IFRS confirms position on fair-value accounting for longevity swaps
The International Financial Reporting Standards (IFRS) Interpretations Committee has confirmed it will not add a project to its agenda to address how defined benefit (DB) pension plan sponsors account for longevity swaps.
The decision came during a review of the issue as part of the committee’s 24 March meeting round.
At an earlier meeting in November, the IFRS IC tentatively ruled that DB plan sponsors must account for longevity swaps as single-instrument plan assets held at fair value but declined to add the topic to its agenda.
Committee members also declined to include a clarification in their final published decision to address the application of paragraph 115 of International Accounting Standard 19, Employee Benefits (IAS 19) to so-called qualifying insurance policies.
IFRS IC committee member Tony Debell said that, although he was “comfortable with finalising the agenda decision”, he nonetheless had concerns about “the additional language that has been added to the agenda decision”.
A longevity swap transfers the risk of pension scheme members living longer than expected from pension schemes to an external party such as an insurer or a bank.
The effect of a swap transaction is to freeze or settle the DB plan sponsor’s obligations to the scheme members and reduce income statement volatility.
Longevity risk is one of the biggest risks faced by DB pension schemes and can lead to schemes paying out higher pension payments than expected and, as such, push a fund into deficit.
During it’s November meeting, the IFRS IC explored to possible accounting approaches.
Under the first approach, a scheme sponsor would book the swap as a plan asset and measure it at fair value.
But under the second approach, a DB sponsor would treat the swap as a so-called qualifying insurance policy and book the premiums as a liability.
The committee published details of its tentative decision 11 November meeting outcome in its official journal, IFRIC Update.
Also during the 27 March meeting, the committee rejected a staff proposal to augment its agenda rejection notice by adding a reference to the application of paragraph 115 of IAS 19 to qualifying insurance policies.
This enhanced wording stated that paragraph 115 of IAS 19 applies to “qualifying insurance policies that exactly match the amount and timing of some or all of the benefits payable under the plan”.
Qualifying insurance policies are defined in paragraph 8 of IAS 19.
Audit giant Deloitte appears to have sparked the staff decision to enhance the wording of the rejection notice.
In a 20 January comment letter, Deloitte argued: “[W]e recommend that the tentative agenda decision also state that the requirements of paragraph 115 of IAS 19 only apply to a plan asset that meets the definition of a qualifying insurance policy.”
Deloitte went on to warn that the issue of longevity swaps is likely to emerge as a more prominent issue in practice in future.
Speaking in November, IFRS IC member Reinhard Dotzlaw noted that longevity swaps are “not uncommon in certain other jurisdictions like the UK”.
For example, in February 2013, the trustees of the BAE Systems plc 2000 Plan entered into an arrangement with Legal & General to insure against longevity risk for the current pensioner population.
The deal covered £2.7bn (€3.7bn) of pension scheme liabilities.
And in December 2013, the trustees of the Royal Ordnance Pension Scheme and Shipbuilding Industries Pension Scheme entered into similar arrangements with Legal & General to cover £0.9bn and £0.8bn of pension scheme liabilities, respectively.
Longevity swaps are usually accounted for as plan assets under IAS 19.
Prior to 31 December 2013, practitioners typically applied the IAS 19 discount rate and mortality basis to discount the net cashflows under a swap.
This approach, combined with insurers’ pricing practices, tended to mean – particularly early on in the contract – that DB sponsors had to book the swap as a negative plan asset.
However, since the introduction of IFRS 13, Fair-value Measurement, sponsors have been able to book longevity swaps at a value equal to or near to their transaction value.
This new approach means sponsors need no-longer recognise a negative plan asset, removing a barrier to longevity swap transactions.
The predominant accounting approach at the moment around longevity swap contracts has focused on the fair-value method.