Some not-for-profit enterprises (NFPs) provide services for a group of people over an extended period of time. Services can include providing accommodation, covering living expenses, and supporting charitable activities. These services may form a key part of the NFPs mission and are often contingent in nature. Accordingly, a difficult and complex aspect of achieving each NFP’s mission can be managing their cashflows and ensuring adequate reserving. NFPs may also face other risks such as investment risk, changes in regulations, and liability claims, which can strain their cashflows.
Without the accurate projection of future cashflows, the organisation may exhaust its available cash and capital, which may not meet its beneficiaries’ expectations and could have negative reputational or mission implications. This article explains the importance of projecting future liabilities and cashflow management for NFPs.
Case Study
A religious NFP was interested in determining the capital required to support the needs of its Sisters for the remainder of their lives while continuing to support its charitable activities. It had limited access to future capital to fund these commitments on a Pay As You Go (PAYG) basis, as it was not expecting new entrants nor new sources of funding going forward. The Trustees and management of the NFP required a projection of future cashflows and assistance with scenario testing to understand the level of reserves needed to meet its commitments under various scenarios.
PFS projected the number of Sisters at different life stages, and the associated costs of maintaining these Sisters. We also projected investment returns, capital growth and other cash inflows and outflows. This enabled us to recommend a central estimate of the liabilities needed to be funded both now and into the future. By stressing our assumptions we were able to recommend an appropriate buffer over this central estimate. Since there were surplus funds available, we recommended a schedule for releasing capital that would allow the NFP to maintain sufficient funds and to adapt if assumptions did not unfold as predicted.
Key outputs include:
Chart 1 – Run-off population of Sisters by life stage
Chart 2 – Projected profit including capital release under different scenarios
With these projections, the NFP is able to make strategic plans and achieve charitable goals, while having the confidence that sufficient reserves are maintained to support their Sisters’ future needs.
Why we need an actuary
Estimating future cashflows and assessing the adequacy of reserves for organisations typically requires actuarial expertise when there is uncertainty inherent in them. This can be due to factors such as longevity risk and investment risk.
Longevity risk
Longevity risk refers to the risk that an individual or group will live longer than expected, leading to higher-than-anticipated costs for NFPs who are supporting a target population. It poses challenges for organisations, as they must manage cashflows, investment, and strategic planning over extended periods to ensure sufficient funding.
Actuaries have expertise in setting mortality assumptions and developing modelling to estimate the cost of supporting population groups as they progress through different life stages. This helps an NFP to forecast the expected target population in each life stage, and to monitor emerging experience against these expectations to reassess requirements, enabling them to manage cash flows, investments, and strategic planning effectively.
Investment risk
Investment risk refers to the possibility of losing money or not achieving the expected return on an investment. It encompasses various factors, including market volatility, economic changes, interest rates, and specific risks related to individual assets or sectors.
Actuaries also possess expertise in risk management and financial modelling, which can assist organisations in projecting investment returns. This helps NFPs estimate key items on their balance sheets and P&L statements, ultimately setting a base for recommendations on reserving.
