What Is the Aggregate Level Cost Method?

The aggregate level cost method refers to an actuarial accounting method that tries to match and allocate the cost and benefit of a pension plan over the span of the plan's life. The aggregate level cost method typically takes the present value of benefits minus the asset value and spreads the excess amount over the future payroll of the participants.

Key Takeaways

  • The aggregate level cost method is an actuarial accounting method.
  • The Actuarial Standards Board defines what it calls the Aggregate Actuarial Cost Method.
  • This method is used to match and allocate the cost and benefit of a pension plan.
  • One step in the method examines the pension plan's benefits, according to the total amount, total cost, and the time of contingent payment.

How the Aggregate Level Cost Method Works

Aggregate cost methods take into account the whole group, and the cost of the plan is usually calculated as a percentage of yearly payroll. In addition, the percent is adjusted yearly if there are any actuarial gains or losses.

According to the Actuarial Standards Board (ASB), the definition of the aggregate actuarial cost method is: "A method under which the excess of the actuarial present value of projected benefits of the group included in an actuarial valuation over the actuarial value of assets is allocated on a level basis over the earnings or service of the group between the valuation date and assumed exit. This allocation is performed for the group as a whole, not as a sum of individual allocations. That portion of the actuarial present value allocated to a valuation year is called the normal cost. The actuarial accrued liability is equal to the actuarial value of assets."

The Actuarial Standards Board (ASB) is affiliated with the American Academy of Actuaries. The ASB is tasked with establishing and improving standards of actuarial practice, and its goal is to set standards for appropriate practice for the United States. The Actuarial Standards of Practice (ASOPs) that the ASB sets forth identify what the actuary should consider, document, and disclose when performing an actuarial assignment.

The aggregate cost level method is unique because, unlike the individual cost method, it takes all of the plan's participants into account (rather than just the individual). Generally, the cost of the pension plan is calculated as a percentage of the yearly payroll. The percentage of the yearly payroll is changed or adjusted to take into account any actuarial gain or losses. So, the aggregate level cost method overcomes many challenges and limitations pertaining to the individual level cost method.

When calculating the cost and benefits of pension plans, these steps are followed:

  • Accounting for the total amount, total cost, and the time of payment for the pension plan.
  • Analyzing all benefits of the pension plan.
  • Discounting cash flows to the present value and add them together.
  • Using the probability of payment, make discounts and adjustments.
  • Some of the liabilities are disjointed, such as current death benefits or past service liability.
  • Applying factors pertaining to amortization are applied to some liabilities.
  • A 'spread' factor is added to the normal liabilities to find out the fund's normal cost.