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LIA $FACTS$ for November 1997
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Gain & Loss Analysis -- Who Cares?

Well, of course, we do. Anyone who has the good fortune to get a Lohmann International Retirement plan valuation report knows the lengths we go to. We feel that the liability gain & loss is the only way to determine the appropriateness of the major actuarial assumptions affecting the PBO, other than the discount rate.

Early on, we got involved in a case where the then current person responsible for the FAS 87 actuarial valuation had done a geometric average of the seniority increases implicit in the current employee structure.

They had recommended a salary scale that was several (!!) percentage points higher than the suggested discount rate (yes, whole points). The client called us in for help. We, watching the cost/benefit ratio, suggested that they use a salary scale that was more in line with local conditions and that we would do the valuation two years in a row to judge the reasonableness of the assumption.

The auditor agreed to our approach, it being cost-effective. He also felt he could rely on our work. The bottom-line was as expected: there was no significant deviation in experience from that expected with a "reasonable" salary scale. Our gain & loss analysis isolated the exact impact of the change in liabilities due to changes in the salary scale other than expected. It was essentially zero!

We break out the actual experience with regard to aggregate retirements and new employees also, as a matter of course, beginning in our second valuation for the same client.

When assumptions change, we isolate each one so that estimates of the impacts of other choices can more easily be made. It is one thing to talk about the relationship of the discount rate and salary scale, it is quite another to see it in action! If called on, we can isolate the effect of each decremental force assumed. Very important when a client is managing his largest employee cost after payroll.

One final benefit of gain & loss analysis is the increase in the auditor's ability to rely on our work, thus, saving you money on your audit. Fewer questions about the actuarial report on the FAS 87 valuation translates to fewer charged hours by the auditor staff. Fewer charged hours ultimately saves you money!

Salary Scale Example ... What's Wrong with Geometric?

Japanese seniority scales tend to provide fairly healthy, better-than-average increases in the early years of a new employee's career. Increases decrease significantly as the employee passes mid-career, disappearing entirely and sometimes becoming negative after the employee reaches the "age limit."

The age limit is a distinctive (compared to North America) element of Japanese lifetime employment. It is the age at which the company may unilaterally stop increasing an employee's pay and, even, decrease it. It is not the "Normal Retirement Age" and often occurs about five years before.

Obviously, the older, longer-service employees contribute the most to the liabilities of the retirement plan. The younger ones contribute almost nothing. The liability-weighted salary increase is strongly affected by the small increases given senior workers and hardly affected at all by the large increases given the younger ones.

A geometric average does not properly weight the increases by plan liability.

The Vesting Normal Cost

In order to project the minor "BO's," one needs the normal cost and expected benefits for each. Once you have these, the gain & loss can be extended to the minor "BO's." While we don't often recommend the extra expense, such an analysis might be useful when a company has found itself hit with an "Additional Liability" due to changes in the liability side of that equation. The normal cost we develop for the VBO (Vested Benefit Obligation) is affectionately called the "Vesting Normal Cost." It is precisely what allows a proper tracking of the relationship of the VBO to the ABO. Because of unusual vesting patterns in Japan, the overall vested ratio can change significantly from year-to-year.

That said, we are still struggling with trying to properly define the VBO for Japanese-style plans. The combination of lump-sum payout and full vesting for involuntary termination combine to muddy the definition waters.

Copyright 1997 Lohmann International Associates

You have been reading the online edition of LIA $FACTS$, the monthly fax newsletter of Lohmann International Associates. For further information, please visit our home page on the Web or send e-mail to Les Lohmann.

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