Dear Corporate Pension Actuary: My company’s pension plan has seen costs fluctuate in recent years. Will an experience study help reduce this volatility? What exactly does the study entail, and what are some important considerations to keep in mind while working with an actuary?

—Curious at Company A

Dear Curious:

It’s an interesting time for corporate pension plans, as many have enjoyed robust stock market returns over the past several years. But while funding levels have in many cases improved, costs haven’t necessarily stabilized. Conducting an experience study can help identify any potential assumptions that warrant updating.

What is a pension experience study?

An experience study is a comprehensive analysis that looks at the historical experience of a pension plan over an extended period. “Experience” describes what has happened over this time to the plan’s population and other metrics, including how well the actuarial assumptions predicted these patterns. The study can explore employee turnover and retirement rates, pay increases, and participant life expectancies.

An experience study evaluates how well your current assumptions align with actual plan experience and estimates the effect of updating those assumptions on calculated plan liabilities and funded status. It reviews a broad range of factors, including actuarial assumptions and demographic trends, by comparing recent outcomes to what was expected under current assumptions.

Why consider an experience study?

As corporations look to better manage their costs and their workforce, an experience study can be an important tool in accomplishing these goals. Understanding retirement and withdrawal patterns not only provides more accuracy in measuring pension liabilities but also better positions corporations to make strategic business decisions such as settlements or divestitures.

What a corporate pension experience study examines

In general, two assumptions are examined during an experience study: demographic and economic. Demographic assumptions focus on the characteristics of the plan population. They include assumptions such as rates of termination of employment, retirement, disability, and mortality. Economic assumptions pertain to the pension plan’s financial landscape. They involve the inflation rate, cash balance interest crediting rates, and pay increases.

Both demographic and economic assumptions play key roles in determining the financial health and sustainability of a pension plan. An experience study assists in creating a set of assumptions that best project the experience of the plan in determining liabilities to help plan sponsors anticipate future costs.

Actuaries can isolate the structure of each assumption to review the experience at virtually any combination of characteristics, such as age, years of service, and gender. They can analyze characteristics individually or in combination to determine which assumption set best fits the current and historical experience to create recommendations.

In addition, while reviewing experience, actuaries should consider temporary factors—such as the COVID-19 pandemic and one-off internal business decisions—that are captured in the study but may not be indicative of future experience.

When is the best time to consider an experience study?

An experience study can be strategically timed to reflect certain business decisions. For instance, if one is done after risk transfer activity, the new assumptions can better align with expectations for the new population going forward. An experience study could also be done prior to an asset–liability study so that fund managers can better align plan assets with the expected plan experience.

The bottom line: Regular experience studies matter for pension plans

Regular reassessment of a corporate pension plan’s assumptions keeps them aligned with evolving demographic and economic realities. An experience study enables plan sponsors and their actuaries to identify needed adjustments to better manage cost volatility and secure the plan’s long-term financial health. Your Milliman actuary can help determine if an experience study is right for your defined benefit plan.

—Your Milliman Actuary

This edition of Dear Actuary was written by Stephen Kowalski, FSA, EA, MAAA.