Few accounting issues have generated such heat in Europe as the application of international accounting standards to companies with defined benefit (DB) occupational pension schemes. In 2000 the former Swissair’ group’s inclusion of a pension fund surplus in its balance sheet, in line with international accounting rules, sparked off a row about whether Swiss second pillar pension plans were actually DB or defined contribution (DC) schemes. Now the Netherlands is witnessing a similar controversy.
The controversy centres on IAS 19, the international accounting standard relating to a company’s employee benefits, to Dutch companies. From 1 January next year listed companies with pension schemes will be required to apply this standard. The aim is to ensure that any pension commitments are recorded in annual accounts. This means that any deficit or surplus will have an impact on the balance sheet.
Companies with defined benefit plans will be required to apply defined benefit accounting standards. Potentially, this requirement will have far-reaching consequences in the Netherlands, where 79% of single company pension plans are DB. Currently a number of companies, including Vendex KBB, Akzo Nobel and Philips, are re-designing their DB plans to remove them from the scope of defined benefit accounting.
However, the debate is fiercest about the status of companies within the 92 Dutch industry-wide pension plans. Under IAS rules for multi-employer plans , these will be expected to account for their DB plans in exactly the same way as single-company schemes.
Paragraph 29 of IAS 19 states that “where a multi-employer plan is a defined benefit plan, an entity for example a_company should account for its proportionate share of the defined benefit obligation, plan assets and cost associated with the plan in the same way as for any other defined benefit plan”.
The Netherlands Council for Annual Reporting (Raad voor de Jaarverslaggeving or RJ) and the Dutch Association of Industry-wide Pension funds (Vereniging van Bedrijfstakpensioenfondsen or VB) have both described this requirement as costly and impractical.
The dispute hinges on the distinctive characteristics of industry-wide pension schemes in the Netherlands. The RJ points out in a recent clarification document that industry-wide pension schemes are usually DC plans. “Employers affiliated to industry-wide funds are, after all, generally under no obligation to pay supplementary contributions, other than prospective higher contributions, if a fund shortfall should arise.”
It also points out that affiliated employers also have no legitimate claim to any surpluses in a pension fund. “Thus employers have no obligation other than to book premium contributions as expenditure in the profit and loss account.”
The RJ says that even when an industry-wide scheme is a DB plan it is difficult to apply defined benefit accounting standards: “It can be well nigh impossible to calculate the employer’s percentage share, for one thing because of the potentially large number of employers affiliated to an industry-wide fund.”
The Dutch system of accounting for employee benefits in unlisted companies makes allowances for this. The RJ issued its RJ 271 directive in July last year. This was based on IAS 19 but contained some key differences. One was the option to treat a company pension scheme as a DC scheme if it could be shown that the employer’s risk was limited to the payment of contributions.
This created a difference in the accounting treatment of listed and unlisted companies which was not immediately recognised. Els van Splunter, technical secretary at the RJ says: “A lot of people in the Netherlands got the incorrect impression that RJ 271 was the same as IAS 19, but there are important differences. The most important difference relates to the treatment of plans as defined contribution plans.”
The RJ has recently issued a ‘clarification’ of this difference. It states that “if in a company pension plan the legal entity of the pension fund bears the actuarial risk and this risk is to be met by future contributions, RJ 271 offers the possibility of treating such a scheme as a DC scheme. IAS 19 does not recognise this possibility”.
The different treatment of industry-wide pension funds by the RJ and IAS reflects the different view the Dutch take of their pension plans. Joos Nijtmans, senior staff member at the VB says: “IAS 19 says it is a black and white issue. Either you are a DC scheme with no risks for the employer or you are a DB scheme and the full risks rest on the employer. RJ 271 says in the Netherlands it is not so black and white. We are not fully a DC scheme but also not fully a DB scheme in the IAS 19 sense. We are a mixture because we share the risks between the employer, the employees and the retired.”
IAS 19 does provide hybrid DB pension funds with one route to DC accounting, however. Paragraph 30 of IAS19 states that “when sufficient information is not available to use defined benefit accounting for a multi-employer plan that is a defined benefit plan, an entity for example, a_company should account for the plan as if it were a defined contribution plan”.
Yet the IAS is strongly of the view that industry-wide pension plans must make every effort to apply defined benefit accounting where possible. The International Financial Reporting Interpretations Committee (IFRIC) of the IASB spelled this out in its recent draft interpretation on multi-employer plans. IFRIC points out that information that ‘is not available’ means ‘cannot be obtained’ and say that companies should make every practicable effort to apply defined benefit accounting to the multi-employer plans in which they participate.
To apply DB accounting, IFRIC says a company should first measure the pension plan’s liabilities on the basis of assumptions about salary expectations, staff turnover and life expectancy. These assumptions must apply to the multi-employer plan as a whole and not just to themselves.
Once companies have measured the plan’s liabilities they must find out whether they can allocate the plan across the participants. The purpose of allocation is to enable companies to find out how any surplus or deficit in the plan will affect contributions.
The central point is that a company in a multi-employer pension scheme should be able to identify its share of the underlying financial position and performance of the pension plan for accounting purposes. If it cannot, then it is exempt from defined benefit accounting.
The key to whether it can identify its share is information. Information – or the lack of it – is at the heart of the Dutch debate. The Labour Foundation (Stichting van de Arbeid), the representative body of the central employers and employees organisations in the Netherlands, supported by VB, has argued strongly that multi-employer schemes cannot provide the information IAS 19 requires.
In a written response to IFRIC’s draft interpretation, the foundation says: “The information required is not available as such the assumptions with regard to expected future developments for the entire sector are particularly speculataive. There is no relation between the future of an etrepries company and the future of the entire sector. The information available will have to be worked up into information based on IAS 19 , and this information must then be allocated to what are sometimes many different entities.”
Even if it were possible to supply information, it would not serve its purpose, which is to identify the employers’ risks: “The data provide no consistent and reliable information on the risks for the employer. The information is highly subjective and of little value. No information that can objectify the employers’ risks can be generated on the basis of the financial position of a fund.”
The foundation says there are three reasons why IAS 19 data provide no information on employer’s risks. The first is the fluidity of industry-wide pension funds, with entities constantly joining or leaving. “Neither newly formed or existing entities joining a plan , nor entities that are leaving or have been wound-up are able to make a claim on the current financial position of the fund.”
The second reason is that salary and staff turnover expectations of individual participants of a sectoral fund will be different from the sector as a whole. The third, and perhaps the most important is that actuarial risk does not rest with the employer in industry-wide schemes.
The RJ has taken a similarly tough stance. In its response to IFRIC it says that the application of DB accounting to multi-employer plans is “ theoretically correct”. However, it has strong doubts about its practicality and says that it will have “little value in practice.”
It says that the information necessary to apply DB accounting will rarely be available for multi-employer plans. It also notes that participants in Dutch plans have little power to demand this information. “Participation in an industry-wide pension plan in the Netherlands is often mandatory in 70% of_plans and therefore participating entities are often not at liberty to withdraw from a plan and invest in another. The leverage to obtain information for monitoring purposes is therefore restricted.”
The RJ concludes that “the cost of obtaining the information required by IAS 19 will exceed the benefits related to it”.
The logical solution to the problem, it suggests , is to give an unqualified exemption the Netherlands’ industry-wide pension plans. it points out. This suggestion has the support of some of the members of IFRIC, who would like to absolutely exempt multi-employers from DB accounting. However, they would except any ‘dominant’ participants in such plans, which are supposed to be able to easily obtain the information needed to apply DB accounting.
Exemption would enable Dutch industry-wide pension plans to move to DC accounting, where they clearly feel they belong. The Labour foundation points out in its response to IFRIC that “DC accounting for the individual employer in multi-employer plans does more justice to the share in the obligations, assets and costs in practice than DB accounting does”.
The RJ also believes the DC route is the right one: “We believe that the application of DC accounting with adequate disclosures of the possible deficits or surpluses and their implications for the entities more objective by nature and is preferable to the application of defined benefit accounting.”
A move to DC accounting would be consistent with both US GAAP and Dutch GAAP, the RJ points out. It would also be consistent with the required convergence between US GAAP and International Financial Reporting Standards (IFRS), which has replaced IAS.
Paradoxically, IFRIC has proposed that state pension plans should be required to be accounted for as DC plans, but has narrowed the definition of state plans to exclude multi-employer plans. While both the RJ and Labour Foundation support the qualification of state plans as DC plans, they oppose the narrowing of the definition.
The Labour Foundation argues that IFRIC is making a false distinction between plans set up by governments and plans set up by the social partners. “It makes no difference whether a government uses legislation to form an autonomous organisation to meet pension obligations, or whether other parties such as the social partners do this.”
It points out that in the Netherlands industry-wide funds formed by the social partners are usually made mandatory with an order declaring a collective agreement to be binding issued by the Minister of Social Affairs and Employment.
“Branch pension funds function on the basis of solidarity,” it says. “Employees are offered the same pension rights and the same conditions, irrespective of gender, age or state of health. A solidarity-based system such as this can only function well if participation is mandatory.”
The foundation concludes that the Netherland’s industry-wide pension funds meet all the criteria of the current definition of a state plan, and by implication, should qualify as DC plans.
The solidarity basis of Dutch pension plans is central to the debate about international accounting standards. As the VB points out, many industry-wide plans simply do not fit the model of DB or DC plans envisaged by the IFRS. If they are forced to fit, one of the effects could be a significant move towards DC plans in a country that has traditionally carried the flag for DB.