The role of the pension actuary on the retirement plan team …
Actuaries are well trained in determining pension liabilities and costs and can often quote the pension sections of the Internal Revenue Code verbatim. But do you need one? Do you have one? Whether you have one is often determined by the type of plan you are maintaining and whether the consulting firm you are working with has an actuary on staff.
What dictates the need for a pension actuary? When should you consider retaining one or retaining a consulting firm that has an experienced enrolled actuary on staff? This article will look at their traditional role; identify some of the important points of working with your actuary; and identify a new role for actuaries in creative, flexible plan designs for the future.
Traditionally, retirement plans were provided through insurance companies who used actuaries to design their funding assumptions. Independent consulting actuaries came into vogue as our economy diversified and private pension plans became the norm. With the passage of ERISA in 1974, the category of "enrolled actuaries" was created and an enrolled actuary was required for each defined benefit pension plan. ERISA requires that an enrolled actuary be hired on behalf of the plan participants to determine the minimum funding obligations of the plan sponsor.
In recent years, there has been a sharp decline in the utilization of defined benefit pension plans by firms of all sizes and particularly in the small to medium plan environment. Defined benefit plans became cumbersome, costly, unpredictable and the bane of HR and personnel directors nationwide. The surge in 401(k) and profit sharing plans and age weighted or "cross tested" profit sharing plans that replicate a defined benefit plan have left defined benefit plans in the dust and a big question mark over the consulting actuary industry. If defined benefit plans are not on the upswing, then what is an actuary to do?
Consulting Actuaries TodayConsulting actuaries can be found in small and large benefits consulting firms and as independent consulting actuaries that provide services to multiple consulting firms on a contract basis. It is not unusual to find a well-established benefits consulting firm, founded and run by a consulting actuary, providing services to a client base that includes only a small number of defined benefit plans. This is because most actuaries working in the retirement plan area can provide a full range of services needed by plan sponsors to design, implement and maintain a defined benefit plan or another type of plan. Their training and background in defined benefit plans gives actuaries an advantage over other pension advisers regarding the ability to understand the relative advantages of all kinds of retirement plans — defined benefit, 401(k) savings, cash balance, profit sharing — and permits actuaries to help employers design the right mix of programs.
Beyond that advantage though, an actuary must have the technical, financial and administrative expertise, as well as the client counseling skills, to be a full-service utility player. Just as some lawyers are not particularly good at putting advice into plain English for their clients, certain actuaries have communication and counseling weaknesses that correspond to their technical strengths.
There are many good arguments for working with a pension consulting firm that has an enrolled actuary on staff that is available to provide feedback and direction in the design and maintenance of your retirement program. In particular, there are new opportunities for the enrolled actuaries to apply their skills to the defined contribution plan area that draw directly on their expertise and historical role as designers of defined benefit plans. It is now possible to achieve in a profit sharing or other defined contribution plan many of the objectives that formerly could be obtained in only a defined benefit plan (or in a combination of plans) without the expense, headache, unpredictability or regulatory madness that typically accompanies a defined benefit plan. The final nondiscrimination regulations issued by the IRS in 1994 now permit a significant amount of creativity in designing benefit structures in defined contribution plans. They go by various names and buzz words in the industry such as tiered plans, benefit-based plans, cross-tested plans and general testing plans.
It is also possible to have any one of these types of plans offered, designed and operated by a consulting firm that is not run by a consulting actuary or that doesn't even have a consulting actuary on staff. The pension industry has produced numerous pension software packages that are available to any pension consultant. The real issue isn't "Do they know how to use the program?" but rather "Do they understand the law and how the IRS treats these plans?" Much like any other technical endeavor, the tools are available in the marketplace, but the question is whether the person using the tools has the technical expertise and credentials to use them to your best advantage.
The Care And Feeding Of Your Actuary
So your consulting firm has an actuary on staff or, perhaps, the benefit firm is run by an actuary. Like any other consultant or adviser, they are only as good as their ability to communicate and handle your account in a professional manner.
To become an enrolled actuary, an individual needs to pass three exams covering interest theory, life contingencies, pension funding methods, pension plan design, pension law and related regulations. There were fewer than 2,000 enrolled actuaries initially qualified right after the effective date of ERISA in 1974. Today, that number has doubled. However, this is a small number of qualified, credentialed professionals in this field compared to other fields. In theory, with the high levels of training and professional standards for continuing education required of enrolled actuaries, one would assume that this would be a higher caliber of professional. Generally, this is a safe assumption. Let's take a look at some of the common sense notions of working with your actuary that may help you better understand his role.
To deliver consulting services effectively, the consulting actuary needs to have an understanding of the plan sponsor's business. A plan sponsor should expect the actuary to understand the industry to the extent that the sponsor's financial condition, revenue predictability, acquisition strategy and employee relations can affect plan funding assumptions or benefit plan needs. The better the actuary understands the client's business, the better he will understand the client's objectives and what should go into the design and funding assumptions. So much for obvious statements.
What are the keys to getting real value from consulting actuaries? Are they performing to the highest professional standard? How do you know? Unfortunately, sometimes you only know if something goes wrong. As in any other profession, such discoveries are made only when it is too late.
The largest problem in consulting relationships is not performing specifically to the client's specifications and expectations. The plan sponsor should receive an engagement letter or service agreement from the actuary that specifies the:
- Scope of the project or engagement.
- Data needed from the plan sponsor.
- Work product that will be delivered.
- Timing and costs involved.
Other exposure areas where the consulting relationship may break down include:
- Failure to meet professional standards.
- Failure to deliver services on time.
- Errors in calculations, assumption, methods and concepts.
- Inability to communicate in plain English and excessive use of technical jargon.
- Higher fees than expected, estimated or appropriate for the services provided.
These possible problem areas are typical for all consulting services. However, because of the technical nature of the actuary's role, it really helps to go through the scope of the engagement in detail at the outset so that the client (plan sponsor) understands and appreciates the services being provided and how problems and mistakes will be handled. While it may be difficult to get actuaries to commit in advance to how they would respond if any of the above problems occur, plan sponsors should try to address these issues up front. In comparison, attorneys are required according to the State Bar Association rules to put such alternatives for fee disputes in their engagement letters and to disclose that they have or do not have malpractice insurance to cover the services being rendered.
Plan sponsors should also make a special effort to communicate their confidentiality concerns to the actuary. Actuaries are used to working with salary information and are generally aware of the sensitive nature of that information. Plan sponsors should set guidelines for access to data and their rules of confidentiality.
Plan sponsors should also expect actuarial reports (for example, in the case of defined benefit plans) to clearly distinguish the information needed for ERISA funding purposes and information that may be needed for financial accounting reporting, such as under FAS-87 Pension Expense Disclosure on the corporation's financial statements. The actuary should use clear and consistent terminology. Taking this one step further, the possibility of unforeseen unusual nonrecurring events that may be subject to financial accounting standards reporting that may occur in the case of settlements, curtailments, early retirement windows and special termination benefits, need to be discussed with the actuary (as well as the plan's third-party administrator, if different) and the plan's qualified independent accountant for audit purposes early on to avoid unpleasant surprises.
When Should I Shop For An Actuary?Given the design flexibility that is now available in qualified retirement plans both on the profit sharing side as well as the defined benefit plan side, it may make sense to consider the services of a consulting actuary any time you are in the process of re-evaluating your retirement plan design. When you re-evaluate, the type of plan or funding formulas and assumptions will, of course, be driven by the plan sponsor's economics and goals. For example:
- Plan redesign may be brought up when the needs of certain key employees come to the forefront in salary discussions or negotiations.
- Plan design may become an issue in the context of a merger, acquisition or disposition of a business.
- Adding or subtracting personnel may also compel plan redesign.
- Finally, plan redesign may be compelled by increases in plan sponsor profitability and the desire and ability to put more money away for employees' retirement objectives.
At any of these crossroads, you should inquire of your current pension advisers whether the services of a consulting actuary to develop a creative plan design would be advantageous. Ask whether the consultant or law firm works with consulting actuaries that have proven their abilities in the areas discussed above. Does the consulting firm have an actuary on staff? Can he be brought into the process or can the services of an outside consulting actuary be recommended?
Be forewarned, there are many so-called "turn-key" plan documents available in the pension market from numerous sources. However, very few of them contain cross-tested allocation procedures that are easy to administer. In the case of a profit sharing plan that has a 401(k) component, it is especially important to check the order of allocation of the various contribution components including the:
- The 401(k) contributions.
- The matching contributions.
- The nonelective contributions, if any (and the matching contribution, if any.
- The top heavy minimum allocation, if required.
- The profit sharing contribution, if any, that is subject to the cross-tested allocation procedure.
In this regard, the preapproval of the lead documents by the IRS is no guarantee that the plan can be easily administered.
Finally, consider once again our caveat regarding relying on a pension software package to perfect the allocation. This is particularly important in the context of discrimination testing and ongoing compliance. It can be downright dangerous to rely on a software package unless the calculations being performed can actually be replicated or tested and confirmed by the consultant or actuary. That is, if the actuary or consultant can't perform the calculation "by hand" using a calculator and know-how, then the actuary may not know enough about what is really going on in the program to determine if the program is working properly.