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ANALYSIS OF SALARY GROWTH RATE ASSUMPTION ADOPTED BY NSE 50 COMPANIES (FY21 AND
FY22)

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 2021-22 along with comparatives for past few FYs.
The analysis for previous financial years can be found here:


https://www.kpac.co.in/kc/77/analysis-of-salary-growth-rate-assumption-adopted-by-nse-50-companies-(fy20-and-fy21)

https://www.kpac.co.in/kc/69/analysis-of-salary-growth-rate-assumption-adopted-by-nse-50-companies-(fy19-and-fy20)

https://kpac.co.in/kc/61/analysis-of-salary-growth-rate-assumption-adopted-by-nse-50-companies-(fy18-and-fy19)

https://kpac.co.in/kc/52/analysis-of-salary-growth-rate-assumption-adopted-by-nse-50-companies-(fy17-and-fy18)

https://www.kpac.co.in/kc/29/salary-growth-rate:-what-are-nse-50-companies-assuming.html



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 assess the net strengtheing /
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
2021-22, the composition of the Nifty 50 index changed for two companies (viz.
Shree Cement Ltd. and Indian Oil Corporation Ltd.) which were part of index as
at 31 March 2021 but were replaced by Adani Enterprises Ltd. and Apollo
Hospitals Enterprise Ltd. in the index as at 31 March 2022. The findings below
are based on the Companies that comprised the index as on 6 Feburary 2023.


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 2020-21 and FY 2021-22):


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 has increased during FY 2021-22
   (being 7.40% p.a. as at 31 March 2022 vs 7.20% p.a. as at 31 March 2021).
   
   During the FY 21-22, 16 companies were observed to have strengthened their
   salary growth rate assumption, whereas only 3 companies were observed to have
   slightly lowered their salary growth rate assumption as compared to FY 20-21.
   Strengthening of salary growth rate assumption can be attributed to the
   relatively lower increments during the pandemic years and to combat the
   “Great Resignation” phenomenon experienced by majorly all the sectors.
   
   The below chart captures the comparison of the last 2 FYs based on the number
   of companies who have increased, decreased or have retained the same salary
   growth rate assumption. We observe a significant jump in the number of NSE 50
   companies who have strengthened their salary growth rate assumption in FY
   2021-22 viz-a-viz FY 2020-21 (16 companies have increased their SGR
   assumption during FY 21-22 as compared to 8 during FY 20-21).
   
   
   
   
 * The average discount rate assumption has increased during the period (being
   6.90% p.a. as at 31 March 2022 to 6.50% p.a. as at 31 March 2021). The
   increase is largely driven by hike in policy rates and high inflation levels.
   As a reference, we note that the benchmark yield on 10-year government bond
   and 5-year government bond has increased by about 70 bps and 40 bps
   respectively. You can access our discount rate articles for 31 March 2022 and
   31 March 2021, which also gives comparison of yields on government bond, by
   clicking on the links below:
   
   https://www.kpac.co.in/pdf/Discount-Rate-March2022.pdf
   
   https://www.kpac.co.in/pdf/Discount-Rate-March-2021.pdf
   
   



 * 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 FY2009:


 * The minimum salary growth rate assumption observed was 4.75% p.a. whereas the
   maximum was observed to be 11% p.a. as at the end of FY 2021-22. The
   following chart shows the split of number of companies based on the range of
   the salary growth rate assumption as at 31 March 2022:
   
   
   
 * 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 category of employees). However, companies could
consider varying the assumption on the following basis:


 * Varying Salary Growth Rate by year of projection: It 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, Cipla Ltd., HDFC Life Insurance Company Ltd. Kotak Mahindra Bank
   Ltd., Nestle India Ltd and SBI Life Insurance Company Ltd.) have adopted this
   approach as at 31 March 2022.
   
   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:
   
   http://www.kpac.co.in/kc/12/salary-growth-rate-varying-by-year-of-projection.html
   
   
 * Varying Salary Growth Rate by category of employees: In this case, the salary
   growth rate assumption is varied basis 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 NSE 50 companies (Coal India
   Limited, HDFC Life Insurance Company Ltd., Kotak Mahindra Bank Limited and
   Tata Consumer Products Ltd.) have adopted this approach as at 31 March 2022.
   
   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.



SECTORAL HIGHLIGHT

The below chart depicts the average salary growth rate assumption adopted as at
31 March 2022 by some major sectors covered by NSE 50 Companies. The average
rate adopted by majority of sectors is above 7% p.a. with logistics leading at
10% p.a.



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. A
stabilization of the salary growth rate assumption could be expected as the
economy matures and inflation continues to be benign and stable. The FY 2022
experienced a slightly higher salary growth rate as compared to last 2 FYs
mainly due to the higher increments in post pandemic years. The increase in
average salary growth rate adopted by top NSE 50 companies also highlights the
fact that the Companies in actual have strengthened their short-term
expectations to combat the great resignation phenomena observed by the market.


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.


Surbhi Jindal, Associate Vice President- Actuarial
KPAC Actuaries and Consultants LLP
s.jindal@kpac.co.in
www.kpac.co.in




Disclaimer: The above content has been furnished solely for information and must
not be reproduced or redistributed. It should be noted that we are not
soliciting any action based upon it. Also, it does not constitute any
recommendation. In particular, the information above is for general purposes
only and is not an advice on actuarial valuations or investments or anything
else. The information given above is in summary form and does not purport to be
complete. We have reviewed the above and in so far as it includes information or
facts, it is believed to be reliable though its accuracy or completeness cannot
be guaranteed. The information contained in the above report should be construed
as non-discretionary in nature and the recipient of this material should rely on
their own investigations and take their own professional advice. Neither KP
Actuaries and Consultants nor any person connected with it accepts any liability
arising from the use of this document. The recipient(s) before acting on any
information herein should make his/her/their own investigation and seek
appropriate professional advice and shall alone be fully responsible / liable
for any decision taken on the basis of information contained herein.





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