Guideline 33. Actuarial input into the management of scheme risks

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The social security institution seeks actuarial input into the management of risks faced by social security schemes.

This guideline identifies some of the risks related to social security schemes, sets out the mechanisms to consider in addressing them through their identification, measurement and treatment using the risk management process set out in Guidelines 30, 31 and 32, and describes actuarial input into this process.

Guideline code
ACT_03800
Mechanism
Mechanism
  • The risk management function and the actuary should identify the risks faced by the social security scheme. These are likely to include, but are not limited to, the following (it should be noted that several risks described below are interrelated):
    • Benefit expenditure risk
  • The benefit expenditure risk is the possibility that benefit amounts paid will be greater than expected. The reasons this may happen include differences between actual and expected benefit payments due to external factors, and changes in benefit rules (e.g. leading to higher payments than expected), as well as higher than anticipated administrative expenses.
  • Differences between actual and expected benefit payments may be triggered by the following factors:
    • Mortality experience different from expected (e.g. lower than expected mortality for retirement systems);
    • Morbidity experience different from expected (e.g. for disability benefits and health schemes);
    • Other demographic factors different from expected (e.g. marriage rates, number of children);
    • Increases in salaries greater than expected (in schemes where benefits depend on the individual’s salary);
    • Inflation greater than expected (where benefit levels depend on the inflation rate);
    • Unemployment higher than expected (for unemployment schemes);
    • Health care reimbursement to providers higher than expected.
  • While changes in benefit rules usually are driven by legislative changes and are phased in, more rapid changes caused by extreme events which lead to, for example, sharp jumps in unemployment or disability cases may also occur. These changes may include ad-hoc payments not envisaged in the benefit rules (e.g. increases to pension in payment). There is also political risk related to reform measures in particular and scheme benefits in general; a change in government or unforeseen changes in policies can have immediate impacts on benefit design and financing mechanisms.
  • Administrative expenses may be influenced adversely by changes in benefits, new legislative requirements as well as by administrative inefficiencies causing cost overruns. Further operational risks described in Guideline 34 may result in higher than projected administrative expenses.
  • Other factors impacting benefit expenditure risk may depend on the evolution of external environments (e.g. increasing unemployment or high inflation) and should be monitored as part of the risk management process.
  • Information on benefit expenditure risk can be secured from the actuarial valuation and cash flow analysis. The measurement of this risk should consider an analysis of experience from past valuations as well as accompanying reconciliations and sensitivity analysis as described in Guidelines 7 and 8. It should be ensured that this information is based on relevant mortality and morbidity tables and appropriate other assumptions (Guideline 3).
  • Treatment of risk should consider changes in benefit design, changes in investment strategy, preventive measures (e.g. reduction in workforce disability cases, partial unemployment schemes), and improving administrative efficiency as well as increasing involvement of all stakeholders.
  • It is important to note that what would appear to be a reduction in expenditure risk through reducing benefits creates or increases other risks related to inadequate benefits (see Scheme objectives risk below).
  • Reference should also be made to Part B and Part G of these Guidelines which cover issues relating to benefit design and financing, and calculation of actuarial factors and benefit entitlements. For example, information in Guideline 19 relating to automatic adjustment mechanisms, and Guidelines 15 to 17 on returns credited to accounts, can be considered as measures that can be or are taken to treat risk.
    • Financing risk
  • Financing risk relates to the possibility of having insufficient financial resources to meet obligations. This may result from lower employer and employee contribution income than expected, reduced government financial transfers or lower income from assets than expected. This risk is extremely important since it could lead to financial and intergenerational unsustainability of the scheme and major schemes changes. These changes could include changes in benefits and contribution levels as well as financing approaches.
  • Guidelines 40 to 43 and 46 provide additional information regarding the treatment of this risk. Similarly Part B may also provide information on measures to take to mitigate and treat such risk.
  • Actuaries should assist in identifying, measuring and treating this risk through the analyses undertaken as part of the actuarial valuations, actuarial studies and asset liability management, as well as through provision of expert advice. Guidelines in Part A and Part C set out more information on the financing risks.
    • Investment risk
  • This risk relates to all aspects of the investment process, including specific risks relating to assets held, income and capital appreciation being less than expected, investment matching risks, third-party risk, volatility risk and default risk. Guidelines 20 to 23 as well as the ISSA Guidelines on Investment of Social Security Funds provide additional information on this risk.
    • Interest rate risk
  • Interest rate risk will particularly impact on actuarial deliberations in Part A (values placed on assets and liabilities) and Part B (calculation of factors and benefit entitlements) of these Guidelines.
    • Currency risk
  • This risk relates to a potential mismatch between the currency in which the liabilities of the social security system (typically the currency of the home country) are denominated and the currency in which some of the assets of the reserve fund are held. Guidelines 21 and 22 provide additional information on this risk and its measurement and treatment.
    • Third-party provider risk
  • This risk concerns external providers (e.g. custodians, health administrations, auditors). Guideline 48 covers a number of the issues to consider in the appointment of external actuaries. The ISSA Guidelines on Investment of Social Security Funds also provide supporting advice on issues relating to the appointment and monitoring of a range of external providers, including investment managers and custodians.
    • Scheme objectives risk
  • Scheme objectives risk is an important risk related to the social security system not meeting its objective to appropriately respond to life-cycle risks. This risk can include inadequate coverage of the population; providing benefits that are not adequate; or the provision of inappropriate benefits (benefits and services provided which do not meet the needs of the individual, the household or society as a whole leading to a sub-optimal use of resources and the system not meeting its objectives). This may arise where the incentives created are inappropriate (e.g. not facilitating return to work of the individual) or do not support wider aims of systems (e.g. labour force participation rates at older ages). In such situations, the risk related to the person covered is transferred out of the social security system to either the individual or another party through formal or informal supporting mechanisms. It is therefore important that the implications of other risk decisions taken on scheme objectives risk are considered. More details of issues relating to coverage and benefit adequacy are set out in Guidelines 44 and 45.
  • The risk of not meeting the system objectives also arises from operational reasons (see Guideline 34).
Parent
E. Risk Management and Analysis
Structure
Principles
  • The role of the actuary and the risk management function should be to analyse the multiple risks faced by social security schemes in the context of the risk management process or framework.
  • This role should be defined and continually reviewed in collaboration with other stakeholders involved in the risk management process as well as the board and management of the social security institution.

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Guideline 33. Actuarial input into the management of scheme risks
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