In 2014, staff at the International Financial Reporting Standards Interpretations Committee (IFRS IC) – the body responsible for developing guidance on the application of IFRSs – recommended the approval of an amendment to its asset-ceiling guidance.
• Accounting for pension promises depends on appreciating assets
• Current policy offers a favourable treatment of buy-ins
• Potential to limit power of UK DB scheme trustees
If you have not guessed already, this is the snappily titled IFRIC 14, IAS 19 and The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction.
The recommendation followed a request for the IFRS IC to clarify whether the right of defined benefit (DB) pension plan trustees to increase member benefits, or wind up a plan, can affect an employer’s unconditional right to a contributions refund. The move immediately set alarm bells ringing among consultants advising UK DB scheme sponsors, not least because it raised a question over whether sponsors should factor in possible future actions by trustees into their decision to recognise an asset on the sponsor’s balance sheet.
Pensions accounting experts commented that the decision to review the guidance could directly impact UK sponsors. They observed along the way that IFRIC 14 puts a lot of emphasis on whether a sponsor can recognise an asset at the expense of considering how much that asset should be. For all its complexity IFRIC 14 is not particularly nuanced. Indeed, practice had emerged where some auditors took the view that sponsors could recognise an asset where there was only a theoretical possibility of accessing a surplus – perhaps by waiting for the last scheme member to expire.
Having explored the matter during IFRS IC meetings in March, May, July and September 2014, the International Accounting Standards Board (IASB) issued an exposure draft (ED) in June 2015 to amend IFRIC 14 and IAS 19. The reaction to the proposals in the 75 comment letters the committee received was mixed. Meanwhile, consultants warned that scheme sponsors should check the wording of their scheme rules to see whether the amendments would affect them.
Despite those concerns, the IASB voted in December 2016 to support the proposed amendments. Consultants Lane Clark Peacock noted that a possible change to the proposal’s wording could mean more schemes were affected than previously thought.
What does IFRIC 14 do?
You might expect sponsor contributions to a defined benefit (DB) pension scheme to become straightforward plan assets. However, paragraph 64 of IAS 19 limits the net DB asset a sponsor can recognise in its accounts to the lower of the plan surplus or the asset ceiling.
The standard goes on to define the asset ceiling as “the present value of any economic benefits available in the form of refunds from the plan or reductions in future contributions to the plan”, while paragraphs 11 and 12 of IFRIC 14 clarify that a refund is available if the sponsor has “an unconditional right” to a refund.
They need not have worried. By the September 2017 IASB meeting, the board’s own staff were pressing the case for “further work to assess whether it can establish a more principles-based approach”. The challenge was that long-standing complaint that IFRIC 14 lacks principle.
As if the issue were not complicated enough, the IASB launched a project to research the feasibility of developing an accounting approach to deal with pension promises that depend on an asset return. This led the board in September 2018 to halt its work on IFRIC 14 until it had a clearer sense of how it wanted to progress its work on the hybrid pension promises conundrum.
There was to be one final twist in the tale. At this February’s board meeting, while IASB members agreed to pause work on the project, they voted by the narrowest of margins to persevere with the effort in a final bid to find what the board’s vice-chair Sue Lloyd summed up as “a more principles-based approach to address the issue”.
So what do the experts have to say? “We actually have very little detail about the principles-based approach the IASB staff is considering,” says Kirsten Miller, a consultant actuary with Aon. “The staff indicated in the February IASB agenda paper that the approach would require a considerable amount of time and effort if it is to be developed further. At this stage it has not been explored at all with external stakeholders and so we have no indication of how it is likely to be received.
“The main issue is that this new approach, as far as we can tell from the limited details available, does not seem to address some of the problems with the approach in the ED. The main concern with the approach suggested in the ED, which will not be pursued further, is that it draws an artificial line between the powers of the trustees to affect the benefits. That is the liability value, and their power to affect the asset value by making investment decisions and suggests these are treated differently. That does not seem to go away with the principles-based approach their staff are suggesting.
“At Aon, we wrote in our comment letter on the ED that it is definitely appropriate to consider those trustee powers, but that consideration should then also be given to how likely it is for the third party to act instead of just assuming they will.”
There is still the question of the impact of the uncertainty on sponsor attitudes toward risk-transfer transactions. “On the wider point of buy-in and buyout activity,” says Matt Davis, a partner and consultant actuary at Hymans Robertson, “the IAS 19 treatment of these events can be a significant consideration for companies and we have seen companies paying quite a lot of attention to this as part of their decision-making process.
“The issue does, however, go beyond IFRIC 14, but it is undesirable for IAS 19 to act as a barrier to a deal that otherwise makes sense both from a company point of view and from the perspective of the scheme members.”
The problem, he explains, is that a buy-in, which covers most – but not all – of a scheme’s benefits can receive a different accounting treatment to a buyout, which does cover them all. “Auditors seem to be scrutinising these transactions in more detail,” he adds, “and there is a lack of clarity at what point a buy-in looks so close to a buyout that auditors expect the transaction to be treated as a buyout. This accounting uncertainty can be a concern for companies.”
Ultimately, it is hard not to return to the one question that refuses to go away: should the IASB just give up? “Given that the IFRIC 14 review has taken six years so far,” says Davis, “it would be an idea to check whether it is worth pursuing the project given the amount of time that it still might take to resolve this.
“From a UK perspective, there may be greater overall benefit from looking at IAS 19 more widely rather than focusing too narrowly on IFRIC 14. In particular, the Pensions Regulator’s plans for scheme funding are expected to lead to stronger funding targets for UK pension schemes and a greater gap between IAS 19 and the position that drives actual cash contributions.”
We can probably take that as a yes.