Real world examples are complicated. To help you understand, in a simplified manner, the general workings of the Actuary in determining the DBO and Service Cost, we ignore decrements (mortality, attrition, termination) in this example and only allow for a benefit to be paid on the retirement date.

Let’s say a company pays an End of Service Benefit (“EOSB”) upon normal retirement age of 60 years. The benefit is defined as one month’s salary per year of service (e.g. 20 years’ work will give 20 months’ salary as a one-off lump sum payment). The company has one employee only.

Our assumptions are as follows:

Assumption TypeDetails of Assumption
SalariesGrowth of 5% for each future year
Interest/Asset rate of return4% per annum, based on 20-year term quality bonds
Contract TermTo Normal Retirement Age
MortalityNone
Attrition/ResignationNone
TerminationNone

The personal details of the one single employee are as follows:

Personal DetailsAssumption
Age at joining companyAge 30
Age at valuation date (current date)Age 40
Current monthly salary5,000
Normal Retirement Age (“NRA”)Age 60
Past Service40 – 30 = 10 years
Future Service60 – 40 = 20 years
Total Service, also Expected Service60 – 30 = 10 + 20 = 30 years

According to IAS 19, the International Accounting Standards for Employee Benefits, the actuarial funding cost method or valuation method to be used is the Projected Unit Credit (“PUC”) Method.

The simplified calculation stages are as follows:

Calculation TypeFormulaOutput/Result
Projected Final Salary (@ NRA) Current Salary * (1 + Salary Escalation) ^ (Future Service)5,000 * (1.05) ^ 20 = 13,266
Projected EOSB (Undiscounted Lump Sum @ NRA) Projected Final Salary * Total Service13,266 * 30 = 397,980
Projected EOSB @ Valuation Date (Undiscounted DBO) Projected Final Salary * Past Service13,266 * 10 = 132,660
Liability or DBO, after discounting (Reflected in FS)Projected Accrued EOSB * (1 + Interest rate) ^ (- Future Service)132,660 * (1.04) ^ (-20) = 60,544
Unit Normal Service Cost (Undiscounted, per annum) Projected EOSB / Total Service397,980 / 30 = 13,266
Normal or Current Service Cost (CSC)Unit Normal Service Cost * (1 + Interest rate) ^ (- Future Service)13,266 * (1.04) ^ (-20) = 6,054

This valuation assumes that there will be no early termination or other decrements. However, in real life situations, the actuarial valuation exercise will also consider decrements such as resignations, early retirements, disability, death, etc.

The computation gets complicated; the Actuary is professionally trained to deal with the mathematical intricacies and probabilities of various exit states, and the resultant impact on Expected Future Service and Discount Rate assumption.