Defined benefit plans come in a few varieties, but most commonly audited are the large traditional pension plans. These plans are quite different from defined contribution plans like 401(k) plans because the benefit due to participants is not based on an individual account balance. Instead, participants receive a benefit based on a specified benefit formula. The formula usually includes inputs such as years of service, age, and some calculation of average compensation. The investment risk is borne by the plan sponsor who is obligated to maintain the funding of the plan to ensure its ability to pay out future benefits.
Defined benefit plans used to be the plan of choice. Back in 1985, 90 percent of Fortune 100 companies sponsored defined benefit plans that were available to new hires. Today, barely more than 10 percent of Fortune 100 companies sponsor traditional defined benefit plans that are available to new hires. Most legacy defined benefit plans are frozen in some way, meaning they might not accept new entrants and/or benefits no longer accumulate.
A few of the key areas of emphasis in the audit of an defined benefit plan include:
Actuarial valuation. Defined benefit plans utilize the services of actuaries to make a variety of assessments pertaining to their benefit obligations. These valuations impact financial statement disclosures, funding levels, and ultimately the amount of money plan sponsors must contribute to keep plan benefit obligations adequately funded. These valuations rely on a variety of assumptions and inputs that must be evaluated for reasonableness and accuracy.
Participant census data. The actuarial valuation is built on the foundation of individual census data for every single plan participant. The census data is the largest and most significant input to the estimated benefit obligation calculated by the actuaries. As such, it can be subject to the classic “GIGO” problem (“garbage in, garbage out”). Census data must be tested for completeness and accuracy and traced back to source documents to ensure that benefit obligations are being calculated using good data.
At Pension Assurance LLP, we design our audits to specifically address these and other key audit risk areas specific to defined benefit plans. When issues are noted, we take a proactive approach, focusing on how to resolve any past errors and make changes to the plan or its operations to prevent the issue in the future. While we must maintain objectivity and independence, we don’t believe that requires us to be adversarial. We take great pride in helping clients positively address issues when they arise.