Definition
Actuarial gain or loss refers to the changes in the estimated future financial obligations of a company, typically related to pension benefits, due to deviations from previous assumptions. This can occur if there are differences between estimated and actual investment returns, longevity, or employee turnover. It’s recorded as a gain if the plan’s assets increase or liabilities decrease more than expected, and a loss if the assets decrease or liabilities increase more than expected.
Phonetic
æ k tʃ uˈeər i əl ɡeɪn ɔr lɔːs
Key Takeaways
- Actuarial gain or loss is a concept related to pension plans. It represents the changes or variations in the estimated amount of financial liabilities or assets in a pension scheme. These variations occur due to differences in actual outcomes as compared to the predicted actuarial assumptions related to factors such as rates of return, employee turnover, or mortality rates.
- Actuarial gain is realized when the actual outcome is better than expected, such as higher than predicted rates of return or lower than expected pension liabilities. Conversely, an actuarial loss is experienced when the actual outcome is worse than the projected results, for instance, if the company’s investment portfolio underperforms or its pension liabilities are higher than expected.
- The detection, calculation, and reporting of actuarial gains and losses are essential for the effective management of pension plans. It helps keep pension funds solvent and ensures that companies can meet their future pension obligations. The management of actuarial gains and losses is also crucial for maintaining transparence and trust among the plan participants and stakeholders.
Importance
The term ‘Actuarial Gain or Loss’ is an essential element in the finance and business world, crucially contributing to the overall risk management strategy of a company. It refers to the financial adjustments reflecting deviations from expected results in a company’s pension plan obligations, caused by changes in actuarial assumptions such as life expectancy, interest rates, or wage growth. Any unexpected change can have profound impacts on a company’s financial health and stability. Actuarial gains or losses help the company and its stakeholders understand how these changes affect the value of the pension plan assets and liabilities, enabling better financial planning, risk management and decision-making process, and compliant disclosures in financial reporting.
Explanation
Actuarial gain or loss is primarily used in the world of finance to evaluate and quantify changes or discrepancies in the estimated liabilities of pension plans and other post-employment benefits. These changes can come from various sources such as differences in actual economic outcomes when compared to initial estimates, modifications in actuarial assumptions, or alterations in the benefits of a plan. At its core, actuarial gain or loss serves as a risk measurement tool, providing comprehensive insights into the financial health of a company’s benefit obligations by weighing the predicted costs against the actual costs.
The purpose of calculating actuarial gain or loss is primarily to guide financial and strategic decisions of both the company and its shareholders. It offers an objective view of the firm’s ability to meet its future obligations to its workers and can influence the company’s planning, investment strategies, and funding allocations. For shareholders and potential investors, understanding a firm’s actuarial gains or losses allows them to gauge how the company’s liabilities may impact its long-term profitability and financial stability. Therefore, it’s extremely valuable in informing both internal and external assessments of the company’s financial position.
Examples
1. Corporate Pension Plan: A large corporation has a pension plan for employees that they account for actuarially. If, at the end of a fiscal year, the corporation’s actuaries calculate that due to higher-than-expected investment returns, the value of the plan’s assets increased beyond what was projected in their original actuarial assumptions, this would be considered an actuarial gain.
2. Insurance Company Reserves: An insurance company may experience an actuarial gain or loss in regards to its claim reserves. If a series of claims turns out to be less costly than initially estimated due to better-than-expected health outcomes of policyholders, the company will experience an actuarial gain. On the contrary, if a catastrophe occurs and the claims far exceed the initial estimate, this will result in an actuarial loss.
3. Life Insurance Policies: A life insurance company estimates mortality rates for policyholders to determine the price of premiums and the company’s possible liabilities. If the actual death rates are lower than expected (meaning policyholders live longer than expected), the life insurance company would experience an actuarial gain, because they will collect premiums for a longer period than expected before paying out death benefits. Conversely, if the death rate is higher than expected, it would result in an actuarial loss, with the life insurance company needing to pay out more in death benefits than expected.
Frequently Asked Questions(FAQ)
What is an Actuarial Gain or Loss?
Actuarial gain or loss refers to changes in the estimated cost of a company’s defined benefit pension plan. It helps determine whether the cost of the plan is more or less than what was anticipated, based on certain assumptions about investment returns, employee turnover, and longevity.
How is actuarial gain or loss calculated?
An actuarial gain or loss is calculated by comparing the actual outcome of an event to the estimate provided by the actuary. If the actual cost is less than the estimated cost, the difference is considered an actuarial gain. If the actual cost is higher than the estimated cost, it’s considered an actuarial loss.
Are actuarial gains and losses important to a company’s financial health?
Yes. Actuarial gains or losses can significantly affect a company’s pension fund and its balance sheet. Large actuarial losses, for instance, might signal a need for additional funding to meet pension obligations.
How often are actuarial gains and losses assessed?
Actuarial gains and losses are typically assessed annually, when the company’s financial year ends.
Where can I find information on actuarial gain or loss in financial statements?
Actuarial gains or losses should be reported in a company’s statement of comprehensive income and also in the notes to the financial statements.
Does actuarial gain mean the company is making a profit?
Not necessarily. An actuarial gain refers specifically to the performance of a company’s pension plan, not to the company’s overall fiscal health.
How do factors like employee turnover and longevity affect actuarial gain or loss?
Employee turnover and longevity influence the costs associated with a company’s pension plan. For example, if many employees leave a company early, they may not fully vest in the pension plan, resulting in an actuarial gain. Conversely, if employees live longer than anticipated after retirement, the estimated cost of the plan could be exceeded, resulting in an actuarial loss.
Related Finance Terms
- Experience Adjustment: Refers to the difference between the actual economic outcome and the assumptions made during an actuarial valuation.
- Actuarial Assumptions: The assumptions made by an actuary regarding future factors that will affect pension costs, such as investment returns, salary scales, and employee retirement age.
- Post-Employment Benefits: These are benefits, other than pension distributions, that employees may receive after their employment ends.
- Defined Benefit Plans: These are retirement plans wherein an employer promises a specified monthly benefit on retirement, which is predetermined by a formula based on the employee’s earnings history, tenure of service, and age.
- Actuarial Valuation: A method used by actuaries to assess a firm’s financial status, accounting for variables such as market expectations, and various risks.
