What is an Actuarial Gain Or Loss?
Actuarial gains and losses are modifications in the actuarial present value of defined benefit pension plan obligations. Actuarial gains or losses are caused by changes in the discount rate and/or the expected rate of return on plan assets. Actuarial gain or loss occurs following external auditors’ evaluation of a reporting employer’s defined benefit pension plan and during actuarial valuations performed by external actuaries retained by the company.
The FASB (Financial Accounting Standards Board) SFAS No. 158 states that pension deficits or surpluses must be reported on the sponsor’s balance sheet. And so, every year, there are periodic updates to the pension obligations, the plan performance, and the financial health of the plan. You can expect an actuarial gain or loss, which is the difference between projected and estimated future pension costs, to impact the changes in your pension plan’s future contributions.
These accounting rules allow pension assets and liabilities to be adjusted to their current market value on the balance sheet. However, changes in actuarial assumptions will be amortized through comprehensive income rather than through the income statement.
Understanding Actuarial Gain Or Loss
Actuarial gain or loss is a measure used in the context of accounting. This is under U.S. GAAP (generally accepted accounting principles).
U.S. GAAP and IFRS prescribe similar principles measuring pension benefit obligations, but their income statements have different treatments of actuarial gains and losses.
Funded status is generally stated as what the company has saved for the future or the amount it still owes. Asset valuation requires a degree of judgment, but PBO valuation is actuarial science. Actuarial gains and losses result from assumptions about market performance.
The two primary types of assumptions are economic assumptions about market forces and demographic assumptions about participant behavior. The economic assumptions deal with the market forces on the plan, and the demographic assumptions deal with how participants’ behavior affects the benefits. Economic assumptions include the interest rate used to discount future cash outflows, and most real-world loss models depend on some form of interest rate, the expected rate of return on plan assets, and expected salary increases.
Demographic assumptions include how long each person is expected to live, how long your company expects them to work for the company, and what age they are assumed to be when they retire.
Actuarial Gains and Losses Create Volatility in Results
Changes in an actuarial assumption can cause a dramatic swing in the PBO, particularly concerning the discount rate. If amortized overtime via the income statement, these adjustments could potentially distort the comparability of financial results.
Under the U.S. GAAP, these gains and losses resulting from the difference in the marketplace’s interest rates compared to mortality assumptions are recorded through other comprehensive income in shareholders’ equity and amortized into the income statement over time. On the other hand, under IFRS, these gains and losses are recognized directly in earnings.
Actuarial adjustments are based on changes to pension payments, and employers experience actuarial gains or losses when their expected payments change. For example, a windfall will increase the pension plan’s assets, while reducing the expected benefit payments will decrease them.
Companies typically set aside money from their earnings to pay their future pension benefits. The amount of money a company needs to set aside depends on the number of employees hired and how much they are expected to earn over their working lifetime.
Accounting for Actuarial Gains or Losses
In order to fully disclose the financial condition of pension reserves, a company must report gains or losses for each reporting period based on the current estimated value of its pension liabilities. After adjusting their pension obligations, businesses must report the financial condition of their pension plan at the end of each annual accounting period.
When accounting for actuarial gains or losses, pension actuaries take into consideration many complex factors. These include employee salaries, retirement rates, mortality rates, future inflation, and future investment returns. This information is used to calculate how much an employer must invest to ensure full payouts to retirees later on.
Actuarial gains or losses are the adjustments employers may have to make due to changes in the value of their plan assets such as stocks, bonds, and corporate loans. When a company amortizes increases or decreases over time, it creates a line item for the amount to be paid if it anticipates paying pension benefits to current employees. This disclosure is meant for investors and regulators who use the information to value financial assets and liabilities.
How to minimize actuarial gains or losses?
Actuarial gains or losses are minimized by the use of sound assumptions in actuarial valuations. Management, actuary, and auditors work together to estimate future cash flows, discount rates, and key variables.
For example, experience may dictate that if policyholder mortality improves faster than projected, future reserves will be lower than estimated. The best practice is to identify potential weaknesses early and reduce them through appropriate risk management strategies and effective information systems. To minimize actuarial gains and losses, it is crucial to identify the most credible assumptions supported by sufficient internal and external evidence.
- Actuarial gain or loss is a measure used in the context of accounting. This is under U.S. GAAP (generally accepted accounting principles).
- Actuarial adjustments are based on changes to pension payments, and employers experience actuarial gains or losses when their expected payments change.
- Actuarial gains or losses are minimized by the use of sound assumptions in actuarial valuations.