What is an Actuarial Gain or Loss?
Let me explain actuarial gain or loss directly: it's the increase or decrease in the projections we use to value a corporation's defined benefit pension plan obligations. You see, the actuarial assumptions in a pension plan are influenced by things like the discount rate for calculating the present value of benefit payments and the expected rate of return on plan assets.
Under the Financial Accounting Standards Board (FASB) SFAS No. 158, the funding status of pension funds must be reported on the plan sponsor’s balance sheet. This requires periodic updates to pension obligations, fund performance, and the overall financial health of the plan. Depending on factors like plan participation rates and market performance, the pension plan might face an actuarial gain or loss in its projected benefit obligation.
Accounting rules mandate that pension assets and liabilities are marked to market on the balance sheet, but they allow actuarial gains and losses—or changes to those assumptions—to be amortized through comprehensive income in shareholders' equity instead of going straight through the income statement.
Key Takeaways
- Actuarial gains and losses happen when the assumptions behind a company's projected benefit obligation change.
- Accounting rules require companies to disclose both pension obligations (liabilities) and the assets to cover them, showing investors the pension fund's overall health.
- All defined benefit pension plans will experience periodic actuarial gains or losses as key demographic or economic assumptions in the model get updated.
Understanding Actuarial Gain or Loss
To grasp actuarial gains and losses, you need to look at them in the broader context of pension accounting. Unless I note otherwise, I'm addressing this under U.S. generally accepted accounting principles (GAAP). While U.S. GAAP and International Financial Reporting Standards (IFRS) have similar ways to measure pension benefit obligations, there are differences in how they report pension costs in the income statement, especially with actuarial gains and losses.
Funded status is the net asset or liability from a company's defined benefit plans, calculated as the difference between plan assets' value and the projected benefit obligation (PBO). Valuing plan assets—invesments set aside for benefits—requires judgment but no actuarial estimates. However, measuring the PBO does involve actuarial estimates, and that's where actuarial gains and losses come from.
There are two main types of assumptions: economic ones that model market forces' impact on the plan, and demographic ones that model how participant behavior affects benefits paid. Key economic assumptions include the interest rate for discounting future cash outflows, expected rate of return on plan assets, and expected salary increases. Key demographic assumptions cover life expectancy, anticipated service periods, and expected retirement ages.
Actuarial Gains and Losses Create Volatility in Results
From one period to the next, a change in an actuarial assumption—especially the discount rate—can cause a big increase or decrease in the PBO. If we recorded these through the income statement, they'd distort financial results' comparability. So under U.S. GAAP, these adjustments go through other comprehensive income in shareholders’ equity and get amortized into the income statement over time. Under IFRS, they go through other comprehensive income but aren't amortized into the income statement.
Footnote Disclosures Contain Useful Information About Actuarial Assumptions
Accounting rules demand detailed disclosures on pension assets and liabilities, including period-to-period activity and the key assumptions for measuring funded status. These disclosures let you, as a financial statement user, understand how a company’s pension plans impact its financial position and operations compared to prior periods and other companies.
