The German institute of public auditors (Institut der Wirtschaftsprüfer in Deutschland e.V., IDW), has sent a letter to the Federal Ministry of Justice (BMJ) asking for a reform to the law regulating the discounting of pension provisions for companies, hoping to start discussions with stakeholders.
The IDW is proposing as a legal requirement a fixed discount rate for pension provisions that reflects a long-term average market interest rate, subject to review at longer intervals by the government supported by experts, including the Bundesbank, it said in the letter.
The fixed interest rate for discounting pension provisions could, for example, be 3.3%, which corresponds to the ‘Ultimate Forward Rate’ (UFR) set for the euro area by the European Insurance and Occupational Pensions Authority (EIOPA) for 2024, IDW said.
Moreover, companies listed on the H-Dax, including DAX, MDAX and TecDAX indices, have achieved annual returns of over 3.3% in the period 2018-2022 and, according to current estimates, will achieve them again in 2023, it added.
Switching to a fixed discount rate concept means also reconsidering whether to continue to apply in the future in its current form the fair value for assets covering pension liabilities, auditors said.
Direct promises made by employers are considered in companies’ balance sheets as pension provisions, which often make up a significant portion of the balance sheet total.
According to accounting rules in the German Commercial Code (Handelsgesetzbuch – HGB), pension provisions are valued based on an interest rate derived from market data, and looking back at the past 10 fiscal years, IDW explained in the letter.
Auditors said that there is an “immense discrepancy” between calculating pension provisions on balance sheets over a 10-year period, that can bring market volatility, also with low interest rates, and a fixed rate of 6% set by the Income Tax Act (EStG).
IDW expects to start discussions with stakeholders to reform rules in the German Commercial Code, and also on a future reform of income tax discounting rules, it said.
The Institute of Pension Actuaries (IVS) has welcomed IDW’s proposal.
“The IDW involved us intensively in the development of the new concept [of the fixed interest rate]. Its proposal largely meets our considerations as to how Section 253 HGB [Commercial code] could be reformed,” IVS deputy chair Stefan Oeckingm said.