Actuarial Cost Method

What Does Actuarial Cost Method Mean?

The actuarial cost method (also known as the “actuarial funding method”) is used by actuaries managing pension plans to calculate the cost of future benefits. It considers various factors, including future wage increases and the current value of retirement benefits.

This method helps companies manage their financial solvency by keeping them informed of the financial obligations they will need to meet in the future. The same math behind these projections is also what makes consumer retirement products work, which is why annuities rely on similar assumptions about future payouts and investment returns.

Insuranceopedia Explains Actuarial Cost Method

Companies often review their financial records to determine if they can afford to pay the benefits owed to future retirees. To make these projections, they rely on actuaries.

There are two main approaches to measuring actuarial costs: the cost approach and the benefit approach.

• The cost approach calculates the amount the company needs to raise periodically to cover future benefits. The company then saves this amount or relies on future investment returns to meet these obligations.
• The benefit approach, in contrast, calculates the benefits employees have already earned based on the duration of their employment.

On an individual level, people approaching retirement run a smaller version of this calculation when deciding how much coverage to carry, which is one reason life insurance for seniors is priced differently than policies for younger buyers.