valuation assumptions (discount rate, salary scale, retirement and withdrawal rates)
To value a pension you must answer a string of 'what will happen?' questions decades into the future: How fast will salaries grow? When will people retire? How many will quit first? How long will they live? What return will the money earn? Nobody knows for sure, so actuaries make explicit, reasoned estimates. These are the valuation assumptions, and together they form the valuation basis.
They come in two families. Economic assumptions concern money: the discount rate (the interest rate used to bring future payments back to a present value — the single most influential assumption), expected investment return, and inflation. Demographic assumptions concern people: the salary scale (how pay rises with age and service, which matters when the benefit depends on final salary), the retirement rates (the proportion retiring at each age), the withdrawal rates (how many leave employment before retiring, also called turnover), and the mortality table (how long pensioners live). Each is built from data, judgement, and prudence. For example, lowering the discount rate from 6% to 5% can raise a long-dated liability by something like 15 to 20%, even though not one benefit has changed.
Assumptions are where actuarial judgement lives, and they are checked and re-set at each valuation; when actual experience differs from assumption, the gap shows up as an actuarial gain or loss. The honest caveat: assumptions are not neutral facts and can be chosen to flatter or stress a result. A sponsor wanting low contributions may prefer an optimistic discount rate; a regulator wanting safety may insist on a cautious one. This is why professional standards demand assumptions be reasonable, justified, and disclosed — and why the discount rate deserves the most scrutiny.
An actuary values a pension at a 6% discount rate and reports a liability of 100 million. The trustees ask: what if returns are lower? Re-running at 5% pushes the liability to about 117 million, turning a small surplus into a deficit. Nothing about the promised pensions changed — only the assumption about the rate at which future payments are discounted.
The discount rate is the heavyweight: a 1% change can swing a long-dated liability by 15 to 20%.
Assumptions are judgements, not facts, and they can be tilted to flatter a result. The discount rate dominates, so always ask what rate (and on what basis) a reported liability uses before trusting it.