For IAS 19 purposes the discount rate used is determined by reference to market yields at the valuation date on high quality corporate bonds or, where there is no deep market, by reference to market yields on Government Bonds, preferably with the same duration and currency as that of the liability. High-quality corporate bonds would mean bonds with credit rating of at least “AA” from a reputable credit rating organisation.
For the GCC (KSA, UAE, +) bond markets are not deep. Reference needs to be made to Government Bonds. Even so, Government Bond markets for issues in SAR or AED are not deep, they are illiquid and the bonds are not traded frequently. Thus we generally refer to the Saudi Government Issuance of dollar denominated bonds and similarly for the UAE. These bonds are generally liquid, marketable and the market price of these bonds is publicly available.
Alternatively, given that the SAR is pegged to the US Dollar, we base the discount rate on US bond yields with an additional country risk premium for KSA compared to the USA. In this approach, quantifying the Country Risk Premium is very subjective but a 1% risk premium can probably be reasonably assumed. (This might not hold true in future readings of this post.)
Typically the duration of the liability for EOSB for companies in KSA is anywhere between 8~13 years, depending on industry. For durations 11~13 years, we update our views here:
- 31 March 2020 – 4.7%
- 31 December 2019 – 3.4%
- 30 September 2019 – 3.4%
- 30 June 2019 – 4.1%
- 31 March 2019 – 4.5%
- 31 December 2018 – 5.1%
- 30 September 2018 – 4.0%
Please note that the duration of the liability is derived by computing the weighted average term (years) of the expected future benefit payment arising from the Scheme Benefit. The weight of each benefit payment is determined by dividing the present value of the sum of the future benefit payment. Thus, for determining the duration, the actuary forecast all the expected future cash flows arising from the Scheme and their expected timing of the payment.
Further, the duration of the liability is dependent on the assumed attrition (withdrawal) rate. The higher the withdrawal rate, the shorter the (expected) service duration, and vice-versa. Also, usually, the longer the service duration, the higher would be the discount rate.