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Valuation Assumption Sensitivities

The Valuation Assumption Sensitivities topic specifies the range of interest rate or valuation benchmark sensitivities (pension modes) you wish to evaluate in your Core Projection , as well as how various assumed valuation assumptions vary with changes in either the interest rate or valuation benchmark.

The Sensitivity change to interest rates parameter contains fields for entering the interest rate adjustment amounts that determine the “Low: - ” and “High: + “ interpolation anchor points for the low and high valuation interest rate assumptions, respectively. That is, the amount that should be subtracted from or added to any baseline interest rate assumed for valuation purposes (e.g., funding valuation interest rate, accounting valuation discount rate, current liability interest rate, solvency liability interest rate, target liability interest rates) to derive the assumed value of that valuation interest rate in the low or high interest rate environment, respectively, is entered here. In general, the spread of interest rate adjustments should be set almost as wide as the range of interest rates that are feasible, over time, for valuations of your plan.

The Valuation benchmark parameter contains fields for entering the “Low:”, “Medium:”, and “High:“ valuation benchmark interpolation anchor points. In the low valuation benchmark core sensitivity run, valuation assumptions that move with the valuation benchmark will be shifted by the difference between the medium and low valuation benchmark. In the high valuation benchmark core sensitivity run, valuation assumptions that move with the valuation benchmark will be shifted by the difference between the high and medium valuation benchmark. For example, if the plan assumes a 3.5% salary scale and the valuation benchmark anchor points are set at 1%, 4%, and 10% the salary scale will be .5% in the low valuation benchmark run and 9.5% in the high valuation benchmark run.

Sensitivity of other valuation assumptions to changes in interest rates or valuation benchmark contains a list of valuation assumptions that may be expected to vary with changes in the valuation benchmark or with changes in interest rates. There are two groups of topics under this parameter, divided according to the corresponding topic for that valuation assumption in the Valuation Assumptions command. How the parameters of the topic affect values assumed for valuation purposes in a Core Projection is explained in the discussion of the respective topic. To define the relationship between interest rate sensitivity and other valuation assumptions, click the name of a topic and edit its parameters.

Increase/Crediting rates – heading is for descriptive purposes only; click indented subtopic name

Conversion Factors – see the discussion below for situations where sensitivities are ignored for valuing a lump sum factor or late retirement type of Benefit Formula Component or an optional payment form.

Selecting a topic from the listed valuation assumptions leads to a dialog box containing a spreadsheet that lists the relevant items, except that selecting the Cost-of-Living Adjustments (COLAs) topic or the Modified Cash Refund Annuities topic leads to a dialog box containing a single item which, for modified cash refund annuities is “Interest during deferral period”, that is, the interest crediting rate that applies during the deferral period.

If you wish, for Benefit Formula Components, Accrual Basis Components, Employee Contributions, Lifetime and Annual Limits and Lump Sum & Optional Payment Forms, you may select a Plan Filter (in German mode, a Promise Filter) from the dropdown list, to reduce the list of possible choices to those items associated with a particular Plan Definition (or in German mode a particular Benefit Promise). Please see Filters for details.

All lump sum factor components unhidden in the current Project will be listed, as will all unhidden regulatory items. Benefit Formula Components and Accrual Basis Components that were defined with a check in the Apply increase rates to this component box will be listed. An unhidden Payment Form Definition will be listed if it is referenced as an Optional form by some Benefit Definition. An unhidden Lifetime Maximum or Annual Limit will be listed if it is defined with Apply increase rates to limit selected or, for a Lifetime Maximum, with Apply increase rates to outstanding balance (med. Spending account) selected.

For each Item, such as the increase assumption for the Social Security National Average Wage, you indicate What fraction of the assumed sensitivity change should be applied to the following valuation increase rates, where your specifications may vary between funding and accounting valuation assumption sets. Choose if the item varies with interest rates or the valuation benchmark and specify values between 0 and 2.

In the following situations, the sensitivity fraction may not vary with interest rates (except those for lump sum factors and optional payment form conversion factors): (1) to run a Deterministic Forecast, if you select a Forecast Yield Curve as the basis of any type of current or future valuation interest rate (for example, a funding liability interest rate or a U.S. qualified mode target liability interest rate) or (2) to run a Stochastic Forecast, if you forecast to the full yield curve for some future valuation interest rate. This is because, in order to determine the effective duration of the liabilities, which ProVal needs for making an accurate non-parallel yield curve shift, it is necessary to determine the change in the liabilities that results solely from interest rate changes. When the valuation interest assumption at some future valuation date is a full yield curve (specified in the Deterministic Assumptions or Stochastic Assumptions), ProVal cannot isolate the change caused by the interest rate change, for a reason we’ll explain by example. Consider a forecast with (1) future valuation interest rates defined as a full yield curve, 4% grading down to 2.5% at duration 25, and (2) an underlying Core Projection whose Projection Assumptions specify (a) a sensitivity fraction of 0.5 for salary inflation and whose Valuation Assumptions specify (b) an interest rate assumption that is a full spot yield curve, 1% grading up to 5% at duration 30. Thus the baseline valuation interest rate basis is “1%, at the initial duration, grading up to 5% 30 durations later”, which must shift to “4%, at the initial duration, grading down to 2.5% just 25 durations later”, so there are several interest rates moving in different amounts and different directions (because, remember, the shift is not parallel, so there is no uniform amount of interest rate change at all durations). As a consequence, to derive the amount of change in the rate of salary inflation, it is not clear how to compute 50% of the change in the interest rate; that is, it is unclear which interest rate to select (from among several duration-based rates). Note that if a Forecast Yield Curve is the interest basis at some future valuation date(s) only for funding (not accounting), then only the fractions in the Funding column need be set to zero; similarly for accounting, if a Forecast Yield Curve is the interest basis at some future valuation date(s) only for accounting, then only the fractions in the Accounting column need be set to zero.

When setting the sensitivities for Conversion Factors, it is important to note that the sensitivity fractions for a lump sum factor, late retirement component or conversion factor Item are ignored for setting the assumed valuation lump sum factor interest rates to be used to calculate liabilities when the Conversion Factors topic of Valuation Assumptions is coded to use underlying liability interest rates (that is, to use the valuation interest rates). When a lump sum interest rate is defined as the underlying liability interest rate, the underlying interest rate will always be used in full, regardless of whether the sensitivity fraction for the lump sum factor is coded as “1” or “0” (or any fractional amount in between). Also, the sensitivity fractions for the optional form conversion factor Item are ignored when a conversion factor is defined by a table (in lieu of a mortality and interest basis).

When setting the sensitivities for Benefit Formula Components and Accrual Basis Components that have increase rates or crediting rates applied, or when setting sensitivities for the crediting rate on Employee Contributions or the guaranteed amount during a deferral period of a modified cash refund annuity, note that setting the Valuation Assumptions increase and crediting rates to the table option and selecting “<no rates>” does not produce the same results as setting the increase and crediting rates to a constant value of zero, because sensitivities are applied to the constant of zero but not applied to the table option if “<no rates>” is selected.  For COLAs, however, selecting “<no rates>” does produce the same results as setting the valuation assumption COLA rates to a constant value of zero, because sensitivities are not applied in either case.