What are Actuarial Gain or Losses?

Introduction

Actuarial profits and losses are important indicators in the areas of actuarial science and financial reporting. Significant deviations between expected results based on actuarial assumptions and actual results observed over time. 

This underscores the importance of accurate forecasts and proactive management in maintaining financial stability.

Characteristics of Actuarial Profits and Losses

To understand the concept of profit or loss in nature. Let's break down the components:

1. Actuarial Gain

An Actuarial gain occurs when the actual experience is more favourable than what was assumed during the actuarial evaluation. This usually results in a reduction in debt or costs. 

For example:

• If the death rate is higher than expected, fewer pension payments are to be made, decreased responsibility and hence actuarial gain.
• If the return on investment exceeds expectations. The surplus can reduce the need for future capital contributions.

2. Actuarial Loss

Actuarial loss occurs when the actual experience is less favourable than expected. This leads to increased debt or costs. 

Examples include:

• A decrease in the discount rate used to calculate the present value of liabilities, which inflates the value of future obligations.

Causes of Actuarial Gain or Loss

Actuarial Gain or Loss occur for two main reasons:

• Change in Assumptions

These assumptions form the backbone of actuarial valuations. It is an estimate of future trends and events, such as death rates, inflation rate and salary escalation rate. These assumptions changes may cause the estimated liability to change significantly:

• Reducing the discount rate increases the present value of the liabilities which lead to actuarial losses.
• Adjustments to reflect longer life expectancy will increase the projected benefit payout amount resulting in a loss.

2. Experience Variance

Experience variation occurs when results differ from actual assumptions. For example:

• If the death rate is lower than expected, liabilities increase, the longer benefits are paid over a longer period of time which leads to loss.
• Higher-than-expected turnover rates among employees reduce the number of beneficiaries eligible for future benefits, resulting in an actuarial gain.

The Impact of Changes in Assumptions

Impact of moving locations

The assumptions underlying actuarial assessments are multifaceted and interconnected. Any change in assumptions may affect the calculation of cascading liabilities. See how some key venues affect a school's win or loss:

1. Discount Rate

The discount rate is the basis for calculating the present value of the future liabilities. Reflects the value of money at time and market rates:

Effect of increasing the discount rate: A higher discount rate reduces the present value of both liabilities. This often results in an actuarial gain.

Effect of lowering the discount rate: A lower discount rate increases debt causing an actuarial loss. 

2. Mortality Assumption 

Mortality Assumption estimate the lifespan of the beneficiaries:

Life expectancy is underestimated: Leads to increased benefit payments over time, resulting in actuarial loss. 

Life expectancy is overestimated: Results in fewer payout than expected, creating actuarial gains. 

3. Salary Growth Rate

Future salary increases affect benefits linked to the minimum wage:

Faster-than-expected wage growth: Increasing projected obligations resulting in the loss of the actuarial.

Wage growth is slower than expected: reduce debt, create profits.

4. Inflation Rate

Inflation affects purchasing power. Two advantages:

Higher inflation: Increases debt, especially for benefits that are indexed to inflation.

Inflation falls: reduce debt, creating gains.

5. Employee Turnover Rates

Employee turnover will affect the number of beneficiaries eligible for benefits:

Turnover exceeds expectations: resulting in less responsibility. This is because fewer employees are eligible for benefits and increase profits.

The Role of Experience Adjustments

Experience adjustments, also known as experience variances, quantify the deviation between actual outcomes and assumptions in specific areas. These adjustments provide valuable insights into the reliability of actuarial assumptions and the accuracy of forecasting models.

Examples of Experience Adjustments:

Investment Returns: Plan assets often perform differently than expected. Better returns than assumed result in actuarial gains, while underperformance causes losses.

Mortality Rates: Deviations in the assumed mortality rates lead to changes in liabilities. If fewer individuals pass away than expected, the organization will incur higher costs.

Salary Progression: Faster or slower salary growth compared to assumptions results in variances.

Medical Costs: For retiree healthcare benefits, deviations in actual medical cost inflation from assumed rates create actuarial gains or losses.

Minimise Actuarial Gain or Loss 

1. Frequent Assumption Reviews

Regularly revising actuarial assumptions ensures they remain aligned with the latest trends and data. For example:

• Using updated mortality tables improves the accuracy of longevity estimates.
• Revising discount rates to reflect prevailing market conditions enhances liability estimates.

2. Experience Studies

Conducting periodic experience studies helps actuaries assess the accuracy of assumptions. This allows for timely adjustments and reduces the likelihood of significant variances.

3. Dynamic Models

Dynamic actuarial models that incorporate trends such as cohort-based mortality or economic cycles can improve the precision of projections.

Conclusion

Actuarial gains and losses serve as a mirror reflecting the accuracy of assumptions and the efficiency of financial management. They highlight the inherent uncertainties in long-term obligations and emphasize the importance of precision in actuarial science.

By understanding the causes—whether due to changes in assumptions or experience variances—organizations can adopt strategies to minimize these deviations. Frequent reviews, dynamic modelling, and diversified investments are essential tools in reducing the volatility of actuarial outcomes.

In the ever-evolving financial landscape, actuarial gains and losses are not just accounting figures. 

Frequently Asked Questions

1. How does salary growth rate affect liabilities?

Faster-than-expected salary growth increases liabilities (losses), while slower growth decreases liabilities (gains).

2. Can changes in economic conditions impact actuarial gains or losses?

Yes, factors like interest rate fluctuations and inflation changes significantly impact actuarial calculations.

3. What is the role of assumption reviews in minimizing actuarial gains and losses?

Regularly updating assumptions ensures they align with current trends, reducing the likelihood of large variances.

4. How can experience studies help in minimizing actuarial losses?

They compare actual outcomes to assumptions, allowing refinements for more accurate future valuations.

5. What is the significance of diversification in plan investments?

Diversification reduces the risk of underperformance, minimizing actuarial losses due to investment variances.

6. What are risk-sharing mechanisms?

They are plan design features, like contribution-linked adjustments, that distribute risks between employers and employees.