News Column

Role of Actuary in Context of Pension Reform Act 2014

August 13, 2014

Pius Apere

ON 1 July, 2014, the President signed the Pension Reform Act 2014 (PRA 2014) into law. This Act repeals the Pension Reform Act No 2 of 2004, governs and regulates the administration of the Contributory Pension Scheme (CPS) in Nigeria.

This article highlights the role of the actuary in the management and regulation of the different pension schemes operating in the reformed pension industry in Nigeria.

Who is an Actuary?

An actuary can be defined as a business professional who uses skills in mathematics, economics, computer science, finance, probability and statistics, and business studies to help both public and private institutions assess the financial and/or non-financial risks occurring and to formulate policies using modelling techniques that minimize the cost of those risks, in order to remain solvent (Wikipedia).

Thus, actuaries are best-known for their expertise in quantifying contingent risk and for the provision of advice to assist the managers and other stakeholders of financial institutions to understand and to manage their risk. Actuaries are also often experts in the design of financial security systems and also in the design and management of pension schemes. Another key area of expertise of actuaries is in investment, particularly in relation to strategic decision-making regarding investment asset allocation, although some actuaries also work in active fund management roles where they are making the day-to-day investment decisions whether to buy, sell or hold particular stocks.

Pay-As-You-Go (PAYG) Defined Benefit Schemes

In pay-as-you-go (PAYG) defined benefit (DB) schemes (e.g. for members of Armed forces, exempted public service employees and pensioners as stated in section 5(1) of PRA 2014) the main roles of the actuary is to estimate the future cost of providing the benefits in accordance with the scheme rules and regulations.

For a pay-as-you-go scheme which virtually has no fund at all, except perhaps a working balance to cover slight mismatches of the timing of income and expenditure, the actuary's role is to make actuarial projections of income and expenditure and to estimate the excess or shortfall, or to calculate the contribution / tax rates which will be necessary if the income and expenditure is to be kept in balance year by year.

Actuaries might have a professional duty to "blow the whistle" if the trustees of the public service schemes are failing in some material way to administer correctly (i.e. allowing fraudulent practices) according to the scheme rules and the general regulatory requirements. An actuarial valuation which serves as a risk management tool is required by law (and also clearly stated in the rules of the pension schemes) and yet it has been inadvertently neglected or carried out on an irregular basis. Thus, the failure to seek an actuarial advice on a regular basis in the management of the public service pension scheme in the past is one of the fundamental causes of the pensioners' problems in Nigeria. For example, the provision of unrealistic budgetary allocations for pension costs due to lack of actuarial advice had led to the availability of excess funds allocated which resulted in the fraudulent practices, ghost or fake pensioners' scandals.

The PAYG DB schemes for exempted employees and pensioners which are under the supervision and regulation by National Pension Commission (PENCOM), as stated in Sections 6 and 46 of PRA 2014, still need the services of the actuary even if the schemes are in their run-off stages.

Funded Defined Benefit (DB) Schemes

In a funded defined benefit (DB) pension scheme (for employees and pensioners in private sector not applicable under section 2 subsections (2) or (3) of PRA 2014), the role of the actuary is to carry out actuarial valuations on a regular basis, often three or five yearly intervals as stated in the scheme rules to estimate the appropriate level of contributions needed to pay for the benefits. The level of contributions and the adequacy of the assets held to meet the future costs of the accrued benefit rights, need to be kept under regular review. Solvency requirements (valuation methodology and assumptions) for the private sector were at the discretion to the actuary.

In addition, actuaries advising funded DB schemes have the role to determine: bulk transfer values in relation to mergers and acquisitions, individual membership transfer values, and blowing the whistle etc.

Section 50(2) of PRA 2014, specifies that an employer in the private sector operating any defined benefits scheme (particularly for the exempted employees) shall undertake, at the end of every financial year, an actuarial valuation to determine the adequacy of his pension fund assets. Thus, section 50(2) takes precedence over any scheme rules in terms of the inter-valuation period.

Funded Defined Contribution (DC) Schemes

In a defined contribution pension scheme (CPS), for employees and pensioners not exempted under PRA 2014, it is sometimes suggested that little actuarial involvement is required, since the benefits will be what they will be. However, notwithstanding the apparently simple structure of defined contribution schemes, there are still many aspects which require actuarial inputs as highlighted below.


Ideally, in order to set an appropriate level of contributions which is likely to generate a target level of benefits, a similar type of actuarial calculation is needed to that for determining contribution levels in a defined benefit scheme. Thus, it is presumed that an actuarial advice was sought in arriving at the contribution rate(s) stated in section 4(1) of PRA 2014.

Actuarial evaluations are required to test the viability of proposed expense/charging structures at the design (or charges review) stage of CPS and to assess the necessary level of provisions (for the administrative and investment expenses of maintaining the contracts for as long as they could remain in force) each year in an ongoing basis.

The actual expenses are incurred at the level of the Pension Fund Administrator (PFA), Pension Fund Custodian (PFC) and PENCOM, but deductions can usually be made from the members' contributions (or income based), and sometimes also as a percentage levy on the funds under management (or asset based), annually or more frequently, in line with regulatory guidelines, as stated in sections 24(d) and 83(2) of PRA 2014.

The current charging structure adopted under the PRA 2014 (including any existing regulation of fees) is less vulnerable to insolvency. However, the PFAs and PFCs can become insolvent in the future. Thus, the management of the expense provisions and general oversight of the adequacy of deductions to cover the expenses actually being and/or likely to be incurred, should be considered to be actuarial tasks.

Individual projections

Once a defined contribution scheme is in place, projections may be carried out for various purposes (e.g. to test maximum funding, to test for the maintenance of prior expectations or predict what proportion of the emerging benefit will be to the final projected salary).

Section 4(1) of the PRA 2014 sets the compulsory level of contributions at quite a modest level so that individual members can make additional contributions into the scheme. Furthermore, individual members of a pension scheme should ideally have access to regular actuarial calculations of their own projected benefits, with a view to determine whether additional voluntary contributions (as required in section 4(3) of PRA 2014) would be needed in order to give a reasonable probability of achieving the level of pension they desire.


Section 84(1) of the Act states that holders of Retirement Savings Account (RSA) who have contributed to a licensed PFA for a number of years are entitled to a guaranteed minimum pension as may be specified from time to time by PENCOM.

This guarantee is usually a form of underpin applicable in a defined contribution scheme which has the main benefit that is defined contribution in nature, with a promise that the benefit will be at least a defined benefit amount, usually a percentage of final salary at retirement date.

This guarantee is normally used to protect the members against some of the risks of low investment returns, particularly in the event of exceptionally poor investment conditions, for instance, during the global economic crisis in 2008.

Furthermore, a more generous guarantee may also be applied on a temporary basis after a conversion of a scheme from a defined benefit form to a defined contribution form. Thus, this should be very appropriate at any time a scheme conversion is being made since after the introduction of the (CPS) in 2004.

The responsibility for making good the guarantee rests with the PFA and PENCOM, as the liability of the pension fund itself is limited to the value of the assets held in the individual Retirement Savings Account (RSA). A Pension Protection Fund (PPF), as stated in section 82 of PRA 2014, is to be established and maintained by PENCOM in order to fund the minimum guaranteed pension.

However, the assessment of the cost of guarantees (using stochastic modelling techniques) becomes an issue for capital adequacy and financial management of the PPFs with guidelines to be issued by PEMCOM and this is clearly a task which should be under the control of an actuary.

Investment management

One of the most important functions in a defined contribution pension scheme, no matter what the legal structure, is the management of the investments. Strategic investment decisions should be made on the basis of a thorough understanding of the trade-offs of risk and return and in the light of clear investment objectives for the fund, including a clear understanding of the risk profile.

Individual funds may have different risk profiles, particularly where pension funds are allowed or encouraged to offer a choice of funds, in order to satisfy different risk appetites of scheme members or to enable them to tailor their pension investments to the duration profile of their employment and retirement prospects (life-style investment strategies).

Actuaries should typically have a part to play in strategic investment decision-making, bringing to bear skills in asset-liability modelling and stochastic modelling of investment portfolios in order to inform the decision-making process. Thus, an actuarial advice is needed by the Investment Strategy Committee, which is to be established by every PFA under section 78 of PRA 2014, in carrying out its functions. In addition, actuaries can also provide PENCOM with an independent assessment of the appropriateness of PFAs investment strategies.

Risk management

The essence of a switch from defined benefit (DB) scheme to CPS is the transfer of risk from the employer to the employee. In this context, risk is the volatility of the standard of living (which could be measured in terms of replacement ratio or real income) that each employee can maintain in retirement by virtue of being a member of the CPS. It is important that employees understand this message, and the actuary has a pivotal role to play in the effective management of this risk.

However, there is a role for the actuaries in projecting the range of pension benefits which could be reasonably and/or realistically expected to emerge from a given contribution rate, taking into account the inflation, the variability of expected pension and the investment funds selected

Other objective of the CPS design is the desire by the employers to reduce pension cost. The pension cost is an integral part of the overall employment benefits package and therefore there is a risk of reduction of some other employment benefits (such as healthcare benefit) by employers as the pension cost, the contribution(s), has been increased in the new law, as stated in section 4(1) of PRA 2014. Thus, I presume that the new contribution rates were arrived at having considered the overall financial and actuarial implications.

An actuarial advice would also assist the Risk management Committee (which is to be established by every PFA, as stated in section 78 of PRA 2014) in carrying out its functions.

Performance Measurement

In many countries actuaries have led the way in the development of sophisticated tools for measuring and monitoring the performance of investment managers. Performance measurement services should be independent of the fund managers (PFAs) so that they can be seen to be fully objective.

Actuaries also benefit from being able to track the performance of a significant number of the investment managers within a market, in order to make comparisons. Regular performance measurement reports should be made available to the managers of a pension fund and to the trustees or directors who have accountability for the scheme under the respective corporate governance structure. These should then be used as a major part of the process of holding the investment managers to account and making decisions on choice of investment manager. Actuaries can assist employers in the choice of their PFAs and PFCs.


The purchase of an annuity is a way of transforming accumulated savings (RSA) into a regular pension, which will also provide a guarantee of continued payment throughout the remaining lifetime of the individual.

An actuary must be responsible for the pricing of annuities at retirement age or at any other point at which an annuity can be purchased. Pricing annuities requires assumptions to be made about future levels of mortality rates for the group of individuals who have purchased annuities, the appropriate rate of interest to use and the expenses of paying out annuities.

The subsequent reserving requirements of the annuity portfolio should also be under the control of the actuary, together with all aspects of the financial management of the pension annuity company (e.g. life insurance company).

Section 7(1)(c) of PRA 2014) states that the guidelines for regulating the purchased life annuity business are to be issued jointly by NAICOM and PENCOM. This means that PENCOM also requires an actuarial advice in order to carry out its responsibility.

Programmed Withdrawal (or Income Draw-down)

Although programmed withdrawal (or income draw-down), in section 7(1)(b) of PRA 2014, as an alternative to purchase of an annuity, appears to require less actuarial involvement, since there is no new contractual commitment. In fact the individuals concerned ought to be provided with regular actuarial advice.

Under programmed withdrawal the individuals maintain more control of their own investment portfolios, but have to bear their own longevity risk. In order for individuals to be able to manage their financial affairs intelligently, they need to be provided with regular projections of their future financial position, on different assumptions about investment returns and their own longevity. There may be legislative restrictions on the amount of the fund that can be withdrawn each year and the age at which drawdown must cease and a pension must be purchased.

Whilst deferral of annuity purchase may allow the individual to remain invested in equities for longer, survivors will experience mortality drag when they purchase an annuity at the end of the drawdown period. This means that they are effectively charged for their survivorship throughout the drawdown period. In practical terms it represents the extra investment return an individual has to achieve to justify not annuitizing a pension fund. If a member is going to use income drawdown, this should be reflected in the assumptions. Thus, the need for actuarial advice in order to provide this benefit cannot be overemphasised.

Lump Sum Payment at Retirement

Section 7(1)(a) of PRA 2014 states that a holder of a Retirement Savings Account (RSA) upon retirement or attaining the age of 50 years, whichever is later, can withdraw a lump sum from his RSA provided the amount left after the lump sum shall be sufficient for programmed withdrawal or purchased life annuity. The assessment of an appropriate lump sum to be taken at retirement will require an actuarial advice since there will be an amount underpinning the payment (in terms of the programmed withdrawal or purchased life annuity) which needs to be considered.

Life cover

Under Section 5 of PRA 2014 there is a separate arrangement for continuing group life insurance cover. Employers are required to maintain life insurance policy in favour of the employee for a minimum of three times the annual total emolument of the employee.

Whether this is handled in ordinary life insurance companies or through some other mechanism, an actuary should be involved in setting the risk premiums for life cover and in monitoring all aspects of the experience in order to update the technical assumptions. This type of business should be subject to the same requirements for actuarial management, reserving, capital adequacy monitoring and financial condition reporting as for any insurance company.

Regulation and supervision

The PRA 2014 requires an extensive regulation and supervision and therefore, the regulator (PENCOM) should also have access to actuarial advice in order to be properly equipped to monitor and understand the financial and actuarial conditions of the CPS and pension fund management companies (PFAs and PFCs).

Transfer Entitlements from DB Scheme to DC Scheme

Section 15(1)(a)(b) of PRA 2014 states that the transfer entitlement (the accrue right to retirement benefit) for any non-exempted public service employees who had been under any unfunded DB pension scheme existing before the commencement of PRA 2004, shall be recognised in the form of a bond to be known as Federal Government or Federal Capital Territory Retirement Benefits Bonds (RBB) issued by Debt Management Office (DMO).

The bond redemption value (amount acknowledged through the issuance of a bond) as at commencement date and the methodology in calculating this value are not clearly specified in the PRA 2014. This transitional cost (the bond redemption value) will not represent a fair value for the employees if the transitional cost is less than the actuarially calculated value of the employees' accrued rights under the existing DB scheme. However, I presume that an actuarial advice would have been sought before the issuance of the RBB.

Furthermore, the Federal Government and Federal Capital Territory shall pay into their respective Redemption Funds held with the Central bank of Nigeria (CBN) an amount, as specified in sections 39(2) and 41(2) respectively, earmarked to redeem any retirement benefit bonds issued pursuant to Section 15 of PRA 2014.

In addition, Sections 39(3) and 41(2) require PECOM to determine the adequacy of the Redemption Funds, at the end of every calendar year, against the projected pension liability of the Federal Government and Federal Capital Territory arising from normal, voluntary and mandatory retirements, death of employees in service and the rights of pensioners. PENCOM will need an actuarial advice in order to carry out this responsibility.

For non-exempted employees in existing funded DB schemes in the private sector, an actuarial computations of each employee's accrued rights are required to determine the transfer entitlement to be credited into the employee's RSA.

National Pension Data Bank

Section 15 of PRA 2014 requires PENCOM to ensure the maintenance of a national data bank on pension matters. A database of this nature needs to be relevant, credible, reliable and appropriate for pension scheme management decisions making process as well as for actuarial computations which would require projections of economic and demographic factors. Therefore, actuarial inputs are necessary elements in the creation of such a database.


It is clear that all types of pension schemes require active input from actuaries. This is unquestionable in respect of DB schemes and most jurisdictions require extensive involvement by actuaries. For defined contribution schemes the picture is more variable, with some countries using actuaries almost as much as for defined benefit schemes and others apparently ignoring the need for actuaries, on the grounds that such pension funds are seen as pure investment accumulation vehicles.

However, notwithstanding the apparently simple structure of defined contribution schemes operating in Nigeria, there are still many aspects which require careful monitoring and control using actuarial skills, from the perspectives both of the employers/employees and the managing company (the PFAs and PFCs), as well as the regulator (PENCOM).

-Dr Pius Apere (FCII, PhD in Actuarial Science), is Deputy Managing Director, Linkage Assurance Plc

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Source: AllAfrica

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