DEFINITION of 'Actuarial Cost Method'

A method used by actuaries to calculate the amount a company must pay periodically to cover its pension expenses. The two main methods used are the cost approach and the benefit approach.

The cost approach calculates total final benefits based on several assumptions, including the rate of wage increases and when employees will retire. The amount of funding that will be needed to meet those future benefits is then determined. The benefit approach finds the present value of future benefits by discounting them.

Also known as an actuarial funding method.

BREAKING DOWN 'Actuarial Cost Method'

When reviewing a company's financial statements, it is important to look closely at the accounting for pension liabilities. This is an area with a lot of assumptions that can be manipulated. The company must make assumptions regarding the rate at which to discount future pension costs, the future rate of return on pension-plan assets, at what age the average worker will retire and the rate of future salary raises. When reviewing these assumptions, investors should note whether the company is being aggressive or conservative.

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