Actuarial Adjustment: What It is, How it Works, Example

What Is an Actuarial Adjustment?

An actuarial adjustment refers to a revision made to capital reserves, premiums, benefit payments, or other values companies determine, based on one or more changes to actuarial assumptions.

Actuarial assumptions are estimates and predictions of unknown variables, such as the age at which a person is likely to die, considering a specific set of factors. When changes to these assumptions occur, they can alter the courses of action that pension funds and insurance carriers must take to ensure they'll be able to sustain payouts to retirees and policyholders. Actuarial adjustments may entail one or more of the following steps:

• Pension plans may have to increase the amount of money they accumulate in their cash reserve accounts, with which they'll need to make future payments to retirees.
• Insurance companies may need to augment the premiums they charge individuals for their policies to remain in effect.
• Both pension funds and insurance plans may have to reduce the amount of future payments they dole out to consumers.

Understanding Actuarial Adjustments

An actuarial adjustment occurs when the assumptions surrounding the timing or amount of a future benefit payout become altered, due to various circumstances. In pension arrangements, actuarial adjustments are made to the retirement benefits when an individual retires before or after the typical age pensions traditionally kick in.

For example, when an individual elects to take early retirement, a reduction is made to retirement benefits, to mitigate the fact that the retiree will be receiving benefits for more years than initially anticipated.

Example of an Actuarial Adjustment

To better understand how actuarial adjustments work, consider the following example. Let's assume that Company XYZ pays its employees a pension when they retire. Consider an employee named David, who's eligible to receive annual retirement funds that equal 80% of his ending year salary, from his retirement age of 65, until he dies.

When designing the pension plan, Company XYZ considers a set of assumptions, including David's life expectancy. But if mortality tables suddenly change, indicating that people on average will live three years longer than previously thought, actuarial adjustments will consequently be made to the pension plan.

Company XYZ may begin contributing more money to its cash reserves, to accommodate for the added years of payouts it will invariably be making to David and other retired employees over the long haul. Alternatively, the company may modify its investment portfolio, to favor more aggressive growth stocks that yield higher returns, in an effort to beef up its cash reserves.

Finally, the company may resort to shrinking the benefits it pays out to employees. Case in point: instead of annually doling out 80% of David's ending year salary, it may depress that figure to 75%, enabling it to stretch its money over a longer period of time.