Table of Contents

1. What the Standards Require
2. Past Increments Are a Guide, Not the Assumption
3. Business vs Actuarial Salary Escalation
4. Cover Every Component of Pay Growth
5. Comparison With the Discount Rate
6. When to Change the Assumption
7. FAQs

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Salary escalation is one of the two financial assumptions that drive an actuarial valuation, alongside the discount rate. Unlike the discount rate, which is set by reference to market yields, this one rests almost entirely on the reporting entity’s own judgement about its future pay policy.

That judgement sits with management, not the actuary. AS 15 (Revised 2005) frames the assumptions as the reporting enterprise’s own best estimates. IAS 19 and Ind AS 19 carries the same position. The actuary advises; management decides and signs off. Our governance framework for setting actuarial assumptions sets out who should own each decision, and companion posts cover the discount rate and the attrition assumption.

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1. What the Standards Require

Both AS 15 and Ind AS 19 require the salary escalation assumption to be the entity’s best estimate of the increases it expects to award over the period the obligation runs (Ind AS 19 para 76; AS 15 para 74). Two conditions follow:

• Unbiased — “neither imprudent nor excessively conservative” (Ind AS 19 para 77). Setting a low escalation rate to flatter the liability is not permitted, and neither is padding it for comfort.
• Mutually compatible with the other assumptions, particularly the discount rate (Ind AS 19 para 78). Section 5 deals with this.

The same principles apply to End of Service Benefit schemes in the GCC valued under IAS 19. There, the award is calculated on the employee’s salary at exit, so the escalation assumption feeds the obligation directly — though what counts as salary varies by jurisdiction, as section 4 notes.

2. Past Increments Are a Guide, Not the Assumption

Setting the assumption equal to the average increase awarded over the reporting period is a common error, and it is the wrong basis. Past experience is evidence. The assumption is a statement about the future.

If the average increase over the reporting period was 12%, it is entirely defensible to set the assumption at 5% — provided management genuinely expects future increments to run at that level and the reasoning is documented at the time.

The assumption also is not a forecast for the next appraisal cycle. It is the compound annual growth rate expected in the salaries of the existing employees over the duration of the liability — commonly five to fifteen years, depending on workforce profile, and at the shorter end where attrition is high. Single-year experience is volatile; importing that volatility into the assumption produces actuarial gains and losses that reverse the next year and inform nobody.

3. Business vs Actuarial Salary Escalation

The assumption should be consistent with the company’s own payroll and budget planning. A valuation assuming 6% alongside a budget built on 12% is not defensible.

Consistent does not mean identical, because the two measure different things:

	Business assumption	Actuarial assumption
Population	Entire payroll, including employees not yet hired	Only employees on the books at the valuation date
Horizon	Usually the next budget year	Long-run compound rate over the liability duration
Purpose	Budgeting and cost planning	Measuring the obligation arising from past service

Increments tend to moderate as employees accumulate service and move up the scale, so the actuarial assumption is generally — though not necessarily — lower than the corresponding business number. Where the two are far apart, be ready to explain why.

4. Cover Every Component of Pay Growth

Ind AS 19 para 90 is explicit that estimates of future salary increases take account of inflation, seniority, promotion and other relevant factors such as supply and demand in the employment market. In practice that means capturing:

• Cost-of-living and inflation-linked increases
• Merit and performance awards
• Promotion and seniority progression
• Pay-scale revisions and market corrections

Promotional progression is the component most often omitted in practice, and it is the one the standard names expressly. Where a benefit is driven by salary at exit, leaving it out systematically understates the obligation.

Escalate the right salary base

The assumption must be applied to the same definition of pay that the benefit formula uses. This changed in India recently and is easy to miss:

The same care applies in the GCC, where the base differs by jurisdiction. Saudi EOSB is calculated on “wage” as defined in Article 2 of the Labour Law — basic wage plus contractual regular allowances such as housing and transport, though generally not discretionary or variable items. UAE gratuity, by contrast, is calculated on basic salary only. Escalating the wrong base is a quiet but material error.

5. Comparison With the Discount Rate

For salary-linked benefits, what drives the obligation is largely the gap between the salary escalation and discount rate assumptions. A 7% discount rate with 5% escalation and a 9% discount rate with 7% escalation give answers within roughly half a percent of each other at typical durations. Two caveats: the relationship is an approximation rather than an exact invariance, and it breaks down where a benefit cap bites, since higher nominal salaries push more employees over the ceiling. It follows that the two assumptions should be reviewed together each cycle rather than in separate exercises.

6. When to Change the Assumption

The assumption should not track realised experience year on year. It changes when management’s view of long-term pay growth changes.

If the assumption was 10% and actual increases came in at 15%, that does not warrant a move to 15% — provided management still believes increases will average 10% over the long run. A single year of over- or under-shoot is precisely the volatility a long-term assumption is meant to smooth.

Legitimate triggers for a change include a structural shift in pay policy, a significant change in workforce mix, a sustained divergence over several consecutive years, or a durable change in the inflation outlook that also affects the discount rate.

An assumption that is reset to last year’s actual increment every cycle is not a best estimate. It is a lagging indicator, and it will be challenged — not least because Ind AS 19 requires disclosure of the significant actuarial assumptions and a sensitivity analysis showing how the obligation responds to a reasonable change in each of them. A salary escalation assumption that cannot be explained is visible in the accounts.

7. FAQs

Can we set the assumption equal to our budgeted increment for next year?

No. The budgeted figure is a one-year number covering the whole payroll, including hires not yet made. The assumption is a long-term compound rate for the existing population only. The two will rarely be the same.

Does a higher salary escalation assumption always increase the liability?

It increases the liability or leaves it unchanged; it does not reduce it. That makes it simpler than the attrition assumption, where the direction is genuinely ambiguous. The “unchanged” cases arise where the benefit stops responding to salary — most commonly a cap. For employees whose projected gratuity already exceeds the ₹20 lakh statutory ceiling, further salary growth adds nothing, though this only applies where the employer pays strictly to the statutory scheme; many plan rules are uncapped or capped higher. Benefits that are not salary-linked at all, such as flat long-service awards, are unaffected either way. Our post on sensitivity of gratuity valuation to assumptions and employee profile shows this with worked examples.

Should the assumption vary by grade or employee group?

It can, and often should. Junior populations typically see faster percentage growth than senior ones, and a single blended rate applied across a wide grade spread can distort the result. Split it where the data supports the split and the difference is material; document the basis either way.

Which salary should we escalate?

Whichever one the benefit formula uses. For Indian gratuity that is now “wages” under section 2(88) of the Code on Social Security, 2020, including the 50% add-back where excluded allowances exceed half of total remuneration. For Saudi EOSB it is “wage” under Article 2 of the Labour Law, which includes contractual regular allowances. For UAE gratuity it is basic salary only.

How often should we review it?

Every valuation cycle, and alongside the discount rate rather than separately. Reviewing and concluding “no change” is a perfectly good outcome, and usually the right one — provided the review is documented.

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Download our guide on transitioning to Ind AS from employee benefits perspective; click on the picture below:

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