Actuarial valuation is a financial analysis conducted by actuaries to determine the present value of a pension fund or an insurance company’s future obligations. This process involves assessing the current cost of future payouts based on various assumptions, such as interest rates, mortality rates, employee turnover, and retirement age. The goal is to ensure that a fund or policy has sufficient assets to meet its future liabilities.
Imagine you have a big jar of cookies that you promise to give out at future parties. An actuarial valuation is like counting how many cookies you’ll need for all the parties and making sure you have enough. It considers how many parties you’ll have, how many guests might come, and how many cookies each guest might eat. If it looks like you’ll run out, you know you need to start baking more now. This helps pension funds and insurance companies make sure they have enough money set aside to cover what they’ve promised to people in the future.
Actuarial valuation is critical in the management of pension plans, insurance policies, and other financial products involving long-term financial commitments. It’s a cornerstone of financial economics, affecting decisions on investment, funding, and policy design to maintain the financial health and sustainability of these instruments. Governments, corporations, and financial institutions rely on actuarial valuations to make informed financial and strategic decisions.
For Example, a pension fund conducts an actuarial valuation to determine if current contributions and investment strategies are sufficient to pay future retirees. An insurance company uses actuarial valuation to assess the adequacy of its reserves for claims that policyholders are expected to make in the future.
Source: A to Z of Economics by Dr. NC Raghavi Chakravarthy