Statistics may be used in a variety of ways in business, but as an actuarial analyst from an employee benefits consulting firm, I will tell you how statistics, or more specifically actuarial science, is used in pension consulting. But first off, what is pension consulting? Ever wonder why GM’s pension fund has been arguably decided as one of the primary causes for their ever-cascading downfall? Curious how companies try to guess how much they need to set aside to fund their pension plans while still adhering to Uncle Sam’s legal demands? Well essentially there is one thing each company with a pension cares about, and that is matching liabilities with assets. This must be done in a number of ways, and the technical knowledge required to make sure this is done correctly can be pretty overwhelming for a corporation, and thus arises the field of pension consulting.
So what about assets and liabilities?
Assets are familiar. The way trustees invest money for a pension fund is a corporate version of how an individual invests in one’s 401(k). we care about maximizing return (unless your company is focused on social responsible investing, but that’s another article). the asset return is at the whim of how well the market performs. It is no surprise that we are in an economic downturn, and pension funds have not been spared by such an unduly solemn time.
Liabilities. Say XYZ Corporation offers a pension to its employees. In the employee’s perspective, he or she knows that for every year he or she works, he or she can earn an additional $100 to one’s total monthly pension benefit, payable at the normal retirement age, which we will assume to be 65 in this case. As an example, say you worked for XYZ Corporation for 10 years and terminated. Your pension benefit, if you retire at 65, is $1,000 a month. In the eyes of XYZ Corporation, they want to know how much money they’ll need to set aside each year to make sure they can pay you your pension benefit when you retire. In fact, they care about the liabilities for all employees. This is when actuarial science, a mathematical branch combining statistics and financial mathematics, is involved. Actuaries must use the mortality tables (rates in which an employee may die based on his or her age) and interest rates that the government has prescribed. Additionally, actuaries must also consider other forms of decrements based on age – the odds of an employee terminating one’s employment from the corporation, the probability of an employee becoming disabled, the odds of one’s spouse passing away, early retirement reduction factors, etc. Throwing all these decrements together, and discounting based on a set of interest rates, an actuary can come up with the value of XYZ Corporation’s liabilities.
This number can then be compared with the assets and we can ultimately determine the health of XYZ Corporation’s pension plan.
So how is this important? Publicly-traded corporations must adhere to standards set by the FASB to value their assets and liabilities under methods prescribed by FASB. Investors may find the pension fund a factor when looking to invest in a corporation. And even more importantly, corporations are legally encouraged to keep their pension plans healthy in order to guarantee their employees a retirement benefit when their loyal workers retire. It is quite a selling point in retaining talent. It also says a lot about a company’s integrity.
