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Analysis of Salary Growth Rate assumption adopted by NSE 50 Companies (FY19 and FY20)

Salary growth rate is one of the most important assumptions made while performing actuarial valuation of salary based employee benefit schemes, such as gratuity, earned leaves, pensions etc. Its significance can be understood from the fact that even a 1% (absolute) change in the year-on-year salary growth rate assumption can easily change the overall liability value by 5% to 10% (absolute).


In addition, the salary growth rate assumption often tends to be a point of discussion and debate between the auditors and the management, with auditors challenging the appropriateness of this assumption based on the actual salary growth rates awarded over the last few years.


As actuarial consultants providing advice and actuarial valuation services, we often receive request from our clients and their auditors to provide benchmarks against which they can validate their actuarial assumptions, in particular the salary growth rate assumption. To facilitate this, we undertake an annual review of the salary growth rate assumption adopted by NSE 50 companies. This article highlights our analysis for FY 2019-20 along with comparatives for past few FYs. The analysis for previous financial years can be found here:


Analysis of Salary Growth Rate assumption adopted by NSE 50 Companies (FY17 and FY18)

 

Salary Growth Rate: What are NSE 50 companies assuming


As part of our analysis, we have also drawn out the relative movement between the salary growth rate assumption and the discount rate. Theoretically, both the salary growth rate as well as discount rate assumption are closely linked to the long term expectation of inflation in the economy and hence should be positively correlated. As such, studying the two movements together helps in assessing the consistency of the assumptions as well as the net strengthening or weakening of the overall salary growth rate assumption.


Why NSE 50 Companies?

The companies considered for this research are amongst the largest corporate houses in India. They are also amongst the ones which get audited by the leading audit firms in the country. It is therefore reasonable to expect the practices adopted by these companies to be amongst the best in their respective industries.

Before looking at the findings below, it should be noted here that during FY 2019-20, the composition of the Nifty 50 index changed with four companies viz. Bharti Infratel Ltd., Vedanta Ltd., Yes Bank and Zee Entertainment Enterprises Ltd. which were part of index as at 31 March 2019 being replaced by Divi's Laboratories Ltd., HDFC Life Insurance Company Ltd., SBI Life Insurance Company Ltd. and Shree Cement Ltd. in the index as at 31 March 2020. The findings below are based on the Companies that comprised the index as on 22 Feburary 2021.

Further, note that the salary growth rate assumption of one company (out of 50) was not readily available from its annual report and as a result the findings in this article are based on the salary growth rate of the remaining 49 companies.


Overview of the findings

The below chart shows the average salary growth rate and the average discount rate of the NSE 50 companies along with the 10 year and 5 year Government bond yields over the last two financial years (i.e. FY 2018-19 and FY 2019-20):




Source: Annual reports of various companies and www.investing.com. The details captured for each company can be accessed by clicking here. Further, note that average assumptions shown above reflect a simple average of the assumptions across different companies.


Following are the main findings of our analysis:

  • As can be observed from the above chart, the absolute level of average salary growth rate assumption for NSE 50 Companies decreased marginally during FY 2019-20 (being 7.4% p.a. as at 31 March 2020 vs 7.5% p.a. as at 31 March 2019).

Whilst majority of the companies maintained their salary growth rates at same levels for both the financial years, 8 companies were observed to have strengthened their salary growth rate assumption during FY 2019-20, whereas 12 companies were observed to have lowered their salary growth rate assumption during FY 2019-20. Lowering of the salary growth rate assumption in case of certain companies can be attributed to outbreak of COVID-19 and the consequent uncertainty that prevailed in the economy as at the end of FY 2019-20.

  • From a relative perspective, we note that whilst the average of salary growth rate assumption has remained largely unchanged, the average discount rate assumption has decreased significantly by about 90 bps, from 7.6% p.a. as at 31 March 2019 to 6.6% p.a. as at 31 March 2020. This decrease is driven by the fall in yields on government bonds of different tenors. As a reference, we note that the benchmark yield on 10-year government bond and 5-year government bond has reduced significantly by about 130 basis points and 140 bps respectively for the period ending 31 March 20. Thus, from a relative movement perspective, the fall in average salary growth assumption is much lower than the fall in average discount rate assumption for FY 2019-20, leading to a relative strengthening of the salary growth assumption over the period.
  • Over a relatively long period, we observe consistent strengthening of the average salary growth rate assumption (on both absolute as well as relative to discount rate basis). The below chart summarizes the average salary growth rate and discount rate assumption adopted by NSE 50 companies since FY 2009:



  • The minimum salary growth rate assumption observed was 4% p.a. whereas the maximum was observed to be 12.5% p.a. as at FY 2019-20. The following chart shows the split of number of companies based on the range of the salary growth rate assumption as at 31 March 2020:




  • Majority of the companies have used a single salary growth rate assumption across employees and future years of service. However, 4 companies used varying assumption for different category of employees and 6 companies varied the assumption by year of projection. This has been discussed in more detail below.

Application of Salary Growth Rate Assumption

As mentioned above, the general trend is to use a single assumption for salary growth rate in their valuation (e.g. assumption of 7.5% per annum for all future projection years and for all categories of employees). However, companies could consider varying the assumption on the following basis:


  • Varying Salary Growth Rate by year of projection

Varying salary growth rate assumption by year of projection means assuming a different salary growth rate for short term and long term. For example, the salary growth assumed can be 10% p.a. for first 3 years of projection and 8% p.a. thereafter. As indicated above, 6 NSE 50 companies (Asian paints Limited, HDFC Life Insurance Company Ltd., Kotak Mahindra Bank Ltd., Nestle India Limited, Reliance Industries Ltd. and SBI Life Insurance Company Ltd.) have adopted this approach as at 31 March 2020.

This approach has the advantage of reflecting the currently higher (or lower) actual salary growth rates as well as the structural view of the Company over the long term. This approach also tends to help build consensus with the auditors who may be challenging the salary growth rate assumption based on the actual salary growth rates awarded over the last two to three years.

You can refer to one of our earlier articles on this approach by clicking on the following link:


Salary growth rate varying by year of projection

 

  • Varying Salary Growth Rate by category of employees:

In this case, the salary growth rate assumption is varied based on the category of employees. For example, employees may be classified as senior management, middle management and non-management employees and a different rate of salary growth may be assumed for each category. As indicated above, 4 of the NSE 50 companies (Coal India Limited, HDFC Life Insurance Company Ltd., Kotak Mahindra Bank Limited and Titan Company Limited) have adopted this approach as at 31 March 2020.

Doing so helps the organization in setting a more realistic liability as generally, it is seen that the increase in the salary tends to vary by the category of employees.


Concluding Thoughts

Overall, the average salary growth rate assumption has risen over the years from FY09 before stabilizing between 7% p.a. to 8%p.a. in the last few years. The FY 2019-20 was an unprecedented year due to the outbreak of Covid-19 and the consequent uncertainty, which also reflected in the actuarial assumptions adopted by certain companies. The same resulted in a marginal decline in the average salary growth rate assumption. The average discount rate, of course, fell sharply driven by a steep fall in the government bond yields as on 31 March 2020. However, a lower reduction in the salary growth assumption meant relative strengthening of the assumption.

The year-on-year salary growth rates may vary considerably between industries and companies, depending upon myriad factors. These can be (and, in our view, should be) reflected in the assumption by adopting rates that vary by years of projection and category of employees, as discussed above.

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


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