What Does Actuarial Cost Method Mean?
The actuarial cost method (also called "actuarial funding method") is a method employed by actuaries in charge of pension plans to calculate the cost of future benefits. It takes into account several factors, such as future wage increases and the current value of retirement benefits.
This is a way for companies to manage their financial solvency by keeping themselves aware of the financial responsibilities they will have to shoulder in the future.
Insuranceopedia Explains Actuarial Cost Method
A company often looks at its accounting books to see whether it can afford to pay the benefits of its future retirees. It relies on its actuaries to calculate this future financial projection.
There are two approaches to measuring actuarial costs: the cost approach and the benefit approach.
The cost approach calculates the amount the company has to raise periodically in order to pay future benefits. The company then saves money or earmarks future investment returns to cover these benefits.
The benefit approach, on the other hand, calculates the benefits that the employees have already received based on the length of their employment.