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Chapter 7

Chapter 7. Actuarial Risk. What Does Actuarial Risk Mean?. Possible assumptions include the frequency of losses, severity of losses and the correlation of losses between contracts. known as "insurance risk".

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Chapter 7

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  1. Chapter 7 Actuarial Risk Afifi,UP, RM, Summer 2010

  2. What Does Actuarial Risk Mean? • Possible assumptions include the frequency of losses, severity of losses and the correlation of losses between contracts. • known as "insurance risk". Afifi,UP, RM, Summer 2010

  3. Making sure that the assumptions in a model actually reflect real life is absolutely vital for the pricing of all types of insurance.  • Flaws in a model's assumptions could lead to premium mispricing. In the worst case scenario, an actuary may underestimate the frequency of an event. The unaccounted incidents will cause an increase in the frequency of payouts, which could bankrupt an insurer. Afifi,UP, RM, Summer 2010

  4. Actuarial Gain Or Loss What Does Actuarial Gain Or Loss Mean? • Gain or loss arising from the difference between estimates and actual experience in a company’s pension plan. Afifi,UP, RM, Summer 2010

  5. Actuarial Gain Or Loss What Does Actuarial Gain Or Loss Mean? • Actuarial gains and losses are used when accounting for pension plans because of the need to make assumptions about the future rate of salary increases, the length of employee tenure, an appropriate discount rate for the plan obligations and the expected rate of return on plan assets. Afifi,UP, RM, Summer 2010

  6. Actuarial Gain Or Loss What Does Actuarial Gain Or Loss Mean? • Under old accounting rules, recognition of actuarial gains and losses was delayed and smoothed over time, so a plan's true funded status was rarely reported on a company’s balance sheet. Afifi,UP, RM, Summer 2010

  7. Financial Accounting Standards Board (FASB) • In December 2006, the Financial Accounting Standards Board (FASB) issued SFAS 158, which stated that a plan’s funded status must be recognized on the balance sheet, and actuarial gains and losses in a period should flow directly to comprehensive income in shareholder’s equity. This move has made the true economic position of pension plans more visible. Afifi,UP, RM, Summer 2010

  8. Actuarial Basis Of Accounting What Does Actuarial Basis Of Accounting Mean? • A method used in computing the periodic payments that a company must make to fund its employee pension benefits. Afifi,UP, RM, Summer 2010

  9. Actuarial Basis Of Accounting What Does Actuarial Basis Of Accounting Mean? • The actuarial basis stipulates that total contributions from the company plus investment returns on pension assets must match the required annual contribution from the pension fund. Assumptions must be made for the length of workers' careers, the rate of return on plan assets, the rate of salary increases and the discount rate used for future benefits. Afifi,UP, RM, Summer 2010

  10. Actuarial Basis Of Accounting What Does Actuarial Basis Of Accounting Mean? • This method follows the basic premise of any actuarial process in that costs and benefits must be equal. Accounting for pensions involves assumptions on both sides of the equation. Afifi,UP, RM, Summer 2010

  11. Actuarial Basis Of Accounting What Does Actuarial Basis Of Accounting Mean? • When reviewing a company's financial statements investors should note whether the company is being aggressive or conservative in these assumptions. • For example, if a company uses a very high rate of return on its plan assets, this will reduce the current costs to fund its pension plan. Afifi,UP, RM, Summer 2010

  12. Actuarial Basis Of Accounting What Does Actuarial Basis Of Accounting Mean? • Information on pension contributions and assets can be found in company's quarterly and annual reports to the Securities and Exchange Commission Afifi, UP, RM, Summer 2010

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