## Attrition rate calculation

### Quick snippet

We can take the average of the annual attrition rate over past few years to predict the likely future attrition rate. Annual attrition rate calculation formula:

Attrition rate = Resignations during the year (excluding new joiners) / Employees at start of the year

In the following post, we discuss the significance, formula, approach, assumptions, and potential pitfalls to avoid in attrition rate calculation for IndAS19 and AS15 actuarial valuation reports.

It is important to keep in mind that we are trying to estimate the future long-term attrition rate. As such, we recommend keeping this assumption consistent year-on-year.

### Importance

Attrition rate or Employee turnover rate is an important assumption in actuarial valuation of employee benefit schemes. It generally has a significant impact on actuarial valuation of Gratuity and Leave Encashment schemes’ liability required for AS15 and IndAS19 reporting.

In India, whenever an employee resigns, and if the employee has served for 4.5 years or more the employer is liable to pay Gratuity. Also, if the employer has “Leave Encashment” (LE) scheme, the employer might need to pay for the accumulated leave balance of the exiting employee as per the LE scheme rules.

Thus, in essence, a cash outflow is triggered whenever an employee resigns. Attrition rate assumption helps us in ascertaining the probability of this event, so that the company may hold appropriate liability to meet the required cash outflow. Given the above, you may have already guessed its importance and why we need to calculate attrition rate correctly:

Attrition rate has a direct impact on triggering the cash outflow event in the model, which in turn impacts the liability.

### Formula + Methodology

There are various approaches one may follow while calculating attrition rate assumption for actuarial valuation. The most common one, owing to ease of its calculation is based on the historical averages and discussed below.

#### Step 1:Historical Annual Attrition

Ideally, we would like to use the following formula for each of the historical years:
Annual attrition rate = Resignations during the year (excluding new joiners) / Employees at start of the year.

However, in certain cases, we might want to allow for resignations of the new joiners during the year. Though this is not ideal since we are not allowing for any new joiners in future cashflow prediction in our model, employers might want to use this option to be consistent with their internal reporting practices or for any other reason. For instance, if the proportion of new joiners is significant and/or a major hiring drive was conducted towards the end of the year, etc.
(In formula below, we divide new joiners count by 2 to allow for the assumption that new joiners are hired evenly throughout the year. Employers may choose to alter this assumption)
Annual attrition rate = (Resignations during the year) / (Employees at start of the year + New joiners during the year/2).

#### Step 2:Average

• Once we have calculated the “annual attrition rate” for a few historical years (say 7-8 years) using the above formula,
• the next step is to exclude any outliers, i.e., too low or too high than the usual experience,
• And then take an average of the remaining historical annual attrition rate.
• If in high-growth phase, you may choose to take a weighted average instead of simple average, where the weights can be number of employees.

Adjust the average calculated in Step 2 for the following:

• Trends: for instance, a consistently increasing attrition rate
• Future expected events: for instance, a recruitment drive for a new department
• Business strategy: for instance, higher planned salary increments expected to result in lower attrition

1. We are calculating attrition rate for the future, not the past. This is very important point and mandated by the regulations and accounting standards.
2. Given the above, we should strive to keep the assumption consistent with future business plans and events, including recruitments, redundancies, budgeting, etc.
3. The historical attrition rate calculation shown above is only a guide to setting the assumption. We must adjust it to reflect the events expected to happen in future.
4. Attrition rate calculation needs to be ‘forward-looking’ ‘time-average’ over a long-term, generally agreed to be the term equal to the duration of liability (DMT).
5. As already mentioned above, we should strive to keep the assumption consistent year-on-year, unless company’s view of future attrition rate has changed significantly.
6. The historical attrition experience may be volatile, and using that as the sole basis for calculation may create unnecessary volatility in the actuarial results.

### Employee Category

#### That’s great! But attrition varies among different employee groups in my company. How can I allow for it?

In that case, you can calculate the attrition rate separately for each of the categories (i.e., in this case “new joiners”, say “NJ” or simply “N”, and “existing employees”, say “EE” or simply “O”). Our app allows you the flexibility to input a different assumption for each category of employee. You then just need to define the category of each employee, so that the software can apply the appropriate attrition assumption for each employee. You can watch our YouTube tutorial video on “multiple categories of attrition rate” to learn this in detail.

Also, please note that you can define the categories as per your company’s requirements, for instance, some may want to categorize based on blue vs white collar, while others may want to categorize senior management vs others and so on.

Not just that, you can also categorize salary escalation rate assumption. To read more on calculation of salary escalation rate, please click here.