Actuarial Gain or Loss

MoneyBestPal Team
The difference between the actual pension payments that the employer makes and the expected payments based on the previous actuarial assumptions.

Estimating the future payments that the employer will make to the retired employees presents one of the management challenges of a defined benefit pension plan. 

Such projections depend on a number of variables, including the workforce, their retirement age, their life expectancy, their level of pay, and the rate of return on the plan's assets. Nevertheless, these variables are liable to alter with time and occasionally turn out to be different from the initial hypotheses. In this situation, the employer can have an actuarial gain or loss.

An actuarial gain or loss is the discrepancy between the employer's actual pension payments and what was anticipated based on prior actuarial assumptions. When actual payments fall below expectations, there is an actuarial gain; when they rise above expectations, there is an actuarial loss. For instance, if a worker leaves earlier than planned, the business will pay fewer pension benefits than anticipated, producing an actuarial gain. On the other hand, if an employee retires earlier than expected, the employer would have to pay out more in pension benefits than anticipated, which will result in an actuarial loss.

Changes in demographic assumptions and changes in economic assumptions are the two main causes of actuarial gains or losses. The behavior and characteristics of the plan participants, including their mortality rate, turnover rate, retirement age, and disability rate, are based on demographic assumptions. Economic assumptions, such as the discount rate, the rate of inflation, and the anticipated rate of return on plan assets, are based on market conditions that have an impact on the plan.

The projected benefit obligation (PBO), which is the present value of every future pension payment that the employer is anticipated to make, must be adjusted by the employer whenever there is an actuarial gain or loss. The discount rate used in the PBO calculation is representative of the market interest rate for high-quality corporate bonds at the time the PBO is generated. Inversely, the PBO decreases with a higher discount rate.

The employer's net periodic pension cost (NPPC), which is the sum recognized as an expense for its pension plan in each accounting period, is likewise impacted by the actuarial gain or loss. The NPPC is made up of a number of elements, including service cost, interest cost, expected return on plan assets, amortization of historical service cost, and amortization of net actuarial gain or loss.

A technique to reduce the volatility of actuarial gains or losses over time is to amortize the net actuarial gain or loss. They are accumulated in a balance sheet account known as cumulative other comprehensive income rather than being immediately recognized in the income statement (AOCI). Next, using a corridor method, they are gradually amortized into NPPC over a number of years. According to the corridor approach, actuarial gains or losses can only be amortized up to 10% of the higher PBO or plan assets at the start of each year.

Actuarial profits or losses are significant proxies for a pension plan's funding and management efficiency. They show how realistic and accurate the actuarial assumptions are as well as how sensitive they are to alterations in participant behavior and market conditions. Employers can make sure that their pension plans are appropriately funded and fulfill their obligations to their employees by monitoring and adjusting for actuarial gains or losses.