Stephen Bouvier examines how Belgium’s pension plan sponsors have struggled to adapt the International Accounting Standards (IAS) 19 accounting model
It would be an understatement to say that Belgian pensions accounting under IAS 19 is problematic. And most troublesome of all, notes Régis Renard, a Brussels-based consultant actuary with KPMG, are the accounting numbers spat out by IAS 19 for the country’s hybrid defined contribution (DC) plans.
A recent KPMG survey estimated that DC provision accounts for roughly 62% of Belgian occupational pension provision. DC plans are governed by the Law of 28 April 2003, which is either WAP in Flemish, or LPC in French. Article 24 of the WAP/LPC stipulates that an employer must guarantee an average minimum return of 3.75% on employee contributions and 3.25% on employer contributions.
This guarantee is not calculated by a single rate from the outset. In fact, during the first five years of pension scheme membership, the guarantee is the lower of inflation or 3.25%. And of 44 companies examined by Belgium’s financial markets regulator, the Financial Services and Market Authority (FSMA), in a study in January, just one company had no DC provision at all. The others all offered at least some retirement benefits featuring a minimum return guarantee.
FSMA noted that 81% of these plans were funded by contributions to an insurance company. Typically, the technical interest rate offered by insurance companies was at least equal to the statutory guaranteed minimum. This has changed recently and, in today’s low-interest-rate environment, a more realistic level of cover is 1.0 to 1.5% on new money. Additionally, some insurance companies have bridged the gap by offering with-profits arrangements that might or might not make up any shortfall.
IAS 19 adds a further layer of complexity because it recognises just two types of retirement plan – the defined benefit (DB) and the DC. By default, any plan that fails to meet the definition of a DC plan under IAS 19 is a DB plan for accounting purposes. And because Article 24 of the WAP/LPC obliges employers to ensure that plan members receive at least the amount of the contributions capitalised at the statutory guaranteed minimum rate when they leave a plan, IAS 19 classifies all Belgian DC plans as DB.
“This situation has arisen because the International Accounting Standards Board (IASB) has offered no real clarification on applying the projected unit credit (PUC) method to Belgian DC pension plans,” says Chris Desmet, a consulting actuary with Towers Watson in Brussels. “Obviously, with a single standard in force, you would expect it to be easier to compare entities, but it isn’t.
“The second problem we have is the uncertainty over how the investment return guarantee will develop over time. There have been discussions between government, trades unions and social partners over a reassessment of the guarantee provision. We expect there to be an outcome on this during the summer.
“But, for the time being, these are ongoing and the outcome is unclear. This matters because it could be the case that the WAP/LPC will evolve in such a way that there is, in fact, no liability for the employer at all. But we don’t know that at this stage, which makes it difficult to come up with a solution to this problem.”
In addition, these plans cannot qualify as insured benefits under paragraph 19.46 of IAS 19 because the sponsor is potentially on the hook if an insurer fails to meet its obligations. And in the absence of a specific accounting treatment in IAS 19 for hybrid Belgian DC schemes, preparers have looked to the requirements of IAS 8.10 and developed an appropriate accounting policy.
“Some people think of service cost and the insurance premiums as being one and the same. That is one interpretation, but there is no single interpretation or position on any of this. That makes things difficult for people to compare plans and their impact on the balance sheet from one company to another”
Against this, the FSMA study found that almost all of the companies it examined recognise the annual contributions paid for retirement contracts in profit and loss. However, they book no additional liability. To justify this accounting treatment, “companies indicated that no (material) liability for these plans existed at financial reporting date”, the FSMA noted.
Nonetheless, the funding gap for plans supported by contributions to insurers means that this position could change as insurance companies reduce their technical interest rates. Renard says it is possible to have any number of interpretations of the requirements in IAS 19 for Belgian plans.
“Some people think of service cost and the insurance premiums as being one and the same. That is one interpretation, but there is no single interpretation or position on any of this. That makes things difficult for people to compare plans and their impact on the balance sheet from one company to another.”
Belgian plan sponsors have alighted on two methods for calculating their pension liability – an IAS 19-based methodology approach and an intrinsic-value approach. Under the first approach, adopted by 15% of companies, a sponsor treats the liability for a DB plan as the difference between the present value of the DB obligation and the fair value of plan assets. Strict application of the project unity credit method implies the projection of contributions based on the greater of the guaranteed minimum rates of return and a best estimate of the expected rate of investment return.
In addition, an entity must assess whether or not a plan is back-end loaded. If so, it must attribute any higher future benefits to the current and prior periods on a straight-line basis. Finally, the sponsor must assess the fair value of any qualifying insurance policy, before applying the asset ceiling guidance in International Financial Reporting Standards Interpretations Committee (IFRIC) 14.
There is agreement that this valuation is troublesome. Equally problematic is the practice of projecting contributions on the greater of the guaranteed minimum rates of return and a best estimate of the expected rate of return before discounting back to the AA bond rate. Paradoxically, an increase in contributions produces a higher liability under this approach. FSMA also points out that an increase in bond yields means that any projection of a guaranteed minimum return can result in a profit and loss expense that is below the contributions paid.
Unsurprisingly, 85% apply an intrinsic-value approach. This consists of calculating the balance sheet liability as the sum of any difference between the mathematical reserve for an entity’s pension provision and the minimum guarantee as determined by article 24 of the WAP/LPC.
“It means,” says Muriel Lejour, a pensions accounting specialist with KPMG in Brussels, “that they just take as the defined benefit obligation (DBO) any vested rights, together with the guaranteed interest component, and net that against plan assets in order to arrive at a net liability. This approach takes no account of future salary increases and is more like an accumulated benefit obligation versus DBO approach.”
Given the inability of the IASB to develop an appropriate measurement approach for Belgian DC plans, the FSMA concluded that entities should disclose: the nature of their provision; the risks they face; measurement assumptions; a measure of the pension liability; and information about the timing and uncertainty of future cash flow. In other words, tell the world what you have done and why.