TYPES OF PENSION PLANS
1. Defined Benefit Plan - Pension plan where a monthly benefit, payable at a certain retirement age, is defined in the plan.
2. Defined Contribution Plan - Pension plan in which specified contributions are made to each participant’s account. The contributions and interest earned on the investments serve as the total retirement amount for the retiree.
3. The equation of pension plan financing is Contributions(C) + Income (I) = Benefits (B) + Expenses (E)
ACTUARIAL VALUATION
1. In in benefit plan, pre-funding allows for assets to be built up to “fund” future benefits.
2. The value of benefits accrued in past years is called the Actuarial Accrued Liability or AAL.
3. The value of benefits accruing for the present year is called the Normal Cost (NC).
3. The value of benefits accruing for the present year is called the Normal Cost (NC).
4. The value of benefits for present year and all future years are called the present value of future normal costs or PVFNC.
5. The total amount of all benefits (AAL + PVFNC) is called Present Value of Future Benefits or PVFB.
UNFUNDED ACTUARIAL ACCRUED LIABILITY (UAAL) & FUNDED RATIO
1. UAAL is the amount that is still “owed” to the fund for past obligations.
2. UAAL is the difference between the AAL and the Actuarial Value of Assets (AVA).
3. The Funded Ratio is the ratio of AAV to AAL & calculated by dividing the AVA by AAL.
4. If the plan is less that 100% funded, there is a Unfunded Actuarial Accrued Liability (UAAL), and an amortization method is needed to systematically pay down the UAAL.
4. If the plan is less that 100% funded, there is a Unfunded Actuarial Accrued Liability (UAAL), and an amortization method is needed to systematically pay down the UAAL.
AMORTIZATION PERIOD
1. The amortization period is the expected period of time for UAAL to be paid‐in‐full.
2. Public plans use one of three amortization period.
3. Open amortization period: A period that begins again each time a new actuarial valuation is performed.
4. Closed amortization period: A specific number of years that is counted from one date and
decreases by one each year.
5. Recalculated amortization period: A period that is recalculated each time a new actuarial
valuation is performed.
AMORTIZATION PAYMENT METHODS - LEVEL DOLLAR & LEVEL PERCENT OF PAYROLL
1. The plan’s funded ratio is the ratio of the assets to the plan’s Actuarial Accrued Liability (AAL).
2. If a plan is less that 100% funded, there is a UAAL, and an amortization method is needed to systematically pay down the UAAL.
3. The Level Percent of Payroll method makes use of an assumption that both the payroll and
the amortization payment are projected to increase annually.
4. The normal cost (NC) plus the amortization payment (used to pay UAAL) determines the total contribution amount.
EXAMPLE
1. Given the below scenario.
Borrowings = $100,000
N = 30 Years
i = 7%
2. Level Dollar is the same with a fixed-rate home mortage & monthly payment would be $665.30 and fully paid after 30 years.
3. Level Percent of Payroll - The monthly payment increases by 3% each year instead.
4. Therefore, the initial monthly payment would be $486.85. and $1,147 in the 30th
year.
