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The Actuary The magazine of the Institute & Faculty of Actuaries

Actuarial Profession publishes new framework for discount rates

The Profession's two-year research and consultation project into the use, construction and communication of discount rates aimed to develop a new framework that will help actuaries, their clients and all those affected by actuarial calculations.

The Profession says that discount rates are vital in actuarial calculations and an area of much debate. In particular they are central to the calculation of some of the key numbers in pensions and insurance today, affecting millions of people, including the calculation of
• Reserves in company accounts for pensions and insurance liabilities
• Pension scheme deficits and contributions to be paid in to pension schemes
• Solvency reserves for insurance companies
• Pension scheme transfer values and insurance policy surrender values.

As well as seeking the views of actuaries, the Profession consulted external stakeholders so as to develop a framework that is fit for purpose.

The Discount Rate Steering Group's final recommendations and the way forward are published together with a final update on the project including feedback from the consultation process following the publication of the sessional research discussion paper. 

"As a chartered professional body, our members are bound by a strong ethical code and professional standards," said Charles Cowling (pictured), chairman of the group which led the project.

"A crucial part of these requirements is that we must communicate clearly to clients about the work we carry out on their behalf. Actuarial work is very technical and discount rates, while crucial to much of the work actuaries carry out, can seem confusing to clients. It was important, therefore, to develop a framework where this information can be communicated clearly while still remaining accurate and informative.

"We hope that, through a process of education on the framework and how it fits within our professional standards, and the introduction of a common language on discount rates, we will be able to equip actuaries to give even more useful advice to clients. This will help our members maintain the highest standards at all times. At the same time, it will help users of actuarial advice (and all those affected by actuarial calculations) understand better the implications of that advice."

The recommendations are as follows:

1. Encourage and equip actuaries (through education and CPD) to determine discount rates (and be able to justify their choice of discount rate) within a matching framework and/or budgeting framework.

2. Where relevant to the context of the actuarial advice being given, actuaries should be encouraged (through education and CPD) to highlight in their work any material difference between the values placed on contractual asset or liability cash flows and their corresponding market or market consistent values, and explain the main contributors to this difference.

3. Encourage and equip actuaries (through education and CPD) when presenting advice involving the use of discount rates to communicate clearly the framework, building blocks and level of embedded risk they have used in assessing the discount rate(s).

4. Encourage and equip actuaries (through education and CPD) to highlight to their clients the limitations of a budgeting calculation in the assessment of Technical Provisions under UK pensions regulations which in isolation does not provide adequate information on the assessment of the certainty of delivery of members' benefits. A more complete view needs assessment of the reliance on the scheme sponsor's covenant.

5. Encourage and equip actuaries (through education and CPD) in assessing what is a "prudent" discount rate for the purposes of calculating Technical Provisions under UK pensions regulations, to give primary consideration to the current or evolving pension scheme investment strategy. However, in support of the BAS requirement to explain the limitations of any models, actuaries to be encouraged (again through education and CPD) to help their clients understand what is "prudent" in the assessment of Technical Provisions by considering the extent to which the sponsor covenant is able to support the difference between a solvency assessment of the liabilities and the proposed level of Technical Provisions.

6. Equip actuaries (through education and CPD) to use a budgeting framework for advising on recovery plans for restoring pension scheme funding up to the level of Technical Provisions (as calculated under UK regulations). Further, encourage and equip actuaries (through education and CPD) to highlight the limitations of this approach in isolation for providing adequate information on the assessment of the security of members' benefits during and at the end of the recovery period.

7. Where such a comparison is required or appropriate, to encourage and equip actuaries (through education and CPD) to calculate estimates of pension scheme solvency using a matching framework making no adjustment for sponsor default on the pension obligation.

8. Encourage and equip actuaries (through education and CPD ) where it is appropriate to have a wider aspect covered by their advice - to encourage, through their advice, more understanding on the likelihood of benefit delivery in the communication of funding information to members and trustees.

9. The Actuarial Profession should support the use of a matching framework for reserving for long term financial liabilities in company accounts.

10. Encourage and equip actuaries (through education and CPD) in giving advice on member/policyholder options/transactions (including cash equivalent transfer values and surrender values) to help users understand the implications of their advice within a matching framework (this may need to be through supplementary information when legislation or other considerations dictate adoption of an alternative approach in practice).

11. The Actuarial Profession should support the apparent move to a matching framework for liability valuation under Solvency II and encourages the UK regulator to preserve this principle in implementing the measures.

12. Encourage actuaries (through education and CPD) to promote understanding of insurance policy/product pricing in a matching framework.

13. Encourage actuaries (through education and CPD) that where the benefits payable under an insurance policy are linked to the performance of a defined pool of assets, projections of benefits payable should be based on a budgeting framework.

More information on the project can be found here.