The money a company contributes each year to its pension plan is placed in a trust and invested in stocks, bonds and other investments. These are the plan's assets. On any given day, the market value of the plan's assets is the amount of money the company would receive if it cashed in the investments. An actuary can't use the market value to predict the amount of money the company needs to set aside to pay future retirees because it varies so much from year to year as the stock market rises and falls.
Market Value Fluctuations
If the stock market falls by 30 percent in a particular year and an actuary uses the market value of the plan's assets in a mathematical model, the results will likely overestimate the amount of money the company needs to contribute to the pension plan. If the stock market rises by 30 percent in a particular year, the market value will cause the model to underestimate what the company's contribution needs to be.
An actuary considers the long-term performance of the company's investments by using mathematics to smooth out the variations from year to year. It creates an actuarial value of the plan's assets, which is the likely value of the investments based on typical long-term investment results. This number is then used to estimate the amount of money the company needs to set aside in the current year to pay its future pension obligations.
Steve McDonnell's experience running businesses and launching companies complements his technical expertise in information, technology and human resources. He earned a degree in computer science from Dartmouth College, served on the WorldatWork editorial board, blogged for the Spotfire Business Intelligence blog and has published books and book chapters for International Human Resource Information Management and Westlaw.