Definition (short)
– Actuarial gain or loss: the change in the measurement of a defined‑benefit pension plan’s projected benefit obligation (PBO) that arises when the actuarial assumptions or experience differ from prior estimates. A “gain” reduces the measured obligation; a “loss” increases it.
Why it matters
– Pension balances are large and sensitive to assumptions. Changes in actuarial assumptions or unexpected plan experience can move a company’s reported pension liability and equity, affecting reported funded status, volatility in reported earnings, and key ratios used by investors and creditors.
Key concepts and jargon (defined)
– Projected Benefit Obligation (PBO): the present value of future pension payments promised to employees, based on current and expected future service and salary levels.
– Discount rate: the interest rate used to convert future pension payments into their present value. A lower discount rate raises the PBO; a higher rate reduces it.
– Plan assets: investments set aside to pay pension benefits; valued at market/measureable value.
– Funded status: plan assets minus PBO (a positive value = overfunded; negative = underfunded).
– Other Comprehensive Income (OCI): a component of shareholders’ equity where certain gains and losses (including many pension actuarial gains/losses under U.S. GAAP) are first recorded instead of the income statement.
How actuarial gains and losses arise (plain language)
1. Changes in economic assumptions: e.g., the discount rate, expected long‑term return on plan assets, or salary‑increase assumptions. Because discounting has a powerful effect, small rate moves often produce large PBO changes.
2. Changes in demographic assumptions or actual experience: e.g., employees live longer than expected (increases liabilities), more employees retire earlier than assumed (timing and amount change), or actual payroll growth differs from assumptions.
3. Investment performance of plan assets that differs from expected returns.
Accounting treatment — summary
– U.S. GAAP (per FASB Statement No. 158): Pension assets and liabilities are recognized on the balance sheet. Actuarial gains and losses are typically recognized initially in OCI and then amortized into pension expense (income statement) over time, reducing volatility in periodic earnings.
– IFRS (IAS 19): Actuarial gains and losses are recognized in OCI and are not recycled (amortized) into the income statement. This difference can cause divergence in how quickly actuarial movements affect profit or loss under the two frameworks.
Why footnote disclosures matter
– The primary numbers (PBO, plan assets, funded status) can mask sensitivity. Footnotes usually show:
– The discount rate and other key assumptions.
– A reconciliation of opening to closing PBO and plan assets.
– The amortization policy for actuarial gains/losses (U.S. GAAP).
– Sensitivity analysis or examples of how changes in assumptions would alter the PBO.
Short checklist for reading pension disclosures
– Is the funded status shown on the balance sheet? (Look for plan asset and PBO amounts.)
– What discount rate did management use? Has it changed from the prior year?
– What expected rate of return on plan assets is assumed?
– What demographic assumptions are material (life expectancy, retirement age)?
– How are actuarial gains/losses treated (OCI and amortized vs. OCI only)?
– Is there a reconciliation of PBO and plan assets (opening → contributions → benefits paid → actuarial gains/losses)?
– Is a sensitivity analysis provided (e.g., effect of ±0.5% change in discount rate)?
Worked numeric example (simple single‑payment illustration)
Assume the plan will pay a single pension benefit of $1,000,000 in 10 years.
– If discount rate = 4.0%, present value = 1,000,000 / (1.04^10) = $675,564.
– If management lowers the discount rate to 3.0%, present value = 1,000,000 / (1.03^10) = $744,094.
– Change (actuarial loss to sponsor) = $744,094 − $675,564 = $68,530.
Interpretation: The lower discount rate increases the measured PBO by $68,530. Under U.S. GAAP this increase would generally be recorded initially in OCI and then amortized into pension expense over time; under IFRS it would be recognized in OCI and remain there (not amortized into profit or loss).
Practical tips for analysts and students
– Focus on trends in assumptions as much as absolute amounts. A single year’s actuarial loss due to a one‑time assumption change is less informative than a multi‑year trend.
– Compare companies within the same accounting framework (U.S. GAAP vs IFRS), since treatment of actuarial movements differs.
– Use sensitivity disclosures to stress‑test funded status under plausible interest‑rate moves.
– Remember plan assets and PBO move for different reasons: asset returns are actual market outcomes; PBO changes reflect discounting and demographic estimates.
Sources for further reading
– Investopedia — “Actuarial Gain or Loss” https://www.investopedia.com/terms/a/actuarial-gain-loss.asp
– Financial Accounting Standards Board — Statement of Financial Accounting Standards No. 158 (summary) https://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176156244646
– IFRS Foundation — IAS 19 Employee Benefits https://www.ifrs.org/issued-standards/list-of-standards/ias-19-employee-benefits/
Educational disclaimer
This explainer is educational only and not individualized investment, accounting, or tax advice. For decisions about a specific company’s financial statements or pension accounting, consult qualified accountants or financial professionals.