The liability with respect to employees’ accrued gratuity needs to be recognised in a company’s financial statements. This liability is calculated by carrying out an actuarial valuation as per AS 15 (R) or IND AS 19 accounting standards. Companies mainly opt for trust fund with insurer/s to secure employee benefits liabilities.

The schemes wherein the companies do not set aside a fund are known as Unfunded Gratuity Schemes whereas the schemes where companies set aside a fund to meet the liabilities are known as Funded Gratuity Schemes Currently, it is not mandatory, in India, to contribute a particular amount to the trust. Some companies contribute when a time of payment arises. While some companies contribute based on the actuarial valuation However, the amount to be actually paid as gratuity will be known only at the time of payment.

Section 4A of the Payment of Gratuity Act,1972 and section 57 of the upcoming Code on Social Security, 2020 have mandated employers to insure their employees’ gratuity benefits with either LIC or any other insurer But the powers of implementation have been given to the state governments.
Recently Karnataka has joined Andhra Pradesh, Telangana, and Kerala, in incorporating a mandatory requirement for companies having sole presence in any of these states to obtain an insurance policy to meet with their gratuity liabilities. In case of companies which are operative in multiple states, the governing authority will be Central Government which has not yet implemented any rules regarding compulsory gratuity funding.

Types of Group Gratuity Plans in India:
Companies can set their own trust to fund the liabilities and manage their money internally. As per Rule 67 of Income Tax Act, it is mandatory to invest the funds. But some companies might not have the expertise for investment market. Also, investing with an insurer gives greater exposure to the market. Hence many companies choose to invest the fund with an insurer.

Insurance companies mainly offer two types of insurance plans : Endowment or traditional plans and Unit Linked plans. Traditional funds offer a steady growth, guaranteed returns, but they are non-flexible and lack transparency. On the other hand, unit linked plans offer the companies to structure their portfolio based on their capacity to take risk, investing in desired equity/debt combination, market linked returns, flexibility in managing funds.

To fund or not to fund:
Whether or not to fund the gratuity liabilities is a strategic decision and requires multiple issues to be considered. The decision can be based on several factors.

  • Trusts are exempt of income tax and capital gains tax on the interest earned by the funds. Contributions made to the trust upto a maximum of 8.33% of annual gratuity salaries can be considered as tax-deductible expense.
  • A company pays the gratuity benefits as the liability arises. But if in case many employees leave together then a sudden liability will cause a great burden on the company’s financials. Having a dedicated fund set aside, with regular contributions made, will avoid such circumstances.
  • Large companies might have an in-house team of experts to manage the trust fund. But smaller companies can be better off by having a third-party asset manager for their funds. It would also offer them exposure to different asset classes.
  • If company has set up a gratuity fund with an insurer, then it ensures safety for its employees’ future livelihood as most medium and low salaries employees might well be dependent on these payments.

A Look at Actual Picture:
We conducted a detailed study of Gratuity valuation done by companies for the FY 22-23. The database used for the purpose of this study comprises of our various clients from all over India, the majority are from Maharashtra, Karnataka, Tamil Nadu and Delhi. The sample size for the study was approximately 1,800 companies. We have also taken utmost care to exclude clients’ data with whom we have signed non-disclosure agreements.

This study is built on the client database of Ranadey Professional Services Private Limited as at 31st March 2023. We don’t claim that the following results necessarily represent the trends in the industry. This report is proprietary information of Ranadey Professional Services. This is to be held strictly confidential and no part of the report should be reproduced or shared without the prior permission of Ranadey Professional Services.

This article focuses on Gratuity funding status for year ended 31st March 2023.

Companies opt for trust fund with insurer/s mainly to secure employee benefits liabilities. Currently there are no funding regulations in India except some states like Andhra Pradesh, Telangana where companies to whom Gratuity Act is applicable, must fund their gratuity liability. Recently a similar regulation has been passed in Karnataka State, making companies liable to opt for a Gratuity trust fund in the month of March 2024.

In the balance sheet, fund values are shown as assets against employee benefits liabilities. In the database under consideration, around 34% companies have funded gratuity schemes.

Figure 1

Figure 1 shows industry wise proportion of funded gratuity plans. Around 50% of engineering, agro-based chemical and manufacturing companies have set up funds for their gratuity plans. A large proportion of companies in service, IT and pharma/healthcare industries have not funded their gratuity plans despite having a large employee base. It is expected that all companies with unfunded gratuity plans will be required to opt for a fund with an insurer/s on implementation of the new Wage Code.

Figure 2

Figure 2 shows the percentage of gratuity actuarial liability that is covered by funds for FY 22-23. Funded ratio is calculated as closing fund value/closing gratuity liability. More than 50% of the companies have a funded ratio of more than or equal to 74%. With new rule by Karnataka Government, fund is required to cover entire actuarial liability. Hence this ratio for Karnataka State companies is expected to reach 100% within next few years.

Figure 3

Figure 3 illustrates industry-wise funded ratios. For FY 22-23, more than 50% of the funded companies from Chemical, Infra/construction, Manufacturing and pharma/healthcare sectors have assets-to-liability ratio of above 74%. In case of Agro based and Engineering sector companies, half of them have assets-to-liability ratio of less than 50% and the other half is above 74%.

Figure 4

Figure 4 shows the percentage of the insurance companies serving the clients under consideration for FY 22-23. As per the data, LIC serves almost 95% of the companies, while the remaining 5% includes Bajaj Allianz, ICICI Prudential, PNB MetLife, HDFC Life, etc.

It is noteworthy that a majority of companies tend to opt for a traditional funds with LIC rather than NAV-linked funds, for NAV linked – most companies prefer private insurers. With new regulations of compulsory funding in few states, private insurance companies may seek further opportunities to increase market share.

Figure 5

Considering introduction of funding rules in few states, Figure 5 shows State wise proportion of funded gratuity plans.

Figure 5 shows State wise proportion of funded gratuity plans. Around 35% companies in Maharashtra state have funded plans. In Telangana, the companies which we have considered are the ones having sole presence in Telangana state, as the funding regulation applies only to these companies. In Tamil Nadu, specifically, about 50% companies have funded plans. On the other hand, Haryana, Gujarat, Delhi states show a lower % of funded plans.

Considering all above aspects, it may be concluded that, it is better for a company to have the gratuity liability insured. It will give a better sense of security to its employees. And in view of employers also they will be better off making regular contributions covering a major portion of their liability, which also gives them a tax benefit, and reduces volatility of the cashflows, helps in retaining employees