The mechanics of funded gratuity schemes remain unclear for many companies, due to a lack of regulatory framework and a general lack of understanding of actuarial principles.
We have examined the issue to consider for gratuity scheme funding in our prior post. This post sets out a list of frequently asked questions about funded gratuity schemes; i.e. gratuity schemes for which funds have been already set aside. Here’s a selection of the most frequently asked questions, from our own experience working with our clients:
1. My company’s gratuity scheme is funded with LIC. Do we still need to get the actuarial valuation done for AS 15?
Yes, the fact that your gratuity is funded doesn’t change anything as far as reporting under AS 15 is concerned. AS 15 is an assessment of your gratuity liabilities and how much you hold in assets to back them.
2. How much contribution should I make into my gratuity fund?
In India, there is no specific regulation that requires companies to maintain a minimum level of fund to back the liabilities. Therefore, companies can contribute any amount they want, or not make any contribution at all! However, it is recommended that companies fund the liabilities in a scientific manner by getting a special kind of actuarial valuation done, called a ‘funding valuation’. Lack of a scientific approach for funding could lead to a possibility where the company may have to release additional cash to fund the payouts at inopportune times.
3. Should I maintain a fund equal to the Defined Benefit Obligation (DBO) calculated under AS 15?
You can aim to maintain a fund level equal to your DBO, or any other measure because currently there are no regulations in India that prescribe any minimum funding level. However, DBO varies quite a lot year on year due to fluctuations in the discount rate. This would mean that your contributions will change greatly year on year, and cannot be predicted until the results of actuarial valuation become known. This would also mean that you won’t be able to avail full tax benefits because there will be certain years where you will make contributions more than the threshold prescribed by the Income Tax department and in some years, it will be much less. Most companies will be wary of contributions which are so uncertain and volatile, and sub-optimal from a tax perspective. A funding valuation should reveal the right level of fund to be maintained.
4. I think the insurance company is asking too much premium. How much do I really need to pay?
Quick answer – really doesn’t matter! It is up to you to ensure that you contribute enough to continue to pay the gratuity benefits as they fall due. If you think that the insurer is asking for too much, the excess that is not used to pay the benefits will remain in the fund and will belong to you. However, consider getting a funding valuation done as explained in question 2. Notwithstanding anything else in your contract with the insurer, you may choose to ignore their demand and pay an amount calculated by an independent actuary instead. However, be careful about the risk premium being charged by the insurer towards future service gratuity insurance.
Download our guide on basics of actuarial valuation under AS 15 and Ind AS 19 by clicking on the picture below: