How Defined Benefit Plans are Valued

In order to determine the value of a benefit under a Defined Benefit Plan as of a specific date, the valuator actuarially determines the present value of receiving a future pension benefit (monthly income upon retirement). Or, said in another way, the valuator determines how much money must be invested today so that when the employee retires there will be enough money in the plan so that he/she can withdraw monthly from the plan the amount of money he/she is entitled to receive for the remainder of his/her lifetime. In determining the present value, the pension appraiser takes into consideration mortality, age on date of valuation and separation, normal retirement age, the monthly entitlement upon retirement, an appropriate interest rate and etc.

For example, the Jones' were married on April 30, 1970. Mr. Jones has been employed by the XYZ Company since April 15, 1965. On April 1, 1996, the Jones' separated. As of the date of separation, Mr. Jones had accrued a vested benefit of $842.14 per month payable at age 62. He was born on April 2, 1940. What is the present value of Mr. Jones' defined pension benefit? The services of a pension appraiser are secured to determine the present value of the defined pension benefit by the P.B.G.C. Actuarial and Mortality Tables Method, Life Expectancy Method , GATT Method or a specific method dictated by state law. Following are two examples of hose these methods are used.

Life Expectancy Table Appraisal
This approach is based upon the use of Life Expectancy Tables. Present Value is determined by this six-step process.
(1.) Calculate the amount of the monthly pension benefit if it were assumed that the pension holder was at retirement age with a fully vested pension based upon compensation and plan provisions as of the Date the Marriage Ended.
(2.) The pension holders’ life expectancy as of the Date the Marriage Ended is subtracted from the normal retirement age to determine the expected number of months of pension benefits.
(3.) An appropriate interest rate is used to determine the present value of the monthly benefit as of the Date of Valuation.
(4.) The present value is then discounted for mortality and disability (if applicable).
(5.) The present value is reduced if the plan has not vested.
(6.) If a portion of the pension was earned outside the marriage, a coverture fraction is applied.

Mortality Table Appraisal
This approach is based upon the use of Mortality Tables. Present Value is determined by a four-step process.
(1.) Calculate the amount of the monthly pension benefit if it were assumed that the pension holder was at retirement age with a fully vested pension based upon compensation and plan provisions as of the Date the Marriage Ended.
(2.) Mortality Tables and the application of an appropriate interest rate are utilized to determine present value.
(3.) The present value is reduced if the plan is not vested.
(4.) If a portion of the pension was earned outside the marriage, a coverture fraction is applied.

From an actuarial standpoint, the use of mortality tables is preferable to the use of life expectancy tables. However, case law in some states dictates the use of Life Expectancy Tables.