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The outbreak of COVID-19 and the ensuing lockdown has affected businesses across every industry. As a result, the Government and Reserve Bank has brought about drastic measures, that will have consequences on the valuation of future liabilities for employee benefits reporting.
In this newsletter, we take a look at how the pandemic has affected Actuarial Assumptions like discount rate and attrition rate, and how we can mitigate the impact caused by the drop in long term bond rates over the last 2 months.
Repo Rate Cut by RBI: In response to the outbreak of COVID19, The Reserve Bank of India has slashed the repo rate several times, by 115 basis points since March 2020.
Discount Rate: The 10 year yields on G-Secs has fallen to a low of 5.86 as on end of day 22nd May 2020. This represents a decrease of around 103 basis points from the start of the calendar year 2020. The significant decrease in discounting rate will lead to an increase in liabilities to be reported.
Salary Growth Rate: In our practice, we have seen significant reduction in estimated salary growth rates reported by companies. Several companies have slashed their salary growth rates to zero. The rise in liabilities due to fall in discount rate can be offset by the reduced salary growth rate.
Attrition Rate: Lower attrition rate can be considered in the present climate, as many employees will prefer the comfort of their jobs over switching jobs. However, this has to be decided considering impact on the specific industry.
There is a need for companies to evaluate additional risks arising from disruption due to COVID-19:
Operational Disruptions: Disruptions resulting in changes to the business model arising from significant drop in demand, reduced customer base, disruption in supply chain, employee's absence or work from home, geographical implications of group operations, public lock down etc.
Contractual Breaches: Contractual non-compliance resulting in contractual breaches, additional security requirements or stressed asset and liability valuations.
Liquidity: Liquidity and working capital issues given the reduced/impaired ability to service debt or replenish working capital requirements due to possible lower cashflows.
Asset Valuations: Asset valuations – downward asset valuations may trigger legal and compliance issues or lead to liquidity challenges.
The forecasts or budgets for future cashflows prepared by management should be updated to reflect the impact of COVID-19.Companies may need to consider the potential impact on estimates including actuarial assumptions used in measuring employee benefits. Market assumptions used to determine fair value for recoverable assets and liabilities require reconsideration. For employee benefits valuations, where assumptions are fairly long term in nature, HR departments will have to revisit the contracts with employees, both formal and informal, considering the implications for industrial harmony and devise strategies with the CFO that are in line with the future budget estimates of the company and advise the necessary change in assumptions for the employee benefits obligations.