We at Charan Gupta Consultants — www.charangupta.com have been serving the industry since 45 years and the article below shares the factors that influence the selection of assumptions
The job of an actuary is full of responsibility. Actuarial requirements include employee database, it includes proper selection of assumptions. The assumptions are required to be decided by the management or the actuary or it has to be decided upon consultation with the actuary. Other requirements include basic company information. The actuary requires making certain financial assumptions as well as demographic assumptions.
The financial assumptions include discount rates, future salary increase, and expected return of plan assets for future. The demographic assumptions include mortality table, turnover or attrition rate, retirement age.
Factors influencing the Selection of Assumptions
In this context it is important to say that the discount rate is based on the market yields of bonds that match the valuation date as well as the discounting period. The bond rate can be obtained from the discount rate chart.
The estimates of future salary hike depend on factors like inflation, ground reality.
Inflation:-In government bond the yearly variation can reach 0.5%. Over a discounting period, say about 25 years, the government bond yearly variation becomes 0.02%. The value (0.02%) is negligible and hence often ignored. In order to maintain the effective rates the salary increase must be adjusted by 0.5%.
Ground Reality:-There are companies which have high salary increase over a short period of time. The normal increase can be a value lower than the high salary increase and when this is spread across the discounting period of about 25 years then the value becomes small yet substantial. In such situations a selective discounting method is often adopted. For additional details on this visit relevant resources online or check the company website.
Mortality Table: — The mortality table is as per the guidelines of the institute of actuaries of India.
Attrition Rates:-The value for the attrition rates should be based on the past experience as well as the company’s HR policy for the future. New companies have high value for attrition rates. Stable large industrial establishments have a withdraw ratio of 3:2:1.
Retirement Age: — The value for the retirement age is to be provided by the company.
Methodology & Terminology Used in Valuation
The company, Charan Gupta Consultants Pvt Ltd use the Projected Unit Credit or PUC method to assess the plan’s liabilities to exit employees for retirement, death in service as well as withdrawals (termination or resignation).
In the PUC method a projected accrued benefit is calculated at the beginning as well as the end of the period for each benefit that will accrue for all active members of the plan. The projected accrued benefit is based on the plan accrual formulae and upon service at the beginning as well as the end of period. In the PUC method a member’s final compensation is projected to the age when the employee is assumed to retire from service. The plan liability is the actuarial present value of the projected accrued benefits as on the date of valuation.
The PUC method of calculation uses all the assumptions including the demographic as well as financial assumptions.