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Changes to discount rates will favour Norwegian pension sponsors, writes Rachel Fixsen. Yet the introduction of dynamic mortality tables will require an increase in reserves

Two regulatory changes affecting defined benefit (DB) pension schemes in Norway will have two opposing effects for employers – while one will increase the liability burden, the other will ease it.

First to hit the corporate bottom line is an accounting standards change. As of January this year, companies with DB pension schemes may calculate their pensions liabilities using the yields of covered bonds rather than those of government bonds.

The second new requirement will take effect from 2014, and takes the form of new, more stringent mortality tables, which are being introduced by the Norwegian FSA (Finanstilsynet).

The accounting standards change has been outlined by the Norwegian Accounting Standards Board (NASB) as part of the IAS19 framework. For several years, government bonds have been the basis of calculations for pensions liabilities in Norway, in the absence – according to the NASB – of a deep market in corporate bonds with long maturities.
But the board decided to reassess this, partly because of the emergence of the covered bond market, and also due to the way market conditions for government bonds has developed.

After receiving advice from market participants and academics, the NASB concluded that the market for covered bonds was, in fact, deep enough and the pricing was reliable enough for their yields to be used.

The board has not endorsed the use of covered bond yields as a discount rate for pension liabilities, but it has withdrawn its conclusion in the previous year’s guidance that this type of bond did not exist in Norway. NASB simply said that each reporting entity must decide for itself on the applicable discount rate.

However, in January, it provided a recommendation on covered bond interest rate curves. The consultancy Gabler was one of the firms proposing that yields on covered bonds should be allowed to be used as an alternative to government bonds.

The difference in yield between government bonds and covered bonds is significant – Norwegian 10-year yields averaged 2.1% over 2012; by contrast, the covered bonds discount rate is 3.9%.

Gabler estimates that corporate liabilities in Norway could fall by as much as 30% if covered bond yields are used for calculating the discount rate.

Espen Rye Ellingsen, director of Aon Norway, says the discount rate that has been used up to now – based on 10-year Norwegian government bonds – is 2.3% as set at the end of 2012.

“The effect on the liabilities will be significant, given a sensitivity in pension obligations of some 15-20% per one percentage point change in the discount rate,” he says.

The change is particularly welcome given more stringent IAS19 accounting rules from 1 January 2013 removing the corridor method, deferring actuarial gains and losses, meaning companies will have to recognise pension liabilities immediately in other comprehensive income.

According to Gabler it is not uncommon for companies in Norway to have pension liabilities equating to between 20-50% of corporate equity, or in some cases as much as the entire equity.

The change, it says, gives employers a pause for breath ahead of the new pension rules due to take effect on 1 January 2014, which are expected to ease liability burdens still further.

The change is also sensible, Rye Ellingsen comments, given the current inconsistency between salary increases and the discount rate in Norway.

But while this extra flexibility over the discount rate has served to ease the pensions burden on companies – on paper, at least – the financial regulator’s announcement on mortality tables will not help sponsors.

The FSA said it will introduce new mortality tables from 2014 to serve as the new longevity basis for collective pension insurance, life insurance companies and pension funds.
The model for the new tables is dynamic – replacing the current static model – and is partly based on proposals by financial industry federation Finans Norge (FNO). As such, the new version assumes there is an ongoing improvement in mortality during the forecasting period.

DB pension schemes in Norway – mostly run by life insurance companies – will need to increase reserves as a result of the upcoming change. “The figures we see from life insurance companies is a need for some 8% extra premium reserves for the pensions that are already vested,” Rye Ellingsen says.

The FSA has already acknowledged that the new tables will increase the requirements for provisions significantly, and that companies would therefore need an escalation period to build up the necessary provisions gradually. As plans stand, the FSA is giving companies up to five years from the beginning of 2014 to make the adjustment.

“They have been given five years to increase these reserves, but due to the Norwegian guaranteed interest rate of some 3-3.5% on average, this could be a problem,” says Rye Ellingsen. “The guaranteed interest rate has to be covered before there is any extra return to start on the 8%.”

Future annual pension premiums in defined benefit schemes will most likely increase by some 10-20%, depending on the number of members. But Rye Ellingsen points out that this will be paid by the sponsors and should not be a problem for life insurance companies.
There are already signs that some of the details of the new mortality tables and the proscribed implementation may change before they come into force in 2014.

The FNO has said the new reserve requirements are stricter than expected. The organisation is now due to discuss the calculation basis, escalation plans and implementation of the new model with the FSA.

Financial services company Storebrandalso remarked on the plans, saying that in its opinion, widows and orphans insurance did not need the extra safety margins that had been added by the FSA.

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