution requirements and we saw an opportunity to provide insight into discussions about a topic with clear actuarial implications.

Our most recent report, Observations on Input and Output Smoothing Methods: How do they affect the funding of defined benefit plans?, provides a high-level comparison of input and output smoothing methods in the context of U.S. statutory requirements for private single-employer DB plans. The report offers several observations about how these two general categories of smoothing methods operate, including:

  • Input and output smoothing methodologies can have similar effects on plan solvency and the predictability of statutory requirements, because any rate of experience recognition can be determined under either form.
  • Input methods smooth specific sources of volatility and may affect multiple statutory requirements. In contrast, output methods smooth the effects of multiple sources of volatility for specific statutory requirements.
  • Input smoothing methodologies change the relationship between market-based and reported values of assets and liabilities, but output methods do not. In order to use this information appropriately, we believe users need to understand the relationship.

The report uses several deterministic illustrations of how hypothetical input and output smoothing alternatives would affect statutory requirements for private DB plans as a way to demonstrate these observations. To be clear, the illustrations do not constitute an analysis of the smoothing alternatives in the report. The scenarios were designed to illustrate the observations and isolate effects for purposes of comparison. For that matter, this report is not intended to advocate a position for or against the use of smoothing methodologies, or for or against the use of any particular smoothing methodology. It is intended to provide an objective, principles-based comparison of two categories of smoothing that are used in our work.

The report was written for a policy maker audience, and I expect that many pension actuaries are familiar with the observations we made. For those who are not, the report may serve as an introduction to the topic. Regardless of familiarity with the topic, I hope that actuaries use the report to help other stakeholders in the defined benefit system understand that they have options. To the extent that one smoothing method has a desired degree of smoothing but lacks in another characteristic, perhaps there is another method with a comparable degree of smoothing that would improve on the undesirable characteristic. Smoothing is a topic that actuaries have unparalleled expertise in, and I believe that our members can develop the best solution for a smoothing problem.

Joseph J. Silvestri, FSA, EA, MAAA. FCA, is retirement research actuary at the Society of Actuaries headquarters in Schaumburg, Ill. He can be reached at