Actuarial gain or loss refers to the adjustments made to the estimates of a pension plan’s obligations or the value of its assets, based on changes in actuarial assumptions. These assumptions might include life expectancy, retirement ages, salary growth, investment returns, and other factors affecting the plan’s finances. An actuarial gain occurs when the actual experience is more favorable than initially expected, leading to a decrease in the estimated cost of providing pension benefits. Conversely, an actuarial loss arises when the actual experience is less favorable than expected, increasing the cost.
Think of a pension plan as a prediction of how much money will be needed in the future to pay for retirees’ pensions. This prediction is based on several educated guesses, like how long people will live after retiring, how fast their salaries will grow while they’re working, and how much the invested pension funds will earn. If things turn out better than expected (for example, the investments earn more money), the plan has an actuarial gain. If things are worse than expected (like people live longer than anticipated), the plan suffers an actuarial loss.
Actuarial gains and losses are crucial concepts in the economics of pension plans and insurance policies. They are used by pension fund managers, insurance companies, and policymakers to assess the financial health and sustainability of these plans. Understanding actuarial gains and losses is essential for adjusting funding levels, setting contribution rates, and ensuring that pensions and insurance policies remain viable over the long term.
For Example, in case if a pension fund assumes it will earn 7% on its investments but actually earns 8%, the extra 1% is an actuarial gain. If actuaries estimate that retirees will live an average of 20 years after retirement, but improvements in healthcare extend this to 22 years, the additional cost represents an actuarial loss.
Source: A to Z of Economics by Dr. NC Raghavi Chakravarthy