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1 July 1980 Financial Analysts Journal Volume 36, Issue 4

How Actuaries Determine the Unfunded Pension Liability

  1. D. Don Ezra

Although much of what the pension actuary does appears to be shrouded in mystery, the basics can be understood by anyone. The actuary compares the benefits specified by a pension plan with the size of a pension fund. This comparison has two fundamental purposes — to determine whether or not the fund is sufficient for the time being and to establish a future contribution rate for the plan sponsor.

To determine whether a pension plan is on track towards the goal of meeting all benefit payments as they fall due, the actuary estimates future interest rates, salary increases and mortality rates among active participants and pensioners. But he also takes into account the plan’s choice of funding method, which specifies the amount and timing of future pension contributions.

The amount of additional funding needed to supplement the specified future contributions is called the “unfunded liability.” The unfunded liability can change with a change in funding method, not because of any reassessment of what has happened in the past, but because different methods promise different contributions in the future.

The accountant and the investment manager can get a lot of information from the actuary’s report. But the basic aim of the report prevents it from being an all-purpose tool.

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