The Code On Social Security, 2020

Implications on Actuarial Valuation of Employee Benefits

KPAC (Actuaries and Consultants) Tanu Saharan

www.kpac.co.in Senior Actuarial Manager
+91-9873760219, [email protected]
Khushwant Pahwa, FIAI, FIA Arpaan Begdai
Founder and Consulting Actuary
Senior Actuarial Manager
[email protected]
+91-9899824848, [email protected]
 Agenda
Agenda

Introduction to The Code

on Social Security, 2020

Key changes impacting

Actuarial Valuations

Potential impact of the

changes

The way forward

Introduction
An overview of the background
• Labour falls under the Concurrent List of the Constitution. Therefore, both Parliament and state legislatures can
make laws regulating labour.

• Central Government stated that there are over 100 state and 40 central laws regulating various aspects of
labour such as resolution of industrial disputes, working conditions, social security and wages. The Second
National Commission on Labour (2002) found existing laws to be complex, with archaic provisions and
inconsistent definitions.

• To improve ease of compliance and ensure uniformity in labour laws, the Central Government recommended
the consolidation of central labour laws into broader groups such as:
(i) industrial relations,
(ii) wages,
(iii) social security,
(iv) safety, and
(v) welfare and working conditions.

• In 2019, the Ministry of Labour and Employment introduced 4 Bills to consolidate 29 central laws. These Codes
regulate: (i) Wages, (ii) Industrial Relations, (iii) Social Security, and (iv) Occupational Safety, Health and Working
Conditions.

• While the Code on Wages, 2019 was passed by Parliament, Bills on the other three areas were referred to the
Standing Committee on Labour. The Standing Committee has submitted its report on all three Bills. The
government replaced these Bills with new ones on September 19, 2020.
Introduction
Journey of the bill so far
• The Code On Social Security, 2020 was introduced in the Lok Sabha on 19th September 2020.

• The following table summarises the journey of the Bill:

Introduced to Passed by Lok Passed by Rajya Notified in the

Lok Sabha Sabha Sabha Official Gazette

• Sep 19, 2020 • Sep 22, 2020 • Sep 23, 2020 • Pending **

• On the date of making this presentation (28h October 2020), the notification of the date of implementation of
the Code in the Official Gazette of India was pending. Please note that the code was published in the Official
Gazette of India on 29th September 2020.

• The code shall come in-force from the date of implementation which shall be notified in the Official Gazette of
India. Once notified, the Code on Social Security, 2020 will replace 9 existing laws (detailed in the next slide).

• The government intends to implement / notify the Code of Social Security,

2020 and other labour codes shortly. You can refer to the following article for
further details:
https://www.livemint.com/news/india/govt-to-implement-four-new-
labour-codes-by-april-11602694241333.html
Introduction
Acts merging into the Code on Social Security, 2020

The Payment of Gratuity Act, 1972

The Employees' Provident Funds and Miscellaneous

Provisions Act, 1952

The Employees' State Insurance Act, 1948

The Employees' Compensation Act, 1923

The Employment Exchanges (Compulsory The Code on Social

Notification of Vacancies) Act, 1959
Security, 2020
The Maternity Benefit Act, 1961

The Cine Workers Welfare Fund Act, 1981

The Building and Other Construction Workers’

Welfare Cess Act, 1996

The Unorganised Workers Social Security Act, 2008

 Agenda
Agenda

Introduction to The Code

on Social Security, 2020

Key changes impacting

Actuarial Valuations

Potential impact of the

changes

The way forward

Key changes impacting actuarial valuations

The key changes impacting actuarial valuations of employee benefits are as follows:

• Change in the DEFINITION OF WAGES

• Change in VESTING CRITERIA for FIXED TERM EMPLOYMENT

• Change in the VESTING CRITERIA FOR JOURNALISTS

The changes and the impact of the same on actuarial valuation of employee benefits (gratuity, leave
encashment, etc.) are discussed in the following slides.

Note: Above are the key changes only and there may be other changes as well. We
are not lawyers and it is best to consult a labour law consultant to get a complete
overview of the changes you need to implement for your organisation. Please refer
to the disclaimer section at the end of this presentation for further details.
Definition of Wages
What does Section 2 Sub Section 88 require?
Change in the Definition of Gratuity Benefit for Fixed Term Change in vesting criteria for
Wages Employment Journalists
Section 2, sub section 88, Definition of Wages requires that the Wages be at least 50% of Total Compensation:

Wages Gross Compensation **

Which shall be sum of:
Defined as sum of:
- Basic Pay
- Basic Pay - Dearness Allowance
- Retaining Allowance
- Dearness Allowance Wages - Bonus payable under any law
(Allowance paid to employees to offset the >= - Value of any house-accommodation
impact of inflation) 50% of Gross - Contribution to any pension or PF plus interest accrued
Compensation - Conveyance allowance
- Retaining Allowance - Sum paid to defray special expenses
(allowance payable to an employee of any - House rent allowance
factory or other establishment during any - Any award / settlement under order of a court / Tribunal
period in which the establishment is not
working, for retaining his services.)
- Overtime allowance
- Commission payable to the employee

• If the above is not true, the wages shall be deemed to be 50% of the gross compensation.
• ** Note: there are discussions / debates amongst practitioners on how the Gross Compensation shall be calculated.
For example, should you be including variable non-statutory bonus or variable components in the same? We are not
going into the same in this presentation. We encourage you to talk to your labour law consultant for the same.
• Refer to exact definition of Wages in the next slide. Implications of the above are discussed in the subsequent slides.
Definition of Wages
Text from Section 2 Sub Section 88
Change in the Definition of Gratuity Benefit for Fixed Term Change in vesting criteria for
Wages Employment Journalists
(88) "wages" means all remuneration, whether by way of salaries, allowances or otherwise, expressed in terms of money or capable of
being so expressed which would, if the terms of employment, express or implied, were fulfilled, be payable to a person employed in respect
of his employment or of work done in such employment, and includes,—

(a) basic pay;

(b) dearness allowance; and
(c) retaining allowance, if any,

but does not include—

(a) any bonus payable under any law for the time being in force, which does not form part of the remuneration payable under the
terms of employment;
(b) the value of any house-accommodation, or of the supply of light, water, medical attendance or other amenity or of any service
excluded from the computation of wages by a general or special order of the appropriate Government;
(c) any contribution paid by the employer to any pension or provident fund, and the interest which may have accrued thereon;
(d) any conveyance allowance or the value of any travelling concession;
(e) any sum paid to the employed person to defray special expenses entailed on him by the nature of his employment;
(f) house rent allowance;
(g) remuneration payable under any award or settlement between the parties or order of a court or Tribunal;
(h) any overtime allowance;
(i) any commission payable to the employee;
(j) any gratuity payable on the termination of employment;
(k) any retrenchment compensation or other retirement benefit payable to the employee or any ex gratia payment made to him on
the termination of employment, under any law for the time being in force:

Provided that for calculating the wages under this clause, if payments made by the employer to the employee under sub-clauses (a) to (i)
exceeds one half, or such other per cent. as may be notified by the Central Government, of the all remuneration calculated under this
clause, the amount which exceeds such one-half, or the per cent. so notified, shall be deemed as remuneration and shall be accordingly
added in wages under this clause.
Definition of Wages
Implication of the change (1)
Change in the Definition of Gratuity Benefit for Fixed Term Change in vesting criteria for
Wages Employment Journalists

• From actuarial valuations perspective, the new definition of wages is the key change, which may impact the costs of
many organisations and take-home salaries for employees.

• The exclusion limit of 50% is aimed at ensuring that companies do not adopt compensation structures which result
in wages being reduced below 50% of the total remuneration.

• To ascertain impact of change (both in terms of proportion of companies impacted and the extent of revision in
compensation structure needed), we analyzed (Wage) Basic salary to Gross Salary ratio of some of the top listed
Companies for whom we have performed the year end valuation for FY 2019 - 20.
Pie chart below captures the split of Companies based on their Basic Salary (and DA) to Gross Compensation ratio:

5%
Less than 35% 15% It appears that a majority of Companies will have to
10% re-design their compensation structures, with basic
35% - 39% salary (and DA) seeing an increased proportion in the
total CTC / Compensation.
40% - 44%
20%
45% - 49% 25% About a third of the Companies may have to
materially increase basic salaries within the
50% - 59% component structures, which may impact take home
25% salaries whilst also pushing up actuarial liabilities.
60% and Above
Definition of Wages
Implication of the change (2)
Change in the Definition of Gratuity Benefit for Fixed Term Change in vesting criteria for
Wages Employment Journalists

As mentioned previously, re-design of compensation structures will have direct impact on actuarial liabilities.
GRATUITY ACTUARIAL LIABILITY (Post Employment Benefit)

• The “applicable wages” considered in gratuity calculation is expected to increase due to re-design of
compensation structure for most companies. It shall result in a one-off increase in gratuity liability.

• The one-off increase in liability shall be charged to Income Statement or Other Comprehensive Income (OCI)
depending upon the applicable accounting standard (refer following section).

• The extent of this one-off increase in liability will depend on the extent to which there is a need to re-design the
compensation structure.

EARNED LEAVE / LEAVE ENCASHMENT LIABILITY (Other Long Term Employee Benefit)

• Similarly, the companies that provide leave encashment on Basic salary (and not gross salary) will experience a one-
off increase in the liability for leave encashment.

• The extent of impact on liability will differ from Company to Company, based on Company’s leave policy (i.e. based
on salary on which the leaves are encashed) and the requirements of the Shops and Establishment Acts of the
state(s) in which the Company operates.

• One-off increase in the leave liability shall be charged to Income Statement in most cases (refer following section).

Liabilities of other post retirement and other long-term employee benefits may also increase, in line with above.
Fixed Term Employment
Vesting Criteria to not apply!
Change in the Definition of Gratuity Benefit for Fixed Term Change in vesting criteria for
Wages Employment Journalists

• In case of Fixed Term Employment, gratuity pay-outs will be made upon the expiry of the fixed term,
irrespective of whether 5 years have been completed or not. Calculation of gratuity benefit, in such cases,
shall be done on pro-rata basis.

• This is expected to result in increase in gratuity liability in case of Companies that offer fixed term
employment.

• The increase in liability because of this change shall be treated as Past Service Cost and charged to Income
Statement, either immediately or over a period of time (depending upon the applicable accounting standard).

• Please refer to the next section for treatment of Past Service cost under different accounting standards.

What is Fixed Term Employment?

As per Section 2, sub section 34 of the Code on Social Security, 2020, Fixed Term Employment means the engagement of an
employee on the basis of a written contract of employment for a fixed period, provided that:

(a) his hours of work, wages, allowances and other benefits shall not be less than that of a permanent employee doing the same
work or work of a similar nature and

(b) he shall be eligible for all benefits, under any law for the time being in force, available to a permanent employee proportionately
according to the period of service rendered by him even if his period of employment does not extend to the required qualifying
period of employment.
Vesting Criteria for Journalists
Reduced to three years from five!
Change in the Definition of Gratuity Benefit for Fixed Term Change in vesting criteria for
Wages Employment Journalists

• Gratuity is payable to an employee on the termination of his employment after he / she has rendered
continuous service for not less than five years.

• However, for working journalists, the Code on Social Security, 2020 reduces the vesting criteria from five
years to three years.

• This shall result in an increase in liability for the Companies in the News and Media industry i.e. the
Companies that employ working journalists.

• The increase in liability because of this change shall be treated as Past Service Cost and charged to Income
Statement, either immediately or over a period of time (depending upon the applicable accounting
standard).

• Please refer to the next section for treatment of Past Service cost under different accounting standards.
 Agenda
Agenda

Introduction to The Code

on Social Security, 2020

Key changes impacting

Actuarial Valuations

Potential impact of the

changes

The way forward

Treatment of impact due to re-structuring
Actuarial Gains / Losses under various GAAPs
• For most Companies, re-design of compensation structure will result in a higher than expected increase in the
“applicable salary”.

• Higher than expected increase in salary (vis-à-vis the assumed salary growth rate) will result in actuarial loss
(experience loss) and an increase in the liability, with the said increase being recognised in accordance with the
applicable Accounting Standards.

• Treatment of actuarial gains and losses under various Accounting Standards is as below:

Recognition of Actuarial
AS 15 IAS 19 / Ind AS 19 US GAAP
Gains or Losses

Immediate or Deferred? Immediate Immediate Immediate

OCI in case of Post Employment Benefits

Recognised where – In case of post employment
(e.g. Gratuity)
Income Statement or Other Income plans - initially OCI with
Comprehensive Income Statement subsequent charge to Periodic
Income Statement in case of Other Long
(OCI)? Benefit Cost (Income Statement)
Term Benefits (e.g. compensated absences)
Reclassification to Income
Not
Statement in case of initial Not allowed / required Yes, refer below *
applicable
recognition through OCI

* Minimum recognition prescribed as per ASC715. The Company can choose to recognize all immediately or any other
systemic approach provided certain criteria is met.
Treatment of impact due to change in Vesting
Past Service Cost under various GAAPs
• The implementation of Code on Social Security, 2020 will result in the change in the vesting criteria from 5 years to 3
years for working journalists and removal of vesting criteria for fixed term employees.

• Companies offering fixed term employment and / or companies in the News and Media industry may, thus, experience
an increase in liability, with the said increase being treated as past service cost and recognised in Income Statement in
accordance with the applicable Accounting Standards.

• Recognition of Past Service Cost under various Accounting Standards is as below:

Recognition of Past Service

AS 15 IAS 19 / Ind AS 19 US GAAP
Cost
Immediate for Vested
Immediate or Deferred? Immediate Immediate
Deferred for Un-vested
Recognised where – In case of post employment
Income Statement or Other plans - initially OCI with
Income Statement Income Statement
Comprehensive Income subsequent charge to Periodic
(OCI)? Benefit Cost (Income Statement)
Reclassification to Income
Statement in case of initial Not applicable Not applicable Yes, refer below *
recognition through OCI

* Minimum recognition prescribed as per ASC715. The Company can choose to recognize all immediately or any other
systemic approach provided certain criteria is met.
Demonstrating impact of re-structuring
Simple worked example (1)
• Let us understand the impact of re-structuring on gratuity valuation of an organisation with current Basic (and DA) to
CTC ratio of 40%.

• Consider following compensation structure as at 31 Mar 2020 and 31 Mar 2021 for an employee with following details:

Compensation as at Compensation as at
Compensation as at
Compensation 31 Mar 2021 31 Mar 2021
31 Mar 2020
(Before re-structuring) (After re-structuring)
4,80,000 5,28,000 6,60,000
Basic plus Dearness Allowance
(40% of CTC) (40% of CTC) (50% of CTC)
Other components (e.g. HRA, Conveyance Allowance,
7,20,000 7,92,000 6,60,000
Contribution to PF, Overtime allowance, etc.)
13,20,000 13,20,000
Total Compensation 12,00,000
(10% increase vs. last year) (10% increase vs. last year)

• As can be seen from the above table, whilst the CTC has increased by 10% between Mar 2020 and Mar 2021, the
applicable salary for gratuity has increased by 37.5% due to re-structuring.

• Of the above 37.5%, 27.5% increase is happening purely due to the need to re-design the compensation structure.

• This shall result in a one off increase in liability and actuarial loss, which shall need to be recognised as per applicable
accounting standard.

• Let us consider the impact on liability and recognition of above re-structuring in the following slide.
Demonstrating impact of re-structuring
Simple worked example (2)
For the employee mentioned in the previous slide, consider the liability reconciliation below, which is based on following
assumptions and particulars of the employee:
Salary growth rate : 10% per annum Age of employee : 40 years
Discount Rate : 7% per annum Retirement Age : 60 years
Attrition Rate : 0% per annum Limit of gratuity benefit : No limit

Liability reconciliation Liability reconciliation

Particulars
(if no restructuring) (after restructuring)

Present value of obligation at the Regular charge to P&L to

120,358 120,358 increase as service cost
beginning (Opening Liability)
starts getting measured
on higher salary.
- Interest Cost 8,419 8,419

33.75% higher
- Service Cost 42,927 57,416

- Actuarial (gain) / loss 0 28,446

- Benefits paid 0 0 One-off increase –

charged to OCI under IAS /
Present value of obligation at the 25% higher
Ind AS19 and to P&L under
171,704 214,639 AS 15
end (Closing Liability)
 Agenda
Agenda

Introduction to The Code

on Social Security, 2020

Key changes impacting

Actuarial Valuations

Potential impact of the

changes

The way forward

The way forward
It is not just about actuarial valuations!

• The Code on Social Security, 2020, proposes to replace nine existing labour laws and is likely to impact most
organisations in someway or the other.

• Once notified, amongst other things, a majority of the companies will have to re-design their compensation
structures.

• Such a re-design of compensation structure will not only impact the take-home salary but also impact the
value of certain post employment and other long term employee benefits.

• The impact may be material for organisations that require significant change to their existing compensation
structure.

• It may be advisable for companies to reach out to labour law (and rewards and benefits) consultants to
understand the complete implications of this new law for their organization.

• The companies are also advised to reach out to actuaries to understand the implication on the values of
liabilities (and consequent charge to Income Statement / OCI) determined using actuarial principles.
 Agendadetails
Contact

Connect with us for any queries

Khushwant Pahwa FIAI, FIA Arpaan Begdai Tanu Saharan

Founder and Consulting Actuary Senior Manager - Actuarial Senior Manager - Actuarial
Phone: +91 - 99102 67727 Phone: +91 - 98998 24848 Phone: +91 – 98737 60219
[email protected] [email protected] [email protected]

Aarzoo Dawar Twinkle Agarwal

Actuarial Consultant Actuarial Consultant
Phone: +91 - 8860195272 Phone: +91 – 8447884272
[email protected] [email protected]

Visit our website to read our latest articles : www.kpac.co.in

Disclaimer

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solely for your information and must not be reproduced or redistributed. This material is for the information of
the recipient and we are not soliciting any action based upon it. Also, it does not constitute any
recommendation.

It should also be noted that we are not engaged in the practice of law. The information contained in this
document does not constitute and is not a substitute for legal advice. The Company should consult a labour law
consultant / lawyer for any legal advice relating to the implementation of the Code on Social Security, 2020.

In particular, the information contained in this document is available in public domain and is for general
purposes only. It is not an advice on actuarial valuations or legal advice on the Code on Social Security, 2020 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
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