Target Cost
The parameters of the Target Cost dialog box pertain to the target cost methodology of forecast analysis. Target cost analysis involves defining a funding target and a contribution pattern, selecting a period in which to reach the target and, in a Stochastic Forecast, selecting a level of conservatism. The target cost is a theoretical percentage of pay required to achieve a prescribed funded status over a given time interval. Note that, although ProVal determines the annual plan sponsor/employer contributions needed to meet the target, these contributions are not reflected in actual (experience) employer contributions when assets are rolled forward to future valuation dates during the forecast period.
The target is expressed as a funded ratio: the market value of assets divided by a liability value. Select the desired Liability type, which can be any of the following funding liabilities:
RPA’94 Current Liability (U.S. qualified mode)
Gateway Current Liability (U.S. qualified mode)
Actuarial Liability (determined under the specified actuarial cost method of the Contribution Policy topic)
Solvency Liability (Canadian registered mode)
Present Value of Future Benefits,
Funding Not-At-Risk Liability
Funding At-Risk Liability
or any of the following accounting liabilities:
Entry Age Normal Accounting Liability (U.S. public mode)
Accumulated Benefit Obligation (ABO)
Projected Benefit Obligation (PBO) or, in OPEB mode, Accumulated Postretirement Benefit Obligation (APBO)
Expected Benefit Obligation (EBO) or, in OPEB mode, Expected Postretirement Benefit Obligation (EPBO).
Select the desired target liability funded ratio (enter as a percentage, not a decimal fraction – e.g., 100, not 1, for 100%). The target cost will be calculated such that if the target cost percentage of total payroll (which percentage is displayed in the forecast output under the “target cost” variable) indicated by the contribution pattern is contributed through the forecast year for which it is displayed, the market value of assets will grow to meet (by the valuation date in that year) the desired liability funded ratio, based on the specified type of liability.
Choose the desired contribution pattern, either a level or a variable percentage of payroll. For a variable pattern, also enter the desired annual relative contribution as a multiple of the target cost percentage of payroll and enter, in the From and To columns, the years to which they apply. For example, suppose the (baseline) valuation date of the forecast is 1/1/2006 and you enter the following:
| From | To | Relative Contribution |
| -- | 2007 | 0 |
| 2008 | 2011 | 1 |
| 2012 | -- | 2 |
With these parameter settings, ProVal will solve for the theoretical level percentage of total payroll (i.e., of the value displayed for the forecast output variable “total salary”) to fund the chosen liability over the time horizon – but with no contributions during 2006 and 2007 and contributions in 2012 and later years at a rate that is twice the contribution rate (as a percentage of payroll) of years 2008 through 2011.
Because percentile results are available from a Stochastic Forecast, a level of conservatism can be introduced. For example, consider the following case. Suppose the employer would like to be very confident (90%) that the plan will be 100% funded at the end of five years. First we need to decide which liability type to use and to find out what contribution pattern the employer wants. Assuming that ABO is used as the measure of the liability and that level funding is desired, we could then calculate the target cost level as follows:
Set the target liability type as ABO and the target liability funded ratio at 100%; select a level contribution pattern.
Run the stochastic forecast and view the 5th year, 90th percentile value of the target cost. This is the level contribution for the five-year period (expressed as a percentage of payroll) that gives the plan a 90% chance of being at least 100% funded on an ABO basis by the end of 5 years.
Employers might use target cost analysis for any number of reasons, including to:
Determine the actual contributions to be made to the plan, subject to applicable minimum/maximum contribution rules. (Note that the actuary may be able to modify the plan’s valuation assumptions to obtain a set of assumptions that satisfy the applicable reasonableness criteria and also allow the desired contribution level.)
Compare alternative asset allocations: at a given point in time and with a desired degree of conservatism, the preferred asset mix is the one with the lowest target cost.
Quantify the cost of a proposed plan amendment.