ALM for Employee benefit funds are we doing enough?

Transcription

1 ALM for Employee benefit funds are we doing enough? Khushwant Pahwa, FIAI, FIA Founder and Consulting Actuary KPAC (Actuaries and Consultants)

2 Agenda Introduction Why we have a role to play? Draft scope of an ALM Investigation Additional areas and ideas

3 Why are we having this session? We need it! COINCIDENCE OF NEEDS! They Need it! Supply of actuarial talent is increasing. Hundreds, if not thousands, of students struggling to find jobs. Battle for traditional areas is becoming intense. Employment opportunities in traditional areas difficult to expand! Cross-selling the way forward for profession and firms. We understand employee liabilities better than clients. We also understand assets, in particular insurance policies. ALM strategies employed by largest companies are flawed. Flawed strategies impacts funding, reported profits, taxation, etc. It also impacts the ultimate cost of benefits in long term!

4 What does an ALM entail? Understanding the liability 4 aspects - Term, Nature, Currency and Uncertainty We already understand employee benefits liabilities well Monitoring the situation ALM Choosing matching assets Minimize mismatch in terms of all 4 aspects Manage within given constraints Managing risks and meeting requirements. Ensure risk taken within risk appetite Ensure regulatory and governance requirements are met

5 Focus of today s presentation

6 Agenda Introduction Why we have a role to play? Draft scope of an ALM Investigation Additional areas and ideas

7 Understanding Nature of Liability - Gratuity Term Usually long term (8 to 15 years) Depends on attrition, retirement age & demographic profile Currency Nature of Gratuity Liability Nature Mostly real as depends on Salary Growth Balance Sheet value is Mark to Market Uncertainity Analyzed in terms of timing (term) and amount (nature) Attrition impacts timing & amount, Salary Growth impacts both

8 Yields 10.0% Yield (semi annual) on 10 year G Sec Bonds in India (Mar 2013 to May 2015) 9.5% 9.0% 8.5% 8.0% 7.5% 7.0% Apr 02, 2013 May 27, 2013 Jul 17, 2013 Sep 06, 2013 Oct 25, 2013 Dec 17, 2013 Feb 12, 2014 Apr 16, 2014 Jun 16, 2014 Aug 06, 2014 Sep 30, 2014 Dec 02, 2014 Jan 27, 2015 Mar 25, 2015 May 28, Mar % 31 Mar % 31 Mar %

9 Extract from Infosys s Balance Sheet Actuarial loss on liabilities Actuarial gain on assets Actuarial loss on liabilities side not offset by actuarial gain on asset side, resulting in increase in expenses!

10 Extract from Infosys s Balance Sheet Increase in expense by 42 crores due to higher actuarial loss of 42 crores!

11 Balance Sheet numbers 800 Gratuity Liability (Rs. Crores) Gratuity Assets (Rs. Crs) Mar Mar Mar Mar Mar Mar-15 Assumptions Mar 2013 Mar 2014 Mar 2015 Salary Growth Rate 7.27% 8% 8% Discount Rate 7.95% 9.20% 7.80% Net Impact Gain / (Loss) % -1.40% Expected Return on Plan Assets 9.51% 9.55% 9.5% Higher increase in liability (Rs. 87 crores in FY15 vs Rs. 54 crores) driven largely by fall in discount rate!

12 A look at P&L expense break up FY FY Expense on Liabilities Rs crs Income on Assets Rs crs Expense on Liabilities Rs crs Income on Assets Rs crs Interest Cost 56 Expected Income 65 Service Cost 89 Actuarial Loss 58 Actuarial Gain 5 Total 203 Total 70 Total expense = Rs. 129 crores (including gain of 4 crores of plan amendment) Interest Cost 45 Expected Income 59 Service Cost 94 Actuarial Loss 8 Actuarial Gain -3 Total 147 Total 56 Total expense = Rs. 87 crores (including gain of 4 crores of plan amendment) Increase in expenses largely due to higher actuarial loss compared to previous year. Mark To Market hit on liabilities of Rs. 54 crores not offset by a similar movement on the asset side. Reason inappropriate choice of assets! Right choice of asset can be easily chosen by matching the duration of asset and liability.

13 What has happened? What did happen. Interest Rates Closing Liability What did not happen.but should have happened Interest Rates Closing Assets Above can happen through better understanding of liability during actuarial valuation and consequent appropriate investment of assets!

14 Assuming proper ALM If, during actuarial valuations, the Company received and monitored duration of liability, it could have invested in a Mark to Market asset of appropriate duration. Investment would still have been safe as such funds invest in government bonds. Exposure to Mark to Market movement on asset side would have offset negative impact of fall in interest rate in liabilities. Consider ICICI Prudential Long Term Gilt Fund (modified duration 7.99 years vs about 6 years of liability). Movement in NAV: 31 Mar Mar Return 19.7% Income of the Company had invested in above fund, actual investment income would have been: Rs. 677 crores * 19.7% = 133 crores (vs Rs. 70 crores currently)

15 P&L if invested appropriately! FY (currently) FY (with appropriate investments) Expense on Liabilities Rs crs Income on Assets Rs crs Expense on Liabilities Rs crs Income on Assets Rs crs Interest Cost 56 Expected Income 65 Service Cost 89 Actuarial Loss 58 Actuarial Gain 5 Total 203 Total 70 Total expense = Rs. 129 crores (including gain of 4 crores of plan amendment) Interest Cost 56 Expected Income 65 Service Cost 89 Actuarial Loss 58 Actuarial Gain 68 Total 203 Total 133 Total expense = Rs. 66 crores (including gain of 4 crores of plan amendment) If the Company had matched duration of asset and liability, its expenses would not have risen! Past is gone but for future it is highly important as the interest rates are expected to fall further!

16 Did they learn the lesson?

17 Understanding Nature of Liability Exempt PF Trusts Term Usually long term (8 to 15 years) Depends on attrition, retirement age & demographic profile Currency Nature of PF Liability Nature Mostly nominal, based on declared rate Balance Sheet value is accumulated balance Uncertainity Analyzed in terms of timing (term) and amount (nature) Attrition impacts timing & amount, Salary Growth impacts both

18 Agenda Introduction Why we have a role to play? Draft scope of an ALM Investigation Additional areas and ideas

19 Scope of an ALM investigation for EB Schmes Scope of an ALM Study of Employee Benefit Scheme Cash flow matching analysis Mark to Market (MTM) / Duration analysis Investment pattern & historical yield analysis Risk Analysis Recommendations / suggestions

20 Cash flow matching analysis For existing (and new) employees over the entire life time of employees Project Liability Cash flows Can consider impact of new entrants Consider details of assets held under trust Project Asset Cash flows Project cash flows both coupons and maturity values May be on an yearly basis over next 3 to 5 years and in a block of 5 years thereafter Compare cash flows Pictorial representation always helps in getting birds eye view here Identify gaps, make recommendations Suggest how future money be invested to ensure better matching Try not to disturb existing investments. Above analysis be carried out considering impact of various scenarios / stresses (e.g. higher than expected attrition (including mass resignations), shock in interest rates etc).

21 Mark to Market (MTM) / Duration analysis Ind AS 19 / AS15 (and other standards on employee benefits) work on fair value basis (as valuations are carried out based on interest rates prevailing as on date of valuation). This exposes the company s balance sheet to Mark To Market (MTM) risk, which can result in significant negative impact on the Company s balance sheet if the interest rates fall. Impact becomes accentuated as usually liabilities are of longer term than assets held. Also, often assets held do not offer the mark to market exposure (e.g. if the trust is holding a cash accumulation plan offered by an insurance company). ALM study should include computation and comparison of the duration of the liability as well as assets and consequently, the analysis of Company s exposure to such mark to market losses. Also, carry out sensitivity analysis to demonstrate the impact (in quantitative terms) interest rate movements can have on the balance sheet of the sponsoring company. Also, can include shock analysis (e.g. in 2008 / 09 the interest rates fell by almost 4% within a span of 6 months driven by significant changes in economic environments). Make suitable recommendations to address concerns of mis-matching (and consequent exposure to market risk).

22 Investment pattern and Risk analysis Investment Pattern Analysis Analyse and comment on the investment pattern of the trust. Provide comparative study of investment pattern of other trusts (to the extent possible based on information available in public domain e.g. annual reports) Analyse the historical investment performance of the fund and compare the same with returns earned on mutual funds of similar nature / composition. Comment on the historical levels of cash or cash equivalents held in the fund vis-a-vis the liability profile. Make suitable recommendations to on the investment pattern and investment philosophy of the trust. Risk Analysis Analyse and comment on various risks trust is exposed to, including market risk (or interest rate risk i.e. the risk of permanent / structural fall in interest rates and consequent impact on cost of benefits), MTM risk (i.e. the exposure to volatility of interest rates), liquidity risk, credit risk (i.e. default risk), currency risk (if applicable) etc. For each risk, present quantitative as well as qualitative observations (to the extent possible) and make recommendations to address those risks.

23 Agenda Introduction Why we have a role to play? Draft scope of an ALM Investigation Additional issues, areas and ideas

24 Help in choosing EPFO or Exempted Trust Can help in determination of rate to declare, over and above the minimum rate declared by EPFO. Can also help Companies choose between exempted trusts and EPFO based on variety of factors such a economic factors, service factors, etc. Consider organisation contributing Rs 50 lakh p.a. towards PF. This illustration indicates the savings potential in cost of exempted, taking 0.5 per cent as fund management charges. However, for larger salary bills the fund management charges would reduce and in some cases is a fixed fee not linked to the contribution made. Trusts vs EPFO Un-exempted establishments Exempt Trusts Rate (%) Actual (Rs.) Rate (%) Actual (Rs.) Administration charged by EPFO ,000 Nil 0 Inspection Charges to EPFO Nil Fund management charges (indicative) , ,000 Total Cost , ,000 Total Cost Annualised (Rs) 7,80,000 4,08,000 Can also expand into the areas of trust governance, given existing relationship with the client.

25 Mark To Market (MTM) Valuations AS15 / Ind AS 19 works on market value basis since discount rate based on yields on government bonds as on the valuation date. Assets also to be measured at fair value something commonly ignored. This is an issue both from Compliance Perspective as well as Asset Liability Management (ALM) perspective. Fair value valuations a huge potential waiting to be exploited.

26 Restrictions on what can be Plan Assets FUNDING Reporting Enterprise Gratuity Trust INVESTED (Non Transferable financial instrument of the reporting enterprise) Such investment cannot be treated as Plan Asset! 7.15 Assets held by a long-term employee benefit fund are assets (other than non-transferable financial instruments issued by the reporting enterprise) that: (a) (b) are available to be used only to pay or fund employee benefits, are not available to the reporting enterprise s own creditors (even in bankruptcy), and cannot be returned to the reporting enterprise, unless either:

27 Restrictions on what can be Plan Assets Reporting Enterprise FUNDING Gratuity Trust Such investment cannot be treated as Plan Asset! Insurance Company 7.16 A qualifying insurance policy is an insurance policy issued by an insurer that is not a related party (as defined in AS 18 Related Party Disclosures) of the reporting enterprise, if the proceeds of the policy:

28 Funding of leave liability do we have a role here?

29 Questions?

30 Thank you! Presenter: Khushwant Pahwa, FIAI, FIA Founder and Consulting Actuary KPAC (Actuaries and Consultants)