There is more to selection of discount rate than simply looking up the interest rates on internet. Many companies don't realise the complexities involved and need to do more than they are doing currently.
Any actuarial valuation involves the use of a 'discount rate', which is used to calculate the present value of future benefits promised by an employee benefit scheme.
This post only covers the selection of discount rate. Details on other topics related to actuarial valuation of employee benefits can be found here.
Accounting standards, such as AS 15, Ind AS 19, IAS 19 and US GAAP have prescribed rules on how the discount rate should be selected.
The significance of discount rate in any actuarial valuation cannot be over-estimated. It has a significant direct impact on the liability.
his is one assumption that can be validated by looking at publicly available information and therefore undergoes the maximum scrutiny of the auditors and external analysts.
whose responsibility is it?
Many companies have a perception that it is alright to leave the decision to set the discount rate to their actuaries. In the past, such an approach has led companies into severe problems. If an error or discrepancy in choosing the discount rate is revealed, companies cannot pass on the consequences to the actuary.
Discount rate, as with all other actuarial assumptions, remains the responsibility of the Board of the reporting enterprise. It is their responsibility to ensure that they have done enough to ensure the actuarial assumptions were set correctly with due attention to the work done by the actuary. Of course, this responsibility can be delegated by the Board to the managers in the company. In case of any issues, the Board and the delegated personnel will be held accountable. In most cases, the consequences on the actuary would be a disciplinary action by the Institute of Actuaries of India, which is unlikely to be of any significant benefit to the company.
WHAT IS PRESCRIBED UNDER the ACCOUNTING STANDARDS?
Most accounting standards prescribe that the discount rate should be set equal to the yield to maturity on Government bonds (Government securities, or GSecs) having term consistent with the term of liabilities, as at the date of valuation.