LSP Valuation – Long Service Payments valuation under the New Legislations for Hong Kong Companies

Long Service Payment (LSP) Valuation after Abolition of MPF Offsetting Mechanism

The Government has announced that the abolition of MPF offsetting arrangement will take effect on 1 May 2025. Employers including companies and non-governmental organizations in Hong Kong should get prepared to fulfill the new requirements in calculating LSP. The new legislation will have impact on both current year expenses and the liabilities in relation to LSP. At Valtech, we provide reliable and accurate LSP Valuation.

Long Service Payment Valuation Services

Past service cost should be recorded in the year of enactment of the Amendment Ordinance. Valtech’s LSP valuation model can incorporate actuarial assumptions and calculate the LSP including the anticipated effects of the Abolition. The calculation process can be adjusted no matter the Company chooses Approach 1 or Approach 2 in the guidance. Valtech can provide similar services on severance payment (SP) and gratuity payment’s valuation.

Methodology: Projected Unit Credit Method

Why are many sizeable companies appoint Valtech to conduct the LSP valuation?

Valtech Valuation has been appointed by many multinational corporations and prominent employers in Hong Kong. Currently Valtech Valuation is actively helping clients with several thousands of employees in quantifying their LSP obligation under the new legislation in a truly detailed manner. It is far more complicated than one can expect in handling a lot of different possibilities in a sizable workforce. Appointment of specialist is highly recommended. Valtech also appoints qualified actuary (fellow) for continuous improvement of our actuarial model. Our core actuarial valuation programme used in valuation has recently been certified by a qualified actuary (fellow).

In the sector of long service payment valuation, Valtech is truly professional and experienced. All of the track records we share with our clients are directly related to LSP valuation but not valuation of other nature. Valtech also provides further support in providing or reviewing figures for accounting disclosure such as sensitivity testing, discount rates etc.

Case References of Valtech’s Actuarial Model for HKAS 19 Employee Benefits Regarding Long Service Payment or Severance Payment

1. Multinational corporation’s (MNC’s) Hong Kong office in publication sector
2. MNC’s Hong Kong office in production sector
3. MNC’s Hong Kong office in telecommunication sector
4. An international law firm’s Hong Kong office
5. A company with approximately ten thousands of staff in Hong Kong
6. A famous medical group in Hong Kong
7. MNC’s Hong Kong business in clothing and baby products
8. MNC’s Hong Kong business in building product
9. The Hong Kong office of a MNC, with headquartered in USA
10. A MNC headquartered in Austria in electronics trading industry
11. A hotel group in Hong Kong
12. Non-governmental Organisations (NGOs) in Hong Kong
13. An organisation with both voluntary MPF and ORSO scheme (a complex case that requires consideration of complicated offsetting issues)
14. The list above is non-exhaustive.

Why are you encouraged to hire a valuation specialist to perform the calculation?

The calculation is not too complicated for one single employee. Following the practical example provided by HKICPA, you can calculate the result and project the impact for a single employee under simplified assumptions using a single worksheet of a spreadsheet program. However, when the number of employees increase from 1 to hundreds or even to thousands, the complexity will increase significantly. Programming technique will be required to handle massive data. On the other hand, according to HKAS 19, actuarial assumptions should be used. For example, staff turnover rate should be considered and turnover rate should be different for staff in different age groups. Combining the impact of actuarial assumptions and the large pool of employees, involvement of valuation specialist can support company in using a proper framework and perform a level review on the input data.

Can I Use Excel Spreadsheet to Calculate LSP?

The projected unit credit method is an actuarial valuation method that views each period of service as giving rise to an additional “unit” of LSP and measures each unit separately to build up the final obligation. In HKICPA’s guidance note, the example is based on a predefined year of service for a particlar employee, that would give you a complete table of each unit that sum up to the total LSP. In practice, we have a lot of employees. Also an employee may leave before they retire and he/she may be dismissed such that LSP may be paid before his/her retirement. In our opinion, unless a company has only less than 10 employees, otherwise, calculating by excel is not a feasible solution. Programme will be required to calculate for a larger workforce.

Valtech have conducted telephone interview with over 20 employers in Hong Kong including public and private companies. We understand that some companies have been using simple excel template in estimating LSP obligation. Some excel template or simple estimation method make use of “time to retirement” concept by assuming that all existing employees will not resign or be dismissed until 65 years ago, then a discount or probability adjustment is applied to consider many employees would leave before retirement. Before enactment of the new legislation, the error caused by such simple estimation will be less material given the overall exposure is much less significant with MPF offsetting machanism. Many simple excel template is not applying the projected unit credit method as suggested by the accounting standard. Some excel templates try to apply “prudence first” approach, which also cannot provide a fair or comprehensive estimate of SP and LSP.

Accounting and Financial Reporting Implications

HKICPA recently issued comprehensive guidance for the accounting for the impact arising from the abolition of the Mandatory Provident Fund (MPF)-Long Service Payment (LSP) offsetting mechanism (the “Abolition”) on entities in Hong Kong.

https://www.hkicpa.org.hk/-/media/HKICPA-Website/New-HKICPA/Standards-and-regulation/SSD/gMPFLSP.pdf

It should be noted that the Government Subsidy does not yet meet the recognition criteria of any element of the financial statements based on an assessment of relevant facts and circumstances at the time of writing of the above publication.

Common Problems Identified in Many LSP Calculation Models

Valtech has conducted review of common models, Excel worksheets, and methodologies used for recording liabilities related to the abolition of the Mandatory Provident Fund (MPF) offsetting mechanism during our provision of advice on valuation or review opinion to auditors. We have identified several areas for improvement, applicable regardless of whether an external valuer is engaged. We strongly recommend companies and auditors to evaluate the impact and risk from the issues.

A prevalent issue is the oversimplified assumption that LSP is only payable upon an employee’s retirement at age 65 (or the defined retirement age). This approach assumes a binary outcome—either LSP is paid upon retirement, or no payment is made if the employee resigns before that age. In reality, employees are entitled to LSP not only at retirement but also in cases of dismissal or death, provided they have been with the company for five years or more.

Another key concern we observed is the potential underestimation of LSP liabilities, primarily due to the practice of applying a global turnover rate or age-specific turnover rates that fail to account for “loyalty.” Typically, more experienced employees exhibit greater loyalty, leading to lower turnover rates. Inaccurate estimations can arise when a generalized turnover rate is applied to employees over the age of 50, particularly when their accumulated LSP balance is significant. This could result in an overestimation of resignation probabilities for loyal, long-serving employees, which in turn could lead to a significant underestimation of LSP liabilities.

Valtech’s Solutions

Incorporating Loyalty Factors:

We account for employee loyalty in our models, particularly for those with longer service histories. This ensures a more accurate estimate of LSP liabilities and avoids underestimations related to staff turnover.

Detailed Breakdown for Audits:

Our valuation reports include detailed individual breakdowns to facilitate a smoother, more formal audit process. This level of detail is crucial for meeting auditors’ requirements.

Tailored Solutions for Diverse Organizations:

Drawing on extensive experience with public and private companies, multinational corporations (MNCs), and non-governmental organizations (NGOs), Valtech designs actuarial programs that cater to various employee benefit schemes (including MPF, ORSO, voluntary contributions, vested portions, gratuities, and withdrawals).

Valtech Calls for Enhancing Accuracy and Compliance in LSP Valuation under HKAS 19 Employee Benefits

Experience Really Matters in LSP and SP Valuation

Many employers have volantary contribution and some even have a vesting scheme for the volantary contribution. Since volantary contribution can still be used to offset LSP or SP, such contribution should be considered carefully in the actuarial model. Some companies may have experienced volatilte turnover in the past few years, posting a challenge in LSP estimation. Experienced valuer and actuary will be able to provider a fairer estimate.

Hong Kong Accounting Standard 19 (HKAS 19) requires businesses to compute and report their defined benefit obligations (DBO) and related expenses. Thus, Hong Kong companies need to have present value assessments on DBO. The most commonly adopted method in valuation of DBO is the projected unit credit method.

The projected unit credit method is a valuation method using actuarial assumptions that considers each period of service as generating an additional unit of benefit entitlement and measures each unit separately to build up the final obligation.

Under the new legislations, significant differences could be found in the calculations of MPF offsetting arrangement. Overall, the related obligations will increase. In the calculation process, the related issues rise from pre- and post-transition have to be solved.

The Hong Kong Government will put in place two supporting measures to assist businesses to adapt to the new policy. The first measure is a 25-year refined subsidy scheme. The Government will subsidize a certain proportion of the total amount of severance payments (SP) and LSP payable by employers under this scheme, in order to lower the burden of employers brought by rising obligations.

Valtech’s valuation team includes Master of Finance, Master of Statistics and valuation experts with background in quantitative finance and financial engineering. In the context of LSP valuatoin, Valtech also works with qualified fellow actuary to improve model accuracy and prevent errors. In addition, Valtech’s valuation services are ISO 9001 certified. If companies’ auditors do not require an actuary to be responsible for the calculations, our valuation team are capable of providing opinion on DBO for financial reporting purposes. Our qualified actuary can provide advice in truly complicated project upon request.

The details of the abolition of MPF offsetting arrangement could be referred below:

Abolition of Offsetting Arrangement (to be implemented in 2025)

The Legislative Council passed the Employment and Retirement Schemes Legislation (Offsetting Arrangement) (Amendment) Bill 2022 on 9 June 2022 to abolish the use of the accrued benefits of employers’ mandatory contributions under the Mandatory Provident Fund (MPF) System to offset severance payment (SP) and long service payment (LSP) (the offsetting arrangement). The Government will implement the abolition of the offsetting arrangement in tandem with the full implementation of the eMPF Platform of the Mandatory Provident Fund Schemes Authority, which is expected to be in 2025.

Key points of the abolition of offsetting arrangement:

• After the abolition of the offsetting arrangement takes effect (the transition date), employers can no longer use the accrued benefits derived from their mandatory MPF contributions to offset employee’s SP/LSP;
• Accrued benefits derived from employers’ voluntary contributions as well as gratuities based on length of service can continue to be used to offset SP/LSP.
• To reduce the risk of large-scale dismissals before the transition date, the “grandfathering” arrangement will be put in place for the pre-transition portion of SP/LSP of employees who are already in employment before the transition date.

Key points of the “grandfathering” arrangement (only applicable to employees who are already in employment before the transition date):

• For employees already in employment before the transition date, their SP/LSP will be divided into pre-transition portion (i.e. for the employment period before the transition date) and post-transition portion (i.e. for the employment period starting from the transition date).
• The pre-transition portion will be calculated on the basis of the monthly wages immediately preceding the transition date and the years of service before the transition date, whereas the post-transition portion will be calculated on the basis of the last monthly wages before termination of employment and the years of service after the transition date.
• The maximum amount of SP/LSP (i.e. the sum of pre-transition and post-transition portions of SP/LSP) is still capped at $390,000. If an employee’s total SP/LSP exceeds $390,000, the amount in excess of the cap will be deducted from the post-transition portion.
• Employers can continue to use the accrued benefits derived from their MPF contributions (irrespective of whether the contributions are made before, on or after the transition date, and irrespective of whether the contributions are mandatory or voluntary) to offset the pre-transition portion (but not the post-transition portion) of SP/LSP.

After the abolition of the offsetting arrangement, calculation of SP/LSP payable to a monthly-rated employee is as follows:

(1) Employment period before transition date

• Employee’s last full month’s wages immediately preceding the transition date× 2/3 × years of service before transition date

(2) Employment period after transition date

• Employee’s last full month’s wages before termination of employment× 2/3 × years of service after transition date

(3) The ceiling on the monthly wages for calculating SP/LSP is $22,500 and the maximum SP/LSP amount is $390,000. These ceilings remain unchanged.

Subsidy Scheme for Abolition of MPF Offsetting Arrangement

How to determine whether a case falls within the $500,000 threshold?

The $500,000 threshold refers to whether the accumulated amount of post-transition portion of SP/LSP payable by an employer during the same year exceeds $500,000.

Employers should pay SP/LSP to employees in accordance with the Employment Ordinance and then submit applications for disbursement of Government subsidy. In short, employers should get prepared and reserve liquidity to pay for the full amount of liabilities in SP/LSP before they can claim the disbursement.

https://www.op.labour.gov.hk/en/government-scheme.html

Further reference:

Concise guide of Severance Payment and Long Service Payment from Labour Department

https://www.labour.gov.hk/eng/public/wcp/ConciseGuide/11.pdf

Comprehensive and interactive information of Severance Payment and Long Service Payment from Labour Department with Calculator

https://www.op.labour.gov.hk/en/main.html

Hong Kong Life Tables

https://www.censtatd.gov.hk/en/EIndexbySubject.html?pcode=B1120016&scode=160#section3