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Actuarial Gains or Losses

Moneyzine Editor
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Moneyzine Editor
2 mins
January 4th, 2024
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Actuarial Gains or Losses

Definition

The term actuarial gains or losses refers to an increase or decrease to a company's estimate of their projected benefit obligation as a result of the periodic reevaluation of assumptions. Actuarial gains and losses occur when this reevaluation reveals the opportunity to adjust an assumption.

Explanation

Companies provide employees with a pension plan as part of a larger array of employment benefits. The FASB Statement of Financial Accounting Standards No. 87 requires firms to measure and disclose pension obligations as well as the performance and financial condition of their plans at the end of each accounting period.

Calculating the company's projected benefit obligation, or PBO, requires the skill of an actuarial to perform. The factors used by an actuarial to determine a company's PBO include mortality rates, employee retirements, salary increases, plan participation, program rules, inflation, and the rate of return on investments. Annually, companies will reevaluate the assumptions used in the determination of their PBO.

A change in the assumptions used in developing an estimate of the PBO results in an actuarial gain or loss. For example, an increase in life expectancies, early retirements, increases to the discount rate, higher than plan salary increases, and lower than expected returns on the plan's investments will increase the company's PBO. Alternatively, an increase in mortality rates, delays in retirements, decreases to the discount rate, lower than plan salary increases, and higher than expected returns on the plan's assets will decrease the company's PBO.

As was the case with prior service costs, accounting rules require companies to amortize this increase in the projected obligation to pension expense. The amortization should occur over a future time span that aligns with the average remaining future service of those participants that benefited from the amended plan.

In addition to the plan's gains and losses, the overall level of pension funding depends on variables such as the return on plan assets, interest costs, service costs, prior service costs, and changes to the plan's formula.

Related Terms

  • The term pension plan refers to an arrangement whereby an employer agrees to provide employees with a stream of income payments after they retire. Pension plans are typically divided into two broad categories: defined benefits plans and defined contribution plans.
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  • The term defined benefits plan refers to a pension plan whereby an employer provides employees with a known stream of income payments after they retire. With a defined benefits plan, the employer assumes all of the risk associated with the performance of the investments in the company's pension fund.
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  • The term defined contributions plan refers to a pension plan consisting of a predetermined schedule of fixed employer contributions to an employee's fund. With a defined contributions plan, the employer contributions are known ahead of time, and the exact retirement income benefit will depend on the performance of the investments in the employee's fund.
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  • The term pension obligation can refer to one of three different ways to measure the future expenses or liabilities associated with a pension plan. Generally, pension obligations can be stated in terms of accumulated, vested, and projected benefits.
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  • Accumulated Benefit Obligation (ABO)
    The term accumulated benefit obligation refers to the present value of retirement benefits earned by employees using current compensation levels. A company's accumulated benefit obligation (ABO) is one of three ways to calculate expenses or liabilities associated with pension plans. The other measures include vested benefit obligations (VBO) and projected benefit obligations (PBO).
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  • The term vested benefit obligation refers to the portion of the accumulated benefit obligation that employees will receive regardless of their continued participation in the company's pension plan. A company's vested benefit obligation (VBO) is one of three ways to calculate expenses or liabilities associated with pension plans. The other measures include accumulated benefit obligations (ABO) and projected benefit obligations (PBO).
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  • The term projected benefit obligation refers to the present value of the retirement benefits earned by employees, using an estimate of future compensation levels. A company's projected benefit obligation (PBO) is one of three ways to calculate expenses or liabilities associated with pension plans. The other measures include accumulated benefit obligations (ABO) and vested benefit obligations (VBO).
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  • The term pension service cost refers to the present value of the projected retirement benefits earned by plan participants in the current period. Generally, a company's pension service cost is the amount it must set aside in the current period to match the retirement benefits accrued by plan participants.
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  • The term pension interest cost refers to the annual interest accrued on the beginning balance of the projected benefit obligation. Since the company's projected benefit obligation (PBO) is the present value of the retirement benefits earned by employees, the company incurs an annual expense equal to the discount rate used to determine the PBO multiplied by the starting balance of the PBO.
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  • Amortization of Prior Service Cost
    The term amortization of prior service cost refers to the systematic recognition of a pension expense in future periods resulting from a retroactive change to the plan's benefit formula. When a company modifies or amends their pension plan, accounting rules require the calculated prior service obligation to be amortized over the average remaining years of service for the plan's participants affected by the change.
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  • The term pension expense refers to the costs associated with pension plans that are reported on the company's income statement. Expenses associated with defined contribution plans are equal to the contribution made by the company in the current period. The pension expense associated with defined benefits plans include service and interest cost, the return on the plan's assets, as well as the amortization of prior service costs and actuarial gains or losses.
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  • The term pension plan assets refers to the funds a company will use to meet its future compensation obligations to retired employees. Pension plan assets consist of cash as well as investments such as capital stock, bonds, and annuities.
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  • The term pension plan funded status refers to the net difference between the assets held in the plan and its projected benefit obligation. The reconciliation between the plan's assets and liabilities will appear in the notes to the company's financial statements.
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