Liabilities may rise as bond yields fall
From the Actuary's Desk
Valuations of Employee Benefits
The discount rate used in actuarial valuations of employee benefit plans such as gratuity, pension, earned leave etc. is determined by reference to market yields at the balance sheet date on government bonds (refer Para 78 of AS15). This means that these valuations are essentially Mark-To-Market (MTM) valuations, which can result in fluctuations in the valuation of liability if the underlying yield on government bonds fluctuates.
What has happened?
The yields on the government bonds have witnessed a declining trend since the beginning of FY 2014-15. In the last few weeks, the yields have in fact seen a significant downward movement, as is evident from the comparison of 10-year government bond yields in the chart below.
The Likely Impact
This fall in bond yields will translate into a fall in discount rate
used in actuarial valuations, which is likely to result in significant
actuarial loss due to change in assumptions and hence increase
in valuation of liability (and expenses). The increase in liability
(and expenses) just because of the above fall in yields can be
easily to the tune of 8% to 12% of opening liability.
The above conclusion is of course based on the assumption that
there is no change in any other assumption and there are no
corresponding Mark-To-Market (MTM) gains on the assets side.
Suggested Course of Action
Whilst it is difficult to comment with certainty but the above
trend of fall in yields is expected to continue and the yields on
March 31, 2015 are expected to fall further. Thus, companies
reporting results on quarterly basis (e.g. listed companies) but
getting actuarial valuations done on annual basis may benefit
by recognising the potential impact of fall in discount rate in
December quarter itself. Else, given the expected further fall in
yields on government bonds, the entire impact of fall in discount
rates will get recognised in the last quarter of the financial year,
which may distort the quarterly results.
I trust you will find the observations and assertions in this note
useful. I thank you for reading this note and welcome any
comments or recommendations or observations you may have
on the subject. You can direct those to the email address
mentioned below.
Khushwant Pahwa, FIAI, FIA, B Com (H)
Founder and Consulting Actuary
KPAC (Actuaries and Consultants)
k.pahwa@kpac.co.in
www.kpac.co.in
Please note that the discount rates used in actuarial valuations are based on yields on government bonds of appropriate term / duration
(and not simply the yield on the 10 year paper), which is determined based on the remaining working life of the employees as well as the
assumptions such as attrition and mortality. For sake of simplicity, however, we have provided comparison of bond yields based on the
benchmark 10 year bond yields only.
We shall be releasing on our website the comparison of complete yield curves as at 31 March 2014 and 31 December 2014 in the first
week of January 2015. The same can be referred to for determining the exact impact on your discount rates.
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