1. There are two widely used actuarial cost methods to calculate the Actuarial Accrued Liability (AAL) and Normal Cost (NC).
2.Pre-funded Defined Benefit Plans require a periodic Actuarial Valuation to determine the recommended contribution amount.
3. Actuaries apply a discount rate to future benefit payments in order to calculate a present value or value in today’s dollars.
Note: The higher the discount rate, the lower the present value, and vice versa.
COST METHODS - ENTRY AGE NORMAL (EAN) & PROJECTED UNIT CREDIT (PUC)
1. The AAL is based on projected pay and current service.
2. EAN method defines the normal cost as a level percent of pay from entry age until retirement (Puts more of the liability into the AAL and less into PVFNC)
3. PUC methods dicates the normal cost for each member increases as a percent of pay as the member. (puts less of the liability into the AAL and more into the PVFNC than EAN)
CALCULATION EXAMPLE
1. This table shows the PVFB, AAL and NC for an employee hired at age 35 who works 30 years until his retirement at age 65. He has annual 3% pay increases, and an ending pay of $50,000.
Age
|
Service
|
PVFB ($)
(AAL+PVFNC) |
EAN AAL ($)
|
EAN NC ($)
|
PUC AAL($)
|
PUC NC($)
|
35
|
0
|
43,464
|
0
|
2,385
|
0
|
1,449
|
45
|
10
|
85,500
|
39,769
|
3,206
|
28,500
|
2,850
|
55
|
20
|
168,191
|
131,678
|
4,308
|
112,128
|
5,606
|
64
|
29
|
309,213
|
303,591
|
5,621
|
298,906
|
10,307
|
65
|
30
|
330,858
|
330,858
|
0
|
330,858
|
0
|
ASSUMPTIONS
1. Pension funding requires actuarial assumptions (economic & demographic) to be made about the future.
2. Economic assumptions include interest rates, salary increases, and inflation.
3. Demographic assumptions include rates of retirement, turnover or withdrawal rates, rates of disability, and mortality rates.
