The valuation of a social security scheme includes analysis of future uncertainties and their impacts on the scheme. An actuary identifies and, if possible, quantifies risks stemming from future uncertainties.
Uncertainty is intrinsic to the valuation since it addresses future events, and users of an actuarial valuation must be aware of this fact. The actuarial analysis of social security schemes is based on models as well as on a number of assumptions. Social security schemes are very complex and their future income and outgo depend on many economic and demographic factors, so the models will not be a perfect representation of future reality. Moreover, the projection of cash flows of social security schemes is performed over an extended future time period. With the passage of time, the emerging picture will almost certainly differ from the projections of any actuarial valuation.
The social security institution, as part of its risk management process, should identify future uncertainties and address the risks they pose to the social security scheme. This guideline should be read in conjunction with Part E of these guidelines.
- The relevance and reasonableness of sensitivity tests presented in the uncertainty of results section should be reviewed in each valuation.
- Sensitivity tests may include, but are not limited, to the following:
- Sensitivity to variations in individual assumptions;
- The use of optimistic and pessimistic scenarios;
- Scenarios illustrating particular demographic and economic environments;
- Scenarios illustrating tail events;
- Stress testing.
- In developing sensitivity tests, an actuary may use a combination of stochastic and deterministic methods. Ultimately, the actuary should use his or her professional judgement to ensure the tests’ reasonableness and relevance.
- An actuary should explore ways to efficiently communicate uncertainty to the social security institution and other stakeholders of the scheme. In this matter, reference should be made to Guidelines 25 and 28.
- The social security institution in cooperation with the actuary should review on a regular basis the national and international demographic and economic environment and identify trends that could have a material impact on the social security scheme.
- In the case of a deterministic model, the actuary should develop different sets of alternative assumptions to quantify the impacts of risks identified by the social security institution in cooperation with the actuary.
- In the case of stochastic or hybrid models, uncertainty should be illustrated through the use of stochastic methods which estimate probability distributions of different potential outcomes by allowing for random variation in one or more inputs. Additional sets of alternative assumptions may be required.
- The report on the valuation of a social security scheme should include a section dedicated to the uncertainty of results.