Impact of Discount Rate in Actuarial Valuations as at 31 st March 2018
Key Learning:
- Study of Quarterly Deviations in Discount Rate
- Discount Rate Comparative Chart
- Study of the Impact of Discount Rate
- Strategies to reduce the Discount Rate Volatility
Introduction
The discount rate is one of the key assumptions used in the actuarial valuation of employee benefit liabilities. It is used to discount the expected future cash outlays from the Plan Benefits. Accounting standard (AS15 / IAS 19 / IndAS 19) prescribes that an entity should use the government bond yields equivalent to the maturity term of the liabilities as a measure of the discount rate.
This guidance has resulted in an increase in the profit and loss deviations year-on-year because of actual deviations in the discount rate. Thus, understanding the discount rate volatility and strategizing ways to reduce its impact has become pertinent issues while performing actuarial valuations year on year.
Study of Quarterly Deviations of Discount Rate
We have given a snapshot of the quarterly discount rate from 1-4-2013 to 31-3-2018 to understand the deviations in the discount rate.
Discount rate Comparison Table as at 31st March 2018
Study of the Impact of Discount Rate
Broadly, the impact of the discount rate on the liability will depend on the change in the discount rate in a given inter-valuation period and the maturity term of the liability.
Impact as a % of Liability = Approx. { Minus (Maturity Term * Change in Discount Rate) } Minus
Example:
Strategies to reduce the Discount Rate Volatility
- Linking the salary growth to discount rate
As the discount rate is used to discount the Expected future outlays in the Plan Benefits, so is the salary growth rate used to project the expected future outlays in a Plan. We can fairly assume that both the discount rates and salary growth rates are inversely proportional to each other while estimating the Plan liabilities. This assumption may not hold good only in cases where the employee has reached the benefit ceiling (example: In gratuity, 20 lakhs).
So if the management can fairly project the salaries for the next few years and then link the salaries to the discount rate thereafter, then the impact of the discount rate can be reduced.
Example:
Both options 1 & 2 will yield the same result in the March 2018 valuations, however, if the discount reduces by 1% in March 2019 to 6.50% then option 2 will have more stable profit and loss account in March 2019
- Asset Liability Matching Strategies
Investment in Traditional funds (example: LIC) don’t give a cushion against discount rate volatility as the fair value of these assets will not change with the change in discount rate expectations year on year. Hence, the liabilities will increase or decrease in line with the discount rate but Traditional funds will remain unfazed by deviations in the discount rate. This leads to Asset Liability mismatch and volatility in profit and loss accounts.
Companies should plan to invest in ULIPs or other investment options which give a good asset-liability match in respect of liability profile and duration. This will help curb the volatility resulting from discount rates.
For example, in falling interest rate scenarios, employee liabilities will increase and asset values will also rise to allow with an increase in bond prices leading to offsetting actuarial gains or losses and smooth profit and loss account.
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